Commentary
Much has been written about interest rates over recent quarters. Is it ‘real rates’, is the Fed going to ‘pivot’ or is it now a question of ‘higher for longer’? There can be little doubt that there is now an attractive risk-free rate and it is a viable alternative for asset allocators. Warren Buffett has said that "Interest rates are like gravity in valuations. If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that's a huge gravitational pull on values." This is why valuations and contrarian value investing remain important throughout. At Oldfield Partners we are stock pickers and do not pay attention to the speculation around the next move in interest rates. We prefer to focus on the valuations and the underlying fundamentals of the companies we invest in to ensure we have essentially sound companies on attractive valuations.
Over the third quarter of 2023 to the end of September, the fund declined -2.6% versus a decline of -4.1% for the MSCI EAFE index and +0.6% for MSCI EAFE Value index. Over the month of September, the decline was -2.5% versus a decline of -3.4% for the MSCI EAFE and -0.8% for MSCI EAFE Value. Year-to-date the fund has provided +7.2% versus +7.1% for MSCI EAFE and +9.9% for MSCI EAFE Value.
For the third quarter, the largest negative contributors to the fund’s performance relative to its benchmark were, in order of their impact, easyJet (-11%, total return in local currency), Siemens (-12%), Bayer (-11%), Embraer (-11%) and Henkel (-8%).
EasyJet was the largest negative detractor to performance in the third quarter of 2023 with its share price declining by 15%, in US dollars. The current share price of £4.27 at the end of September is back to its Covid induced trough and remains well below its pre-Covid level which was over £12.00 per share. In the year to end September 2019, the last full year before Covid, easyJet generated revenues of £6.4bn and had a market capitalisation of £4.6bn. In the financial year 2021 (year-end September), the Covid induced grounding of much of their aircraft fleet led to revenues collapsing to just £1.5bn but it ended the year with a market valuation that was again at £5.0bn. Today, easyJet has a market capitalisation of just £3.2bn but is forecast to generate £8.2bn in revenue this year and £9.2bn the year after. It did issue equity in the crisis which increased the share count by 60% and eroded shareholder value. However, today it is forecast to generate an operating margin of just over 6% in 2024. In 2019, easyJet generated an operating margin of over 7% but this include the first full year of operation from their expansion into Tegel airport (Berlin) which was heavily loss making. In 2015, easyJet had generated operating margins of over 14%. Fuel expenses have gone from £1.4bn in 2019 to £1.3bn in 2022 but fuel cost per available seat miles have increased from £1.06 in H1 2022 to £1.71 in H1 2023. If fuel prices remain at these levels, all airlines will need to increase airfares and the main carriers in Europe have far worse balance sheets than easyJet which is forecast to have net debt of £280m at end September 2023. Expectations for easyJet are low, with the consensus operating margin at just over 6%. This means the market consensus earnings per share of £0.58 on the increased share count versus £0.75 in 2019. If fuel prices fall, the operating margins at easyJet could recover significantly. The valuation is similarly low, for 2024 it trades on 2.5 times Enterprise Value to EBITDA (EV/EBITDA). Historically, easyJet has traded on an EV/EBITDA valuation multiple which is almost triple the current level with c.7x the long-term median.
For the third quarter, the largest positive contributors to the fund’s performance relative to its benchmark were, in order of their impact, MHI (+26% total return in local currency), Eni (+18%), Fresenius SE & Co (+16%), Svenska Handelsbanken (+8%), and Alibaba Group (+5%).
The other side of the fuel price move is the impact it has had on the performance of our holdings in Mitsubishi Heavy Industries (MHI), the Japanese energy conglomerate and Eni, the Italian energy company. MHI was the largest positive contributor to performance over the third quarter of 2023 with its share price increasing by over 21% in US dollars. We bought MHI in 2017 when it was suffering from the decline in its gas turbine business given the switch to renewables and added to the position in the Covid induced sell-off which also impacted its aircraft business. In March 2020, MHI’s market value had fallen to just $8.5bn and yet it still generated sales of $37bn but only $914m in adjusted operating profit, a 2.5% operating margin. Given the higher energy costs and moves towards energy security in the aftermath of the war in Ukraine, MHI is seeing a resurgence in orders for its gas turbines and nuclear energy businesses. It is also providing products and services for carbon capture and more efficient utility scale energy usage. It is also a Tier one supplier to Boeing and it has seen a stabilisation in its aircraft business. Today MHI has a market capitalisation of close to $18bn, with its share price up 273% over the last three years to end September 2023, in local currency terms. The weakness of the Japanese Yen has detracted somewhat from this return but it is still up over 160% in US dollar terms over the last three years. Despite this stellar move in the share price, MHI still only trades on a forward price to earnings ratio of less than 13 times to March 2024 and just over 11 times for the year to end March 2025.
These two investments in easyJet and MHI aptly demonstrate the importance of contrarian value investing and holding firm to that discipline. Whilst in retrospect it may seem obvious that MHI represented a terrific value opportunity in March 2020, it is far from easy making those contrarian investments at the time when most investors have written it off. EasyJet was once held in high regard by investors and was seen as a ‘category killer’ taking market share from the incumbent European airlines. But now investors have turned off to its potential and its valuation is depressed. The history of investment has shown time and time again that one should hold these investments through these periods and be patient, always alert to the underlying fundamentals and the potential for the recovery in the share price. When interest rates went to zero investors chased growth and valuations exploded in whole sections of the market. We have looked for opportunities outside of where everyone else is chasing and being driven to by their index driven benchmarks. The EAFE portfolio has a forward price to earnings of less than 9 times, one times price to book and a dividend yield of 3.6%. The weighted average upside to our target prices on a two-year view is 58% which remains highly attractive.
Newsletter changes
We are moving to Quarterly Newsletters. These will now encompass a fuller write up of what has been happening in the portfolio over the previous quarter. In between these Quarterlies, we will produce a monthly fact sheet. These will not have a written piece but will have comprehensive facts on the fund. Why have we done this? We have a longer-term outlook, have low turnover and things don’t change an enormous amount month to month. We felt that the clients would learn a lot more from a fuller review of portfolio movements on a quarterly basis.
If you have any questions, please contact Ed Troughton or James Lindsay.
Commentary
Much has been written about interest rates over recent quarters. Is it ‘real rates’, is the Fed going to ‘pivot’ or is it now a question of ‘higher for longer’? There can be little doubt that there is now an attractive risk-free rate and it is a viable alternative for asset allocators. Warren Buffett has said that "Interest rates are like gravity in valuations. If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that's a huge gravitational pull on values." This is why valuations and contrarian value investing remain important throughout. At Oldfield Partners we are stock pickers and do not pay attention to the speculation around the next move in interest rates. We prefer to focus on the valuations and the underlying fundamentals of the companies we invest in to ensure we have essentially sound companies on attractive valuations.
Over the third quarter of 2023 to the end of September, the fund declined -2.6% versus a decline of -4.1% for the MSCI EAFE index and +0.6% for MSCI EAFE Value index. Over the month of September, the decline was -2.5% versus a decline of -3.4% for the MSCI EAFE and -0.8% for MSCI EAFE Value. Year-to-date the fund has provided +7.2% versus +7.1% for MSCI EAFE and +9.9% for MSCI EAFE Value.
For the third quarter, the largest negative contributors to the fund’s performance relative to its benchmark were, in order of their impact, easyJet (-11%, total return in local currency), Siemens (-12%), Bayer (-11%), Embraer (-11%) and Henkel (-8%).
EasyJet was the largest negative detractor to performance in the third quarter of 2023 with its share price declining by 15%, in US dollars. The current share price of £4.27 at the end of September is back to its Covid induced trough and remains well below its pre-Covid level which was over £12.00 per share. In the year to end September 2019, the last full year before Covid, easyJet generated revenues of £6.4bn and had a market capitalisation of £4.6bn. In the financial year 2021 (year-end September), the Covid induced grounding of much of their aircraft fleet led to revenues collapsing to just £1.5bn but it ended the year with a market valuation that was again at £5.0bn. Today, easyJet has a market capitalisation of just £3.2bn but is forecast to generate £8.2bn in revenue this year and £9.2bn the year after. It did issue equity in the crisis which increased the share count by 60% and eroded shareholder value. However, today it is forecast to generate an operating margin of just over 6% in 2024. In 2019, easyJet generated an operating margin of over 7% but this include the first full year of operation from their expansion into Tegel airport (Berlin) which was heavily loss making. In 2015, easyJet had generated operating margins of over 14%. Fuel expenses have gone from £1.4bn in 2019 to £1.3bn in 2022 but fuel cost per available seat miles have increased from £1.06 in H1 2022 to £1.71 in H1 2023. If fuel prices remain at these levels, all airlines will need to increase airfares and the main carriers in Europe have far worse balance sheets than easyJet which is forecast to have net debt of £280m at end September 2023. Expectations for easyJet are low, with the consensus operating margin at just over 6%. This means the market consensus earnings per share of £0.58 on the increased share count versus £0.75 in 2019. If fuel prices fall, the operating margins at easyJet could recover significantly. The valuation is similarly low, for 2024 it trades on 2.5 times Enterprise Value to EBITDA (EV/EBITDA). Historically, easyJet has traded on an EV/EBITDA valuation multiple which is almost triple the current level with c.7x the long-term median.
For the third quarter, the largest positive contributors to the fund’s performance relative to its benchmark were, in order of their impact, MHI (+26% total return in local currency), Eni (+18%), Fresenius SE & Co (+16%), Svenska Handelsbanken (+8%), and Alibaba Group (+5%).
The other side of the fuel price move is the impact it has had on the performance of our holdings in Mitsubishi Heavy Industries (MHI), the Japanese energy conglomerate and Eni, the Italian energy company. MHI was the largest positive contributor to performance over the third quarter of 2023 with its share price increasing by over 21% in US dollars. We bought MHI in 2017 when it was suffering from the decline in its gas turbine business given the switch to renewables and added to the position in the Covid induced sell-off which also impacted its aircraft business. In March 2020, MHI’s market value had fallen to just $8.5bn and yet it still generated sales of $37bn but only $914m in adjusted operating profit, a 2.5% operating margin. Given the higher energy costs and moves towards energy security in the aftermath of the war in Ukraine, MHI is seeing a resurgence in orders for its gas turbines and nuclear energy businesses. It is also providing products and services for carbon capture and more efficient utility scale energy usage. It is also a Tier one supplier to Boeing and it has seen a stabilisation in its aircraft business. Today MHI has a market capitalisation of close to $18bn, with its share price up 273% over the last three years to end September 2023, in local currency terms. The weakness of the Japanese Yen has detracted somewhat from this return but it is still up over 160% in US dollar terms over the last three years. Despite this stellar move in the share price, MHI still only trades on a forward price to earnings ratio of less than 13 times to March 2024 and just over 11 times for the year to end March 2025.
These two investments in easyJet and MHI aptly demonstrate the importance of contrarian value investing and holding firm to that discipline. Whilst in retrospect it may seem obvious that MHI represented a terrific value opportunity in March 2020, it is far from easy making those contrarian investments at the time when most investors have written it off. EasyJet was once held in high regard by investors and was seen as a ‘category killer’ taking market share from the incumbent European airlines. But now investors have turned off to its potential and its valuation is depressed. The history of investment has shown time and time again that one should hold these investments through these periods and be patient, always alert to the underlying fundamentals and the potential for the recovery in the share price. When interest rates went to zero investors chased growth and valuations exploded in whole sections of the market. We have looked for opportunities outside of where everyone else is chasing and being driven to by their index driven benchmarks. The EAFE portfolio has a forward price to earnings of less than 9 times, one times price to book and a dividend yield of 3.6%. The weighted average upside to our target prices on a two-year view is 58% which remains highly attractive.
Newsletter changes
We are moving to Quarterly Newsletters. These will now encompass a fuller write up of what has been happening in the portfolio over the previous quarter. In between these Quarterlies, we will produce a monthly fact sheet. These will not have a written piece but will have comprehensive facts on the fund. Why have we done this? We have a longer-term outlook, have low turnover and things don’t change an enormous amount month to month. We felt that the clients would learn a lot more from a fuller review of portfolio movements on a quarterly basis.
If you have any questions, please contact Ed Troughton or James Lindsay.