Global Concentrated Strategy

June 2019

THE MARKET ENVIRONMENT
Major global markets finished mixed in the second quarter. The reporting period began steadily enough, but fears regarding new tariffs and trade wars caused market volatility mid-quarter before markets rallied in June. Trade talks between the U.S. and China faltered once again and rattled markets in May, despite some forward progress in April. However, following meetings at the G-20 Summit in late June, markets cheered the progression made by U.S. President Donald Trump and Chinese President Xi Jinping, both of whom agreed to reopen trade negotiations and cease additional tariff increases in the hopes of eventually reaching a trade deal. Similarly, after announcing a planned 5% tariff on goods imported from Mexico in May with the goal of deterring illegal immigration from Mexico into the U.S., Mexico’s efforts to mitigate this issue were enough to prompt Trump to suspend his plans to implement new tariffs on the country. Irrespective of the noise, indexes in the U.S. touched record highs during the period. 
 
Meanwhile, crude oil prices also experienced instability in the second quarter as markets weighed the implications of data and global happenings on supply and demand. In April, the U.S. announced it was ending sanction waivers on Iranian-produced crude oil, sending prices higher. However, continued uncertainty regarding trade tensions sparked demand concerns in May. Ultimately, growing tensions between the U.S. and Iran and subsequent supply uncertainties spurred a boost to crude oil prices late in the second quarter.  
 
In the U.K., Prime Minister Theresa May announced her resignation, effective June 7, as she was unable to build consensus on a Brexit deal to lead her country out of the European Union (EU). As of the end of the second quarter, May’s replacement had yet to be named. As things stand, the country will leave the EU on October 31 with or without a deal (unless a withdrawal agreement is settled upon prior to that date), leaving room for many possible outcomes and causing continued unease for investors.  
                                                                                                                                                                      
We believe that although a company’s share price may be performing poorly, it is not always indicative that a business is performing poorly. We seek to identify companies with hidden value that feature high-quality business fundamentals and management teams that act in the best interests of shareholders. Often these opportunities unearth themselves during ambiguous times like these when we can take advantage of short-term hindrances to unlock underlying value in underappreciated companies. 

THE PORTFOLIO
Top Performers:
American International Group (AIG) delivered strong first-quarter earnings results, which worked to boost its share price for the quarter. Total adjusted after-tax income reached $1.4 billion, which reflected an increase of 44% from the prior-year period and adjusted after-tax income per share ($1.58) handily beat consensus expectations ($1.06). Notably, the insurance unit posted an underwriting profit with improved results due to better risk selection and cost actions with expectations for further improvement moving forward. CEO Brian Duperreault also maintained his commitment to earning at least a 10% return on equity on adjusted book value within three years. Although the company did not repurchase any shares in the first quarter, AIG bought back $1.8 billion for full-year 2018 and the board of directors authorized an additional $2.0 billion for repurchases going forward. 

Hilton Worldwide’s share price began to climb early in the quarter as market analysts anticipated the company’s first-quarter results (scheduled for release in early May) would be solid, and investors were not disappointed with the official report. The company’s first-quarter adjusted earnings growth of 12% propelled adjusted earnings to $499 million to beat both management’s guidance and analysts’ estimates. First-quarter earnings per share ($0.80) also exceeded the market outlook ($0.75) while comparable revenue per available room (RevPAR) grew 1.8% (constant currency), which aligned with management’s forecast. Management slightly increased full-year guidance for adjusted earnings and earnings per share while reiterating its plan to achieve 1-3% (constant currency) RevPAR growth and 6.5% net unit growth. In addition, Hilton returned $340 million of capital to shareholders during the quarter and expects a total capital return for the full year in the range of $1.3-1.8 billion. 

Charter Communications’ first-quarter results included total revenue growth of 5.1% and total adjusted earnings growth of 4.2% (driven by cable segment earnings of +7%) from a year earlier. The strong earnings advance was driven by accelerating broadband subscriber net additions and margin expansion of 112 basis points, while capital expenses also declined 27% year-over-year. Management’s commentary called for fast-paced growth throughout 2019 and continued margin expansion stemming from decreasing non-programming costs, despite an increasing subscriber base. Cable companies in the U.S. are benefiting from strong demand for high-speed internet access, and in many markets, Charter currently has the only fiber-rich network capable of providing internet speeds that align with that demand. We believe the company is favorably positioned to grow its business and expand its market presence as new market entrants would need to invest considerable capital to compete.

Bottom Performers:
Glencore’s share price fell early in the quarter when the company received notification that the U.S. Commodity Futures Trading Commission (CFTC) is conducting an investigation to determine if its subsidiaries violated certain Commodity Exchange Act provisions or CFTC regulations. Glencore is one of many trading organizations currently under scrutiny by various regulatory bodies. Although we find the news of a new investigation disappointing, we are confident that the company will work through the matters at issue and continue to focus on its core business. Glencore subsequently released its first-quarter production report with output of copper, zinc, nickel and coal that fell short of our estimates. In addition, management decreased copper and nickel production guidance for the full year. As we have mentioned previously, production levels may vary in the near term. Nevertheless, we believe the company should meet our key estimates over the long term. Late in the quarter, several artisanal miners died in an accident at the company’s Kamoto Copper (KCC) site in the Democratic Republic of Congo. However, these artisanal miners were working without Glencore’s knowledge in an unsafe and unmanaged area of the KCC site that was not in operation and had been accessed illegally. While these deaths are certainly a tragedy, Glencore stated that production at the KCC site has not been impacted. We are watching the situation closely, but at this time we do not believe the issue impairs our intrinsic value estimate. 

Alphabet’s share price fell mainly in the middle of the quarter upon releasing first-quarter earnings. Results were sound, by our measure, given that total revenue grew 19% (constant currency) to $36.3 billion. While revenue growth decelerated somewhat compared to increases from prior first-quarter periods (e.g., +20%-23% growth in the first quarters of 2016 through 2018), we do not view the lower growth as being outside of the typical range. Furthermore, Google segment revenues advanced nearly 17% from last year (excluding effects from the $1.7 billion European Union fine) and Google paid clicks rose 39%. On a conference call subsequent to the quarterly release, CFO Ruth Porat expressed that some revenue variability is normal due to adjustments from “product innovations and enhancements” as well as comparisons with “strong 2018 results.” Overall, we believe investors overreacted to signs of slowing growth as Alphabet continues to meet our long-term expectations. Later, the company’s share price sank on news that the U.S. Department of Justice would conduct an antitrust investigation on Google. While we continue to monitor the situation, we believe the valuation for Alphabet remains attractive, offering a compelling reason to own. 

Lloyds Banking Group issued first-quarter results that included profit before tax of GBP 1.60 billion, which underperformed market expectations by nearly 15%. However, total revenue was largely in line with projections and underlying profit before tax exceeded forecasts by roughly 6%. From our perspective, the company’s operating performance was solid, as total revenue rose 2%, underlying operating profit increased 8% and total costs dropped 4% from the prior-year period. Importantly, Lloyds generated an underlying return on tangible equity of 17.0% for the quarter, which reflects an increase of 160 basis points from a year earlier and was precisely aligned with our long-term estimates. Furthermore, in keeping with management’s plan for additional cost reductions, full-year guidance calls for a decline in operating costs of roughly 2% (to less than GBP 8 billion) in 2019. Management also expects the cost-to-income ratio to fall to the low 40% level (from the current level of 44.7%) by the conclusion of 2020.

During the quarter, we initiated positions in Constellation Brands and Regeneron Pharmaceuticals. We eliminated General Electric along with the shares of Wabtec we received last quarter from a GE spinoff.

Past performance is no guarantee of future results.

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