Global 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:
Charter Communications’ share price soared upon the release of its fourth-quarter earnings 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.

General Electric (GE) issued fourth-quarter results that were not as weak as investors had feared with revenue of $33.3 billion, which was slightly better than market expectations. Other positive news included a $1.5 billion settlement reached with the Department of Justice pertaining to mortgage lending activities, an amount that was far less than the market projected and already held in reserve since the first quarter of 2018. In addition, GE announced the sale of its biopharma business to Danaher for $21.4 billion (pretax), which compared favorably with our estimates, and also spun off its transportation business (mainly locomotives and associated parts/services) by merging it with Wabtec (Westinghouse Air Brake Technologies), a leading rail equipment supplier. Both transactions helped boost GE’s available cash and improved the balance sheet.

Late in 2018, President Trump told German auto executives that he had no immediate plans to impose additional U.S. vehicle tariffs, which benefited Daimler’s share price early in the first quarter. At the start of 2019, we spoke with members of the company’s management team about the appointment of Ola Källenius as CEO, the first non-German to hold this position at Daimler. The team believes Källenius is extremely knowledgeable about the company and possesses a collaborative mentality. Later, despite a difficult macro environment, Daimler’s full-year 2018 total revenue advanced 0.4% year-over-year, as we expected, driven by outperformance from buses. However, full-year earnings missed our estimates primarily from weak margin performance in the Mercedes-Benz and vans segments. We reviewed these results with CFO Bodo Uebber and discussed Daimler’s mid- to long-term strategic plans. We came away confident that the company is working to capitalize on opportunities for improvement, especially cost reductions, going forward.   

 

Bottom Performers:
Bayer issued fourth-quarter results in February that included revenue, adjusted earnings and earnings per share that were ahead of market forecasts by roughly 4%, 5% and 34%, respectively. Furthermore, management confirmed fiscal-year 2019 revenue growth guidance of about 4% and reiterated Bayer’s overall 2022 targets. While we found these results to be acceptable, the company’s share price fell in March after a jury ruled in favor of a litigant and found that Bayer’s Roundup product (produced by Monsanto) was responsible for causing cancer. The jury later issued an award of slightly more than $80 million. Although this was the second time Bayer was found liable, management vowed to keep defending the safety of the herbicide glyphosate. Furthermore, we expect several more cases will emerge because of the outcomes of the initial two. Even though the juries’ conclusions were disappointing, we have factored potential future costs from litigation into our valuation metrics. We recently spoke with CEO Werner Baumann and discussed various possible scenarios specific to Roundup. Baumann believes an outright ban for Roundup in the U.S. is an extremely low probability because of the support for this product by regulatory bodies and how disruptive it would be to the industry since he estimates it would take about five years to build capacity for alternative herbicides. Baumann also expressed that the integration of Monsanto is progressing well. While we continue to monitor this situation closely, our investment thesis for Bayer remains intact.

Grupo Televisa’s full-year results included total revenue that matched our estimates and earnings that slightly outperformed our expectations. By segment, year-over-year content net sales (ex-World Cup) rose 7% and underlying advertising sales increased 2%, both of which aligned with our projections. The cable segment continues to drive results as net sales advanced almost 10% and revenue generating units (RGU) grew by 1.2 million for the full year with all sub-segments achieving RGU growth (broadband +18%, video +5%, voice +40%). Sky segment revenues were down 1% for the year because of subscriber losses after the World Cup broadcast. However, management expects Sky’s subscribers will return to positive growth in the second half of 2019. Despite these overall acceptable results, it appears investors were disappointed that management decided not to spin off the cable business. We met with CEO Alfonso de Angoitia Noriega and discussed rationale for keeping the cable business and operating trend expectations for the current year. He expressed that the costs and dis-synergies associated with the cable spinoff would not improve shareholder value. At this point, we agree with this assessment. In addition, Noriega noted that while the government’s decision to decrease advertising spending will impact current-year results, he expects private sector advertising will grow in a range of 2-3% in 2019, which we view as acceptable. He also supposes that the government will not cut spending further in the  near to mid term. Overall, we are pleased with the incremental improvements management continues to make and our investment thesis for Grupo Televisa remains intact.

Ahead of WPP releasing fourth-quarter results, its share price suffered from news that peer firm Publicis Groupe’s fourth-quarter 2018 organic sales growth fell far short of market forecasts. WPP recouped some of its losses as it was later reported that its own fiscal-year results were largely in line with market outlook, but first-quarter guidance proved troubling on expectations for a margin decline in 2019. Later in the first quarter, the company was negatively impacted by continued uncertainty surrounding Brexit. Even though WPP has faced some near-term difficulties, we believe that the company is well positioned to realize strengthening performance going forward. WPP has admitted they were slow to recognize industry challenges and subsequently contain costs, but management will be more diligent to such changes going forward. Shortly after being appointed, new CEO Mark Read and COO Andrew Scott conducted a strategic review and set fresh priorities for the reworked company. We recently met with Read and Scott and were impressed with how well they work together and pleased that they agree on the company’s main areas for improvement. We like that the new strategy incorporates a streamlined organizational structure built around clients’ needs. In the meantime, we continue to monitor the situation closely, but find that WPP is trading at a steep discount to our perception of its underlying value.

During the quarter, we initiated positions in Bank of America and Constellation Brands. We received shares of Wabtec and MultiChoice Group through spinoffs (GE and Naspers respectively). We subsequently sold out of MultiChoice Group and also eliminated Wells Fargo from the portfolio.

Past performance is no guarantee of future results.

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