Global 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. 

WPP’s share price gained a healthy amount of value in the second quarter, by our measure, as a couple of positive events occurred early in the period. The company’s first-quarter earnings report was in line with our expectations and revenue less pass-through costs also met market forecasts. We found it particularly positive that new business won during the reporting period amounted to an estimated $2 billion in annual billings, compared to $4 billion in new business won for full-year 2018. In addition, WPP’s intent to sell its data consulting business Kantar continued to generate solid interest. A Bloomberg report indicated management was seeking to sell this business for up to GBP 3.5 billion. By quarter end, the company attracted four bidders for a majority stake in Kantar: Bain Capital, Apollo, Platinum and Vista Equity. Although management had hoped to complete a deal by the end of June, a final transaction is still pending. In a related matter, WPP sold its post-production services company The Farm Group to Picture Shop for an undisclosed amount. We like that WPP’s management team is executing the strategic changes established in 2018 and the restructuring is progressing according to plan. Overall, we believe WPP is poised to realize significant improvements going forward.

Bottom Performers:
In our assessment, Baidu’s first-quarter results were extremely disappointing and its share price fell materially upon the report’s release. Although total revenue increased 21% year-over-year, the core search business posted weak results with revenue growth of only 16% and the company’s operating margin contracted into negative territory (-3.9%), which fell far short of our estimates. Even though quarterly results were largely aligned with market expectations, investors focused on management’s second-quarter revenue guidance, which was nearly 12% softer than market forecasts. Understandably, management has been spending heavily on investments to expand the business. The largest incremental investments are going into promoting the main Baidu App along with a host of other apps in short video and to a lesser extent payments. Concurrently, we are hopeful that the two main video apps, Haokan (short video) and Quanmin (flash video), will once again perform as planned. Lastly, the company announced a new $1 billion share repurchase program to be completed by July 2020. Upon review of this earnings release and a fresh assessment of the company’s near-term plans, we have reduced some of our valuation estimates for Baidu. 

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. 

Energy prices were volatile in the second quarter, especially in May, and ended the period lower, which impacted Halliburton’s share price, as is typical. In addition, the company issued first-quarter results that reflected the impact of a very challenging operating environment, from our perspective. Total revenue, adjusted operating income and earnings per share surpassed market expectations. However, revenue of $5.74 billion was unchanged from the same period last year and adjusted operating income and earnings per share fell 31% and 44%, respectively, owing to pricing pressure and elevated international start-up costs that took a toll across the business. While cash flow was soft from the timing of working capital spending, we anticipate cash flow will improve materially going forward. Management is forecasting free cash flow in 2019 will be greater than 2018. In addition, management believes the worst period of price deterioration has passed and expects high single-digit international growth for all of 2019.

During the quarter, we eliminated Experian from the portfolio. We also sold the shares of Wabtec we received last quarter through a General Electric spinoff.

Past performance is no guarantee of future results.

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