THE MARKET ENVIRONMENT
Major global markets generally showed strength during the fourth quarter, despite pressure in October when Hamas, an Islamist political and military organization, orchestrated an attack against Israel, shaking markets and the geopolitical landscape. The U.S. reported its strongest quarter of gross domestic product growth in nearly two years at 4.3% annualized, while economic data throughout Europe and China was mixed and provided reasons for both pessimism and optimism.
The U.S. 10-year yield reached as high as 5% in the quarter before declining and ending the period around 3.86% as investors continue to digest economic data and expectations on interest rates. In November and December, the U.S. Federal Reserve met and held its benchmark interest rate steady at 5.50%. Similarly, the Bank of England held its benchmark interest rate at 5.25%, and the European Central Bank held rates steady at 4.50% at its most recent meeting. Headline inflation in the U.S. and the U.K. declined during the quarter and ended at 3.1% and 3.9% in the most recent release, respectively. The Bank of Japan continued its accommodative monetary policy stance, although it took a step toward reversing the policy when it announced that the 1% cap on its 10-year government bonds would be considered a reference rate going forward. The yen reversed its recent trend and gained value during the quarter, ending the period at approximately 141 USD/JPY.
We believe our intensive research process and focus on the long term help us find opportunities despite the pervasive theme of the time. When the market does not separate the macro from the micro, there is an exploitable opportunity for long-term investors, such as ourselves. We use times of uncertainty and volatility to strategically position our portfolios for long-term success and believe this approach best positions us for achieving the protection and appreciation of our investors’ capital over the long term.
Capital One Financial, which specializes in consumer finance, was the top contributor for the quarter due to strong third-quarter results. The company’s earnings per share of $4.45 was about 37% above consensus estimates, and its loan growth, net interest margin, non-interest income, operating expenses and charge-offs were all better than consensus estimates. In regard to credit quality, management noted that while portfolio-wide monthly delinquency and charge-off rates slightly exceeded 2019 levels, those trends were stabilizing. In addition, Capital One maintains sizeable capital and liquidity buffers. Overall, we appreciate the company’s value-focused management team, consistent reinvestment in technology development and stable deposit base.
KKR was a contributor during the fourth quarter. The U.S.-headquartered financial firm’s stock price rose in December as the company negotiated terms to purchase Iris Software from Hg Capital, though later in the month Hg Capital opted to finalize a deal with its rival, Leonard Green & Partners following some disagreements with KKR. The company acquired a $7.2 billion portfolio of super-prime recreational vehicle loans from BMO Bank National Association in December and announced in late November its acquisition of the remaining 37% of Global Atlantic (GA) for $2.7 billion. Management believes this acquisition is an attractive valuation given the growth opportunity as it believes GA can double earnings over the medium term and anticipates that owning all of GA will accelerate growth, which will be beneficial to KKR’s asset management business. Lastly, KKR raised its 2026 fee-related earnings target by 12.5%, mainly due to a stronger fundamental outlook and a change in the company’s compensation framework. We continue to believe that KKR is an attractive, high-quality business and a fast-growing franchise that is run by an excellent management team.
Ryanair Holdings, a European ultra-low-cost airline, was a contributor this quarter. Ryanair released strong results for the first half of fiscal-year 2024 and was accompanied by an even stronger outlook, in our view. The company’s revenue grew 30% year over year, and average fares increased by 24% to EUR 58, driven by record demand and constrained capacity at European peers. Total passengers flown expanded 11% year over year to 105.4 million, and management is on track to maintain its target of 183.5 million passengers for 2024, depending on Boeing’s ability to meet its delivery commitments. Management is expecting full-year 2024 net income to be between EUR 1.85-2.05 billion ahead of the EUR 1.82 billion consensus estimate. The company’s strong free cash flow levels and balance sheet allowed Ryanair to reinstate a EUR 400 million dividend (35 cents per share). We spoke with CEO Michael O’Leary about additional uses for its excess capital and were happy to hear about an incremental EUR 1.5 billion return to shareholders starting in 2025. We continue to be optimistic about Ryanair’s future.
Bayer, a life science company with pharmaceuticals, consumer health and crop science divisions, was the quarter’s top detractor. During the quarter, the company announced its decision to stop its OCEANIC-AF trial for asudenxian early due to lack of efficacy. The company was ordered to pay $1.5 billion to three plaintiffs in a recent RoundUp case. While both events were disappointments, the asundexian news is more relevant to us because we expected both wins and losses in the RoundUp legal saga and anticipate this recent verdict will likely be reduced significantly on appeal. Asundexian was Bayer’s largest late-stage pharma pipeline opportunity and had potential to be a next-generation Xarelto, but the trial was riskier than usual due to its data profile in earlier stages. We have modestly reduced our estimate of Bayer’s intrinsic value, but we still believe the stock is attractively priced, trading at around 6 times 2024 earnings. We continue to monitor the situation and will adjust our analysis, if necessary. We met with new CEO Bill Anderson after the news, and we are impressed by his thoughtfulness, strong background in pharma, and urgent desire to improve the areas of the company that have held it back from its full earning potential.
Charter Communications was a detractor during the fourth quarter. In October, the U.S.-headquartered communication services company’s share price fell as its third-quarter broadband subscriptions fell short of consensus estimates. Despite the shortfall, volume remains above peers. Adjusted earnings were in-line with consensus estimates, and we believe should improve next year as there are multiple tailwinds including expense growth, mobile promotion roll-offs and a higher contribution from rural subs. In December, Charter’s presentation at the UBS conference resulted in the company’s volatility. CFO Jessica Fischer’s comments during the presentation led investors to conclude that unfavorable trends in the third quarter have continued. “In our third quarter call…we had seen a little bit of carryover churn related to the combination of Disney and rate impacts that occurred inside of Q3. November has been similarly soft, so I can certainly see that it’s likely that we could end up with negative internet net ads inside of Q4.” However, management believes this is a short-term challenge and that its total broadband opportunity in the long term has not changed. Despite the market’s reaction in the short term, we believe that Charter Communications is a solid investment.
Julius Baer Group was a detractor during the quarter. In November, the Swiss private bank released a trading update that showed material deterioration in the profitability of its business over the past four months. We believe recent weakness is due to market volatility and upfront investment in hiring new relationship managers, which was confirmed through conversations with CFO Evie Kostakis. In our view, Julius Baer is an excellent business due to its strong competitive position in growing emerging markets and a new CEO who has taken steps to improve operating efficiency.
During the quarter, we added Agilent Technologies, Centene, Kroger and Roche Holding to the portfolio. We eliminated our positions in Oracle and Parker-Hannifin.
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