Commentary

Global market sentiment remains driven by economic data coming out of the US. The data in January had suggested inflationary pressures may be easing, whilst February’s data suggested otherwise causing falls in equity markets led by the US, a rise in bond yields and a rise in the US dollar. The fund’s low absolute weighting in the US equity market was helpful during the month, but the low exposure to the US dollar relative to the benchmark was not, subtracting one per cent from relative performance. The negative currency impact in February was the same as the difference in performance between the fund and the MSCI World Value index, -3%, against the fund return of -3%.

At a stock level, the largest negative contributors to relative performance, in order of their impact, were Alibaba (-20% total return in local currency), LG H&H (-10% but -16% in US dollars) and NOV (-10%).

The shares of Alibaba, the Chinese ecommerce giant, gave up the entirety of the gain made in January. They announced quarterly results which reflected the Covid lockdowns in China, explaining the decline in value of products purchased on Alibaba’s websites compared with the previous year. However, cost reductions meant profits increased. Now that China has moved on from its Zero Covid policy, we expect Alibaba to return to growth. Markets’ expectations have fallen sharply with the share price but we are more optimistic on the level of growth it can achieve over the next few years. Even using consensus views on profit and cashflow over the next couple of years, the share price, adjusted for the value of the net cash expected, trades on a single digit multiple of expected net profits.

LG H&H has also been impacted by Covid and the Chinese lockdowns but the recent sales success with end consumers suggest to us that the all-important luxury skincare brand, The History of Whoo, remains in good health. Over the short-term, LG H&H has higher than normal inventory on its balance sheet and is re-negotiating commercial terms with the Chinese resellers. As travel between Korea and China returns to normal, we expect to see sales recover strongly led by Duty Free retail sales. Other global luxury brands like L’Oreal and Estee Lauder have also faced similar challenges in the travel retail channel. Longer-term, we think the shares are at a bargain given that, adjusted for the net cash on the balance sheet, they are valued at just 14 times the net profit expected in 2024.

The largest positive contributors to the fund’s relative return during the month, in order of their impact, were BT Group (+12%) total return in local currency), Exor (+7%) and Henkel (+5%).

BT Group, the leading fixed and mobile phone operator in the UK, reported a solid set of results at the beginning of the month for their fiscal third quarter ending December 2022. While cashflow was a little lighter than expected this was easily explained by the phasing of capital expenditure during the year. The fibre roll out is going extremely well, with better than expected take-up from the homes passed. The company was

Commentary

able to reiterate its outlook for the full year and give investors confidence that the tide is turning for BT’s investment thesis. More importantly perhaps, Ofcom, the telephony and media regulator in the UK, gave the provisional go-ahead for Openreach’s Equinox 2 pricing package. We agree with management that Equinox 2 improves BT’s competitive position against the smaller alternative network providers (“alt-nets”). The alt-nets managed to raise significant sums of money during the era of free money but which have yet to make a real impact with their relatively nascent fibre builds. Due to lack of scale, the alt-nets have higher costs per line installed. Equinox 2 provides BT with the opportunity to lower prices for the bulk purchase of their full fibre broadband to levels that, while good for BT and the end consumer, provide unattractive returns to the alt-nets. BT’s enterprise value is just 5.3 times 2024’s operating cashflow before interest and tax and the shares offer an attractive 6.3% dividend yield. We think the shares should double from current levels over the next two to three years as the market appreciates BT’s strong and improving competitive position.

The strategy’s weighted average total upside on a two year view is 50%, and this on estimates we think conservative. The strategy has a forward price to earnings ratio (P/Es) of 10.2 times and a price to book multiple (P/B) of 1.1 times. The MSCI World and MSCI World Value have forward P/Es of 15.9 and 12.3 times respectively. MSCI World and MSCI World Value have forward P/B multiples of 2.8 and 1.9 times, respectively. The strategy offers genuine contrarian value and, through our bottom-up approach to portfolio construction, is currently positioned with relatively low exposure to the US market where even the MSCI USA Value index is valued at a forward P/E of 14.4 times and a price to book multiple of 2.7 times.

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Commentary