Commentary

Global All Cap Strategy

June 30, 2021

THE MARKET ENVIRONMENT

Despite experiencing some volatility in June, major global markets finished largely higher for the second quarter. In April, inflation in the U.S. accelerated at the fastest rate in more than 10 years as the Consumer Price Index rose 4.2% year-over-year and 0.8% month-over-month. Core inflation (stripping out food and energy prices) in May rose at the fastest pace since 1992, up 3.8% versus the year-ago period, while concerns for supply shortages drove national gasoline prices in excess of $3 per gallon for the first time in over five years. In June, oil prices reached their highest point in more than two years, and markets responded unfavorably to the U.S. Federal Reserve’s heightened expectations for inflation in 2021. While the Fed noted that inflationary pressures are “transitory,” it also now foresees two interest rate hikes in 2023. This compares to its forecast in March for zero rate hikes until at least 2024. However, Chairman Jerome Powell made assurances later in June that the Fed would not be coerced into raising interest rates on inflationary fears alone.

On the Covid-19 front, total global cases surpassed 180 million and global deaths approached 4 million. By the end of the second quarter, more than 800 million people reached full vaccination, representing about 10% of the global population. The overall increased distribution of Covid-19 vaccines and the additional stimulus in the U.S. contributed to the International Monetary Fund’s (IMF) decision to increase its outlook for global economic expansion for 2021 from 5.5% to 6.0%. The IMF also now expects 8.4%, 4.4% and 3.3% economic growth in China, the eurozone and Japan, respectively, as well as 6.4% economic expansion in the U.S in 2021.

In our view, there is still value to be had in value investing. We are finding a large gap in valuations when comparing growth and value stocks, and believe value stocks remain attractive on both an absolute and relative basis. Though conditions are ripe for value stocks to recognize upside potential, we also acknowledge that the backdrop of the market could change at any time as evidenced most recently by Covid-19. As such, we aim to invest in companies with strong balance sheets and management teams that can remain successful no matter the macroeconomic backdrop.

THE PORTFOLIO

Top Performers:
Alphabet’s results continue to positively surprise the market as the company’s first-quarter total revenue, operating income and earnings per share outpaced expectations by 7%, 39% and 67%, respectively. From our perspective, Alphabet’s results were impressive and again exhibited faster than expected revenue growth across the board with total revenue that advanced 34% from the prior year. In addition, the adjusted operating margin (excluding “other bets” activity) expanded by 820 basis points. By segment, search revenue grew 30%, YouTube advertising revenue rose 49% and cloud revenue increased 46%. Furthermore, margin trends improved across all segments as underlying operational expenses appear progressively well controlled relative to history. Management repurchased $11.4 billion worth of shares in the quarter and authorized an additional $50 billion to buy back Class C shares. Based on this solid fundamental performance and share repurchases, we raised some of our near-term valuation metrics

Tenet Healthcare issued first-quarter results in April that were good, by our measure, and its share price gained value for the quarter. Total revenue, adjusted earnings and adjusted earnings per share all advanced from the year-ago quarter and exceeded market forecasts. In addition, we found it noteworthy that Tenet generated more than $400 million of free cash flow in the first quarter that it used to pay down debt, which lessened its balance sheet leverage. Management provided second-quarter guidance ranges for revenue of $4.65-4.85 billion, adjusted earnings of $675-775 million and adjusted earnings per share of $0.69-1.39. They also raised full-year guidance for these metrics. Later, Tenet announced the sale of five hospitals in the Miami, Florida area for $1.1 billion. We view the sale positively. It’s consistent with the company’s strategy to shift away from hospitals and toward surgery centers. Lastly, the U.S. Supreme Court upheld the legitimacy of the Affordable Care Act, which helped establish some insurance-related stability across health care providers. In our view, Tenet’s management team continues to execute well, which we think can provide further shareholder rewards.

The share price of Lloyds Banking Group soared upon the release of solid first-quarter earnings. This was driven by a reserve release of GBP 459 million for credit losses, which resulted in a GBP 323 million net impairment credit and pointed to management’s view of an improving economic outlook in the U.K. Lloyds’ first-quarter revenues reached GBP 3.6 billion, which is trending ahead of our full-year estimates. The company’s common equity Tier 1 ratio expanded by 54 basis points to 16.7%, despite funding half of its full-year pension contribution in the first quarter. In addition, Lloyds saw strong inflows of low-cost deposits, while higher than expected mortgage underwriting margins led to the company increasing its net interest margin target to more than 245 basis points, which exceeded our estimate for 240 basis points. Operating expenditure trends were also positive, in our view, and management lowered its expectations for full-year expenditures to GBP 7.5 billion, which now aligns with our estimates.

Bottom Performers:
The share price of Incitec Pivot dropped in the first quarter after management announced a delay in reopening its Waggaman ammonia plant. The facility resumed operations in mid-April as management had expected. However, the company subsequently experienced some unexpected equipment issues and the restart process halted on May 8, which management thinks will additionally decrease full-year earnings by AUD 33-42 million. Later, Incitec released fiscal first-half results that we saw as mixed. Total revenue declined 6.7% from the prior year and earnings fell nearly 31%, both of which also undershot market projections. As we had anticipated, the explosives business suffered from Waggaman and other planned and unplanned facility outages, including the Cheyenne and Louisiana Ammonium Nitrate plants. Consequently, total earnings fell by AUD 49 million from a year ago. Even so, the drop was partially offset by a net benefit of AUD 25 million, mainly from increasing commodity prices. Conversely, the fertilizer business achieved a revenue advance of 1.9%, and first-half earnings reached AUD 20 million, which was a material reversal from the loss of AUD 10 million in the first half of 2020. While Incitec continues to work through these near-term challenges, we believe the company is well positioned to realize stronger fiscal second-half performance.

Several developments influenced Naspers’s share price over the course of the quarter, beginning with management’s announcement that it reduced its stake in Tencent from 31% to 29%. Subsequently, the company raised $14.7 billion in cash and agreed not to sell any additional Tencent shares for three years. While this strategy aligns with our expectations as we believe it is a good time to sell shares and raise cash following its additional investment in Delivery Hero and the $5 billion share buyback program, investors appeared disappointed that Naspers did not immediately announce it would use the proceeds to fund a new share repurchase program. Later, its share price suffered on news that Prosus is making a voluntary exchange offer for up to 45.4% ownership of Naspers. We see both positive and negative aspects to this transaction. We spoke with CFO Basil Sgourdos who stated that though this plan is not a perfect solution, the long-term benefits outweigh the share exchange ratio. In addition, he indicated that the company will take additional steps to close the discount, including listing assets, executing share repurchases and improving profitability at various businesses. Lastly, Naspers reported fiscal full-year headline earnings per share that were roughly 6% ahead of market projections, while total revenue missed forecasts. The company’s negative operating income (-$1.19 billion) for the period regressed from the $720 million realized in the prior year, though it was better than market expectations. From our perspective, Naspers remains equipped to sustain growth and reward shareholders over the long term.

Prudential released a first-quarter trading update at its annual general meeting in May. The company’s net annual premium equivalent sales for Asia and Africa rose 14% year-over-year to $1.19 billion and new business profit rose 21% to $624 million. Net sales performance compared with last year was strongest in China (+83%), Malaysia (+62%) and Singapore (+19%), while Hong Kong and Indonesia saw declines. Prudential’s solvency remained strong at 343% compared with 329% at the end of 2020. Management provided additional information on the delayed demerger of Jackson National, which was originally scheduled for completion by the end of May. The company now expects to complete the demerger in the second half of the year, owing to extra time necessary for regulatory approvals. Management is still considering raising roughly $2.5-3.0 billion of new equity following the demerger. Investors may have found the delay concerning, which weighed on the company’s share price for the quarter. We continue to believe that Prudential is well positioned to reward shareholders over the long term.

There were no new purchases or final sales during the quarter, however, we received shares of Wickes Group as part of spin-off from Travis Perkins.

Past performance is no guarantee of future results.

The MSCI World Index (Net) is a free float-adjusted, market capitalization-weighted index that is designed to measure the global equity market performance of developed markets. The index covers approximately 85% of the free float-adjusted market capitalization in each country. This benchmark calculates reinvested dividends net of withholding taxes. This index is unmanaged and investors cannot invest directly in this index.

The specific securities identified and described in this report do not represent all the securities purchased, sold, or recommended to advisory clients. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time one receives this report or that securities sold have not been repurchased. It should not be assumed that any of the securities, transactions, or holdings discussed herein were or will prove to be profitable. Holdings are representative of Harris Associates L.P.’s Global All Cap Equity composite as of 06/30/21.

Certain comments herein are based on current expectations and are considered “forward-looking statements”. These forward looking statements reflect assumptions and analyses made by the portfolio managers and Harris Associates L.P. based on their experience and perception of historical trends, current conditions, expected future developments, and other factors they believe are relevant. Actual future results are subject to a number of investment and other risks and may prove to be different from expectations. Readers are cautioned not to place undue reliance on the forward-looking statements.

The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.