International Equity 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:
Issues regarding glyphosate litigation prompted episodes of stock price volatility for Bayer during the second quarter. While we acknowledge there is a large amount of uncertainty surrounding these lawsuits, we see Bayer as much more than just a company that (through recently acquired Monsanto) produces the herbicide Roundup. Bayer’s first-quarter earnings report  included a year-over-year revenue increase of 4.1% (to EUR 13.02 billion) that led to earnings per share that rose 13.8% (to EUR 2.55), both of which exceeded market forecasts. Results were driven by Bayer’s pharmaceuticals segment, where organic revenue advanced 5% and exceeded our full-year estimate. The pipeline for new drug launches is progressing as we anticipated and we continue to see the pharmaceutical segment as a key source of growth for Bayer. In addition, late in the quarter the company’s share price soared on news it had created a supervisory board committee to manage ongoing litigation regarding Roundup. The company also brought on an advisor with many years of experience dealing with environmental litigation along with a legal mediator to address the continuing issue, and the market viewed these appointments positively. We recently met with CEO Werner Baumann who indicated that his view of a successful settlement is one that brings finality in that it is truly capped against the anticipated long line of plaintiffs and that is financially responsible. Following our meeting, we believe there is an increased probability of a settlement coming sooner than we had initially anticipated, which we find to be an important positive. 

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. 

Ashtead Group reported fiscal full-year results that were solid, by our measure, and largely aligned with our estimates. Total revenue advanced 19%, earnings rose 19% and earnings per share advanced 33% from the prior year. These metrics were also better than market forecasts. Furthermore, the company increased the shareholder dividend by 21% to 40 pence for the full year.  Management’s fiscal-year 2020 guidance included organic rental revenue growth of 9-12% in the Sunbelt division (U.S.-based construction and industrial equipment rental unit), which aligned with our expectations. These compatible projections are important to us as we have assessed that over 90% of Ashtead’s underlying value comes from the Sunbelt division. We recently met with CEO Brendan Horgan and CFO Michael Pratt and discussed industry trends. Horgan believes Ashtead will continue to build market share. The company has used incremental growth to generate higher levels of profitability compared with smaller competitors, which enables it to invest in new equipment and technology and further enhance the scale advantages of its platforms. Overall, we like how the company’s management team continues to execute its strategic plan.

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. 

Ryanair Holdings reported fiscal full-year net income (excluding results from subsidiary Lauda) of EUR 1.02 billion, which was aligned with management’s prior guidance. However, net income fell 29% from a year earlier. Even though total revenue grew 6% and reached EUR 7.56 billion, it fell short of market forecasts. In addition, traffic (including Lauda) advanced 9%, though average airfare dropped 6%. Subsequently, several market analysts issued negative reports for Ryanair and downgraded the company. Management’s fiscal-year 2020 guidance includes traffic growth of 8% and an increase in passenger unit revenue of 3%. Management also stated that, thus far, current-year first-half bookings are slightly ahead of the same period last year, while fares are lower. Management expects this trend will continue through 2019. In the meantime, management issued a new EUR 700 million share buyback program scheduled for completion within the next 9 to 12 months. We still trust that Ryanair’s management team will continue to improve the airline’s competitive position while de-risking the model via high asset ownership and a strong balance sheet, which we believe should benefit long-term shareholders. 

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.

During the quarter, we initiated positions in EssilorLuxottica and Swatch Group. We eliminated Experian from the portfolio.

Past performance is no guarantee of future results.

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Past performance is no guarantee of future results.

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