Global Concentrated Strategy

March 2019

THE MARKET ENVIRONMENT
Major global markets moved higher in the first quarter, despite contending with a barrage of geopolitical pressures. Following the second rejection of her Brexit deal, Prime Minister Theresa May secured a two-week extension on the U.K.’s departure from the European Union (EU) with the exit date now set at April 12. The EU also offered a later exit date of May 22 should the prime minister ultimately receive approval from British Parliament on her version of Brexit before the end of March. In the meantime, members of parliament brought eight alternative plans to the floor, none of which achieved a majority. A subsequent third vote on May’s deal late in March also failed to pass, leaving Brexit very much in limbo.
 
Meanwhile, trade disputes proved challenging for the Chinese economy as February exports dropped over 20% from the year-ago period. The country’s industrial output growth also experienced its slowest pace of expansion in more than 15 years. In the U.S., even though manufacturing sector job growth at the end of 2018 was the highest it had been in the last 30 years, factory production during the first quarter reached the lowest level since 2017. Contrary to market analysts’ forecasts of gains, manufacturing output fell in January and February due to pressures of trade disputes and slower global growth. Monthly building permits also fell in excess of market projections. In Europe, the IHS Markit’s Purchasing Managers’ Index’s (PMI) March reading decreased to 51.3 from 51.9 the month prior, while the Flash Eurozone Manufacturing PMI sank to a near six-year low.
 
The European Central Bank announced increased stimulus, a decreased economic growth forecast for 2019 and a hiatus on interest rate increases until 2020. The Federal Reserve left key interest rates in the U.S. unchanged and noted it does not foresee raising rates in 2019, stating intent to employ patience and consider market concerns before taking action. Despite this, the reigniting of trade negotiations between the U.S. and China in the final days of March provided a late boost for global markets.
 
That being said, we use these periods of uncertainty in the market as opportunities to invest in temporarily undervalued companies by looking beyond readily available statistics to uncover hidden value. Our differentiated perspective comes from our unusually long time horizon, an unwavering focus on identifying quality businesses and a deep level of engagement with management teams.

THE PORTFOLIO
Top Performers:
Lloyds Banking Group’s underlying fiscal-year 2018 results were largely in line with our expectations as lower credit costs offset slightly higher operating expenditures. That being said, the market appreciated the company’s announcement of a new share repurchase program for 2019 worth up to GBP 1.75 billion, up from GBP 1 billion in 2018 and higher than our expectations. Lloyds also guided for 14-15% return on tangible equity and further operating expenditure reductions in 2019. In addition, the company announced plans to switch its computer systems to a new platform, pending regulatory approval. Management expects the change will result in technology cost savings amounting to hundreds of millions of pounds annually. We continue to view Lloyds as a best-in-class financial institution.

CNH Industrial delivered strong fourth-quarter earnings results as revenue ($8.20 billion vs. $8.09 billion) and earnings per share ($0.21 vs. $0.14) surpassed market estimates. Fiscal-year 2018 organic growth exceeded expectations, driven by the agriculture equipment segment where global deliveries of tractors and combines increased 8% and production increased 10%, reversing some of the underproduction in 2017. Construction equipment also boosted full-year performance as organic growth increased 20% and margins improved by 340 basis points year-over-year to 3%, benefiting from operating leverage, positive price realization and business mix improvement. Early in the quarter, we met with new CEO Hubertus Mühlhäuser and discussed the company’s significantly simplified organizational structure that incorporates streamlined global functions. Overall, we believe Mühlhäuser is a capable leader and our conviction in the investment thesis for CNH is secure.

Charter Communications’ share price soared upon the release of its fourth-quarterearnings report late in January. Year-over-year revenue rose 5.9% and adjusted earnings (excluding mobile revenue and operating expenses) advanced 7.6%, which was the highest rate since the second quarter of 2017. Both metrics outpaced market projections. Broadband net subscription additions accelerated to 289,000 (+9.9% year-over-year). In addition, management provided upbeat commentary about 2019 performance and expressed expectations that capital expenditures will decline from 2018, while margins will continue to expand. Charter’s quarterly results provided evidence of increasing profitability, declining capital intensity and improved free cash flow generation as the business transitions toward broadband.

Bottom Performers:
In February, General Electric (GE) spun off its transportation business (mainly locomotives and associated parts/services) and merged it with Wabtec (Westinghouse Air Brake Technologies), a leading rail equipment supplier. We reviewed Wabtec, including the new exposure to GE’s transportation business, and found that it is a reasonably attractive investment. Concurrent with the merger, Wabtec reported fourth-quarter revenue of $1.12 billion and cash from operations of $277 million, both of which surpassed market forecasts. However, earnings per share of $0.97 fell about 5% short of projections and its share price declined after we acquired our shares.

During the quarter, we initiated a position in Booking Holding and received shares of Wabtec through a spinoff (GE). We eliminated Wells Fargo from the portfolio.

Past performance is no guarantee of future results.

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