Commentary
The progression of the virus and its impact on economic life around the world continues to merit a mixture of stable earning holdings and cyclical holdings. There is much to be hopeful for as lockdowns are lifted but also uncertainty as to a second wave and strength of the economic rebound. We continue to favour holdings that can ‘tough it out’ - having characteristics such as a strong balance sheet, solid proven franchises, producing assets low down on the global cost curve, or access to government assistance. We believe all our holdings are survivors. Value investing has had a difficult time this year, circumstances have favoured growth stocks, which does create opportunity for a patient value investor, and we have not seen such upside potential for the portfolio since early 2009.
The bottom performers by contribution for the month were Ternium, Lee & Man Paper, and Lukoil. Ternium (Latin American steel producer) ended the first quarter of 2020 with a strong cash position and little debt refinancing needs through 2021. Management is effectively reducing working capital and is delaying some elements of capital expenditure. We expect positive free cash flow during 2020 and 2021. The timing of a volume recovery in its key US and Mexican markets remains uncertain, but Ternium is well positioned to benefit in a recovery and supply chains are re-starting. The stock trades on a price to book ratio of 0.4. The share price of Lee & Man Paper (Chinese containerboard manufacturer) closed flat for the month, lagging a strong market performance. We wrote last month US/China tensions can be a negative, affecting import prices of recycled cardboard. These tensions increased as China introduced stricter laws in suppressing Hong Kong protests. More positively, we have seen some small price hikes by the larger containerboard producers. The stock trades on a price-earnings ratio of six and a price to book ratio of 0.8. Lukoil (Russian oil producer) released first quarter results in the month and adjusted down capex guidance for the year. We continue to expect positive free cash flow as Lukoil usually benefits from Ruble weakness and more favourable Russian oil taxes during low oil prices. This supports an expected 8% dividend yield for 2020 under its policy of distributing 100% of free cash flow. Management is focusing on liquidity near term, against an already solid balance sheet, deemphasising buybacks and indicating it would not borrow to support dividends.
The top performers by contribution for the month were Buenaventura, Indofood, and Samsung Electronics. Buenaventura’s (Peruvian gold miner) debottlenecking program and shutdown of operations are a (now well known) near-term negative compared to the gold price rise. The benefit is improved costs upon completion. Management planned for a full restart of operations by end June, after the strict Covid-19 related shutdown in Peru since mid-March. Volumes will further improve as debottlenecking matures. It extended near-term debt maturities and could reduce capex through postponing some growth projects. Debt repayments through 2022 are manageable. The stock trades on a price to book ratio of 0.8. The share price of Indofood (Indonesian snack food producer) recovered after a weak performance in May when it moved forward with its acquisition of an international noodle business we wrote about last month. The increased debt, should the acquisition be successful, is manageable given the stability of its highly profitable domestic noodle business. The stock trades on a price-earnings multiple of 12. Samsung Electronics (South Korean electronics producer) benefitted from signs of recovery in smartphone volumes, both as a phone producer and as supplier of leading-edge memory and displays to the sector. A memory competitor – one of the three main producers in this consolidated sector – reported strong quarterly results and optimistic guidance. Demand from data centres remains a strong positive. Supply discipline remains in the all-important memory sector with all three key players focused on profitability. The stock trades on a price to book ratio of 1.4.
The top performers by contribution for the quarter were Petrobras, SK Telecom, and Lukoil, and the bottom performers were Embraer and Lee & Man Paper. Embraer (Brazilian aircraft manufacturer) is our worst performer this year as Boeing walked away from the deal to buy the majority of Embraer’s regional jet business and the global aviation industry saw a demand collapse from Covid-19. We believe regional jet demand in the US will benefit from a recovery in domestic flying (before international flight demand) and its business jet division is seeing renewed interest to ‘cocoon’ executives. Embraer has no near-term liquidity demands, sufficient cash on hand, and the Brazilian government is keen to protect it – meaning it should survive even a prolonged multi-year aviation slump. The stock trades on a price to book ratio of 0.3.
Capacity and flows
AUM of the strategy is now below our US$1bn capacity so we are accepting capital from investors, with priority given to existing investors and those on the waitlist, and then from new relationships. Our client base has always been a competitive advantage for us, and this has been underlined in the recent months as we have received net inflows. If you are interested in the strategy, please contact us.
Jamie Carter is leaving the firm to take up a position at Longview Partners. Jamie was one of the founding partners of the firm with Richard Oldfield and Nigel Waller in 2005, and has been chief executive since 2013.
Jamie has played a key role in the development of the firm over the last 15 years, and all his partners are grateful to him. He goes with our best wishes.
The board has asked Nigel Waller to become chief executive. He will delegate a great deal of the running of the firm and client relations to his colleagues on the management committee Chris Driver, John McEwing and Ed Troughton and to Dave Gallagher in the US. This will allow Nigel to remain firmly focused on his role managing the global and EAFE strategies with Andrew Goodwin and as chief investment officer. The investment team is not impacted by Jamie’s departure.
Commentary
The progression of the virus and its impact on economic life around the world continues to merit a mixture of stable earning holdings and cyclical holdings. There is much to be hopeful for as lockdowns are lifted but also uncertainty as to a second wave and strength of the economic rebound. We continue to favour holdings that can ‘tough it out’ - having characteristics such as a strong balance sheet, solid proven franchises, producing assets low down on the global cost curve, or access to government assistance. We believe all our holdings are survivors. Value investing has had a difficult time this year, circumstances have favoured growth stocks, which does create opportunity for a patient value investor, and we have not seen such upside potential for the portfolio since early 2009.
The bottom performers by contribution for the month were Ternium, Lee & Man Paper, and Lukoil. Ternium (Latin American steel producer) ended the first quarter of 2020 with a strong cash position and little debt refinancing needs through 2021. Management is effectively reducing working capital and is delaying some elements of capital expenditure. We expect positive free cash flow during 2020 and 2021. The timing of a volume recovery in its key US and Mexican markets remains uncertain, but Ternium is well positioned to benefit in a recovery and supply chains are re-starting. The stock trades on a price to book ratio of 0.4. The share price of Lee & Man Paper (Chinese containerboard manufacturer) closed flat for the month, lagging a strong market performance. We wrote last month US/China tensions can be a negative, affecting import prices of recycled cardboard. These tensions increased as China introduced stricter laws in suppressing Hong Kong protests. More positively, we have seen some small price hikes by the larger containerboard producers. The stock trades on a price-earnings ratio of six and a price to book ratio of 0.8. Lukoil (Russian oil producer) released first quarter results in the month and adjusted down capex guidance for the year. We continue to expect positive free cash flow as Lukoil usually benefits from Ruble weakness and more favourable Russian oil taxes during low oil prices. This supports an expected 8% dividend yield for 2020 under its policy of distributing 100% of free cash flow. Management is focusing on liquidity near term, against an already solid balance sheet, deemphasising buybacks and indicating it would not borrow to support dividends.
The top performers by contribution for the month were Buenaventura, Indofood, and Samsung Electronics. Buenaventura’s (Peruvian gold miner) debottlenecking program and shutdown of operations are a (now well known) near-term negative compared to the gold price rise. The benefit is improved costs upon completion. Management planned for a full restart of operations by end June, after the strict Covid-19 related shutdown in Peru since mid-March. Volumes will further improve as debottlenecking matures. It extended near-term debt maturities and could reduce capex through postponing some growth projects. Debt repayments through 2022 are manageable. The stock trades on a price to book ratio of 0.8. The share price of Indofood (Indonesian snack food producer) recovered after a weak performance in May when it moved forward with its acquisition of an international noodle business we wrote about last month. The increased debt, should the acquisition be successful, is manageable given the stability of its highly profitable domestic noodle business. The stock trades on a price-earnings multiple of 12. Samsung Electronics (South Korean electronics producer) benefitted from signs of recovery in smartphone volumes, both as a phone producer and as supplier of leading-edge memory and displays to the sector. A memory competitor – one of the three main producers in this consolidated sector – reported strong quarterly results and optimistic guidance. Demand from data centres remains a strong positive. Supply discipline remains in the all-important memory sector with all three key players focused on profitability. The stock trades on a price to book ratio of 1.4.
The top performers by contribution for the quarter were Petrobras, SK Telecom, and Lukoil, and the bottom performers were Embraer and Lee & Man Paper. Embraer (Brazilian aircraft manufacturer) is our worst performer this year as Boeing walked away from the deal to buy the majority of Embraer’s regional jet business and the global aviation industry saw a demand collapse from Covid-19. We believe regional jet demand in the US will benefit from a recovery in domestic flying (before international flight demand) and its business jet division is seeing renewed interest to ‘cocoon’ executives. Embraer has no near-term liquidity demands, sufficient cash on hand, and the Brazilian government is keen to protect it – meaning it should survive even a prolonged multi-year aviation slump. The stock trades on a price to book ratio of 0.3.
Capacity and flows
AUM of the strategy is now below our US$1bn capacity so we are accepting capital from investors, with priority given to existing investors and those on the waitlist, and then from new relationships. Our client base has always been a competitive advantage for us, and this has been underlined in the recent months as we have received net inflows. If you are interested in the strategy, please contact us.
Jamie Carter is leaving the firm to take up a position at Longview Partners. Jamie was one of the founding partners of the firm with Richard Oldfield and Nigel Waller in 2005, and has been chief executive since 2013.
Jamie has played a key role in the development of the firm over the last 15 years, and all his partners are grateful to him. He goes with our best wishes.
The board has asked Nigel Waller to become chief executive. He will delegate a great deal of the running of the firm and client relations to his colleagues on the management committee Chris Driver, John McEwing and Ed Troughton and to Dave Gallagher in the US. This will allow Nigel to remain firmly focused on his role managing the global and EAFE strategies with Andrew Goodwin and as chief investment officer. The investment team is not impacted by Jamie’s departure.