Commentary
From the 23rd of March, indices rebounded sharply. Investors have been buoyed by the Federal Reserve Chairman Jerome Powell’s promise to do whatever it takes, an echo of Mario Draghi’s pledge of 2012. They have flocked back to equities and in particular to that handful of large US technology names known as the FAANGs (Facebook, Amazon, Apple, Netflix and Google). Major indices had one of the fastest drawdowns in history with major indices falling around 35 per cent to March 23rd.. They have now staged one of the sharpest rebounds in history. The Covid 19 pandemic continues to rage in the Americas while the rest of the world braces for a potential second wave.
The dispersion between Growth and Value investing is now as great as the most extreme examples in history. On numerous measures one has to go back to 1929 for similar dispersions. Being a value investor has been as tough now as we have known it in our careers but we know that this a pre-condition for future outperformance. It is at such times that it has tended to be right to be a value investor.
It was highlighted to us on a call recently with a prospective client that the price to book multiple on the global strategy has remained consistent despite very different underlying holdings. This was seen as a positive. This is not something we target at the portfolio level but the price to book multiple for the global strategy was one times in December 2012 and it was one times in December 2019 for a broadly similar forward return on equity. Clearly, at the stock level we have remained consistent in the discipline of finding value opportunities. The price to book multiple for our benchmark, the MSCI World index, has increased from 1.6 times to 2.5 times. Our benchmark has re-rated but our hunt for, and definition of, value has remained unaltered. Only time will tell whether the re-rating of the index is justified and will hold, but any re-rating can only ever happen once and can only continue onwards with stocks getting ever more expensive and hence more vulnerable to a pull back.
A criticism often levelled at value investors is that we shun technology investments. The high valuations often associated with technology puts investors like us off, meaning that we may miss out on opportunities that technological change can offer. At OP we contend that value can be found in all sectors (we held Microsoft for 11 years) but we are selective and do prefer it when we are being contrarian and investing in stocks that are not already well-owned by the market. Furthermore, starting valuations always matter.
One such stock is Nokia, which we purchased in the first quarter of 2020. Nokia is a leading player in 5G, optical, broadband and software, in effect the infrastructure that will underpin the numerous technological services that are currently being deployed and under development. It has consistently reinvented itself starting as a Finnish paper mill and tyre manufacturer, before evolving into electronics and telephone switches. Eventually Nokia became the world’s leading mobile phone manufacturer (which it exited in 2014) before re-focusing on network infrastructure with the acquisition of Alcatel Lucent in 2016. The integration of this business has led to issues in their legacy networks at a time when its engineers were also tasked with developing 5G, the next generation mobile technology. These operational issues have weighed heavily on the share price which peaked at over €6.50 in 2015 and fell to €3.50 at our time of purchase. This gave Nokia a market value of just €20 billion, having spent some €16 billion on the Alcatel Lucent business just a few years earlier.
Nokia’s problems are also self-inflicted and under new leadership, it is embarking on a strategy to improve customer diversification and profitability. It has guided to margins as high as 16 per cent in the past, well above the level achieved in 2018 and the 8 per cent currently forecast by the Bloomberg consensus for 2020. We believe that an 11 per cent operating margin is achievable given the restructuring being undertaken and comparing with history and peers. we used a multiple of just over one times enterprise value (EV) to sales, which is the multiple of sales that Ericsson trades on, this would suggest over 50 per cent upside from the time of purchase. We use a blend of valuation measures to derive our price target, including EV to sales and price to book value.
Nokia has net cash on the balance sheet, something we find particularly attractive - especially in the current environment. It also has a strong installed base among some of the world’s leading telecom operators which ensures it a strong position in the deployment of 5G. Its competitive position will improve given the increased scrutiny under which Huawei, its main competitor from China, is under from international governments. Huawei had initially used price as a weapon and gained significant market share over the last decade in the deployment of 4G, serving to depress the profitability of its competitors. Our research shows that it is difficult and expensive for operators to switch suppliers, but that at the very least the severe competitive threat from Huawei has been reduced in global markets.
Over the year to date, the share price of Nokia (+18%) has been strong in relative and absolute terms. The strength in the share price has been buoyed in recent weeks by continued reports of the desire from Western governments (led by the United States) to see a stronger player in 5G which may involve corporate activity. We still see ample upside in the shares today and in fact added to the position in the market sell off. Barrick has been the best performing holding in the strategy in the first half and second quarter, up some 48 per cent in US dollar terms over the second quarter on the strengthening gold price.
From the end of March to the end of June one of the weakest stocks in the portfolio was Kansai Electric. The market recovery meant that stocks which had held up well, such as utilities, lagged in the rebound. This highlights that we are at an interesting juncture for investors. If markets continue to recover it is surely in the more value orientated sectors where the catchup potential is the greatest. However, if markets do roll over then investors may look to sell the shares of those that have held up the best, especially if driven by outflows from passive funds. This maybe “having our cake and eating it”, but it does mean that we would urge investors to allocate to value at a time when this feels the worst thing to do. The two-year weighted average anticipated total return for the portfolio currently stands at a very attractive 50 per cent.
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, Ed Troughton and to David 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 are not impacted by Jamie’s departure.
Commentary
From the 23rd of March, indices rebounded sharply. Investors have been buoyed by the Federal Reserve Chairman Jerome Powell’s promise to do whatever it takes, an echo of Mario Draghi’s pledge of 2012. They have flocked back to equities and in particular to that handful of large US technology names known as the FAANGs (Facebook, Amazon, Apple, Netflix and Google). Major indices had one of the fastest drawdowns in history with major indices falling around 35 per cent to March 23rd.. They have now staged one of the sharpest rebounds in history. The Covid 19 pandemic continues to rage in the Americas while the rest of the world braces for a potential second wave.
The dispersion between Growth and Value investing is now as great as the most extreme examples in history. On numerous measures one has to go back to 1929 for similar dispersions. Being a value investor has been as tough now as we have known it in our careers but we know that this a pre-condition for future outperformance. It is at such times that it has tended to be right to be a value investor.
It was highlighted to us on a call recently with a prospective client that the price to book multiple on the global strategy has remained consistent despite very different underlying holdings. This was seen as a positive. This is not something we target at the portfolio level but the price to book multiple for the global strategy was one times in December 2012 and it was one times in December 2019 for a broadly similar forward return on equity. Clearly, at the stock level we have remained consistent in the discipline of finding value opportunities. The price to book multiple for our benchmark, the MSCI World index, has increased from 1.6 times to 2.5 times. Our benchmark has re-rated but our hunt for, and definition of, value has remained unaltered. Only time will tell whether the re-rating of the index is justified and will hold, but any re-rating can only ever happen once and can only continue onwards with stocks getting ever more expensive and hence more vulnerable to a pull back.
A criticism often levelled at value investors is that we shun technology investments. The high valuations often associated with technology puts investors like us off, meaning that we may miss out on opportunities that technological change can offer. At OP we contend that value can be found in all sectors (we held Microsoft for 11 years) but we are selective and do prefer it when we are being contrarian and investing in stocks that are not already well-owned by the market. Furthermore, starting valuations always matter.
One such stock is Nokia, which we purchased in the first quarter of 2020. Nokia is a leading player in 5G, optical, broadband and software, in effect the infrastructure that will underpin the numerous technological services that are currently being deployed and under development. It has consistently reinvented itself starting as a Finnish paper mill and tyre manufacturer, before evolving into electronics and telephone switches. Eventually Nokia became the world’s leading mobile phone manufacturer (which it exited in 2014) before re-focusing on network infrastructure with the acquisition of Alcatel Lucent in 2016. The integration of this business has led to issues in their legacy networks at a time when its engineers were also tasked with developing 5G, the next generation mobile technology. These operational issues have weighed heavily on the share price which peaked at over €6.50 in 2015 and fell to €3.50 at our time of purchase. This gave Nokia a market value of just €20 billion, having spent some €16 billion on the Alcatel Lucent business just a few years earlier.
Nokia’s problems are also self-inflicted and under new leadership, it is embarking on a strategy to improve customer diversification and profitability. It has guided to margins as high as 16 per cent in the past, well above the level achieved in 2018 and the 8 per cent currently forecast by the Bloomberg consensus for 2020. We believe that an 11 per cent operating margin is achievable given the restructuring being undertaken and comparing with history and peers. we used a multiple of just over one times enterprise value (EV) to sales, which is the multiple of sales that Ericsson trades on, this would suggest over 50 per cent upside from the time of purchase. We use a blend of valuation measures to derive our price target, including EV to sales and price to book value.
Nokia has net cash on the balance sheet, something we find particularly attractive - especially in the current environment. It also has a strong installed base among some of the world’s leading telecom operators which ensures it a strong position in the deployment of 5G. Its competitive position will improve given the increased scrutiny under which Huawei, its main competitor from China, is under from international governments. Huawei had initially used price as a weapon and gained significant market share over the last decade in the deployment of 4G, serving to depress the profitability of its competitors. Our research shows that it is difficult and expensive for operators to switch suppliers, but that at the very least the severe competitive threat from Huawei has been reduced in global markets.
Over the year to date, the share price of Nokia (+18%) has been strong in relative and absolute terms. The strength in the share price has been buoyed in recent weeks by continued reports of the desire from Western governments (led by the United States) to see a stronger player in 5G which may involve corporate activity. We still see ample upside in the shares today and in fact added to the position in the market sell off. Barrick has been the best performing holding in the strategy in the first half and second quarter, up some 48 per cent in US dollar terms over the second quarter on the strengthening gold price.
From the end of March to the end of June one of the weakest stocks in the portfolio was Kansai Electric. The market recovery meant that stocks which had held up well, such as utilities, lagged in the rebound. This highlights that we are at an interesting juncture for investors. If markets continue to recover it is surely in the more value orientated sectors where the catchup potential is the greatest. However, if markets do roll over then investors may look to sell the shares of those that have held up the best, especially if driven by outflows from passive funds. This maybe “having our cake and eating it”, but it does mean that we would urge investors to allocate to value at a time when this feels the worst thing to do. The two-year weighted average anticipated total return for the portfolio currently stands at a very attractive 50 per cent.
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, Ed Troughton and to David 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 are not impacted by Jamie’s departure.