Commentary

Global Concentrated Strategy

September 30, 2022

THE MARKET ENVIRONMENT

Major global markets continued to experience pressure and volatility in the third quarter as investors reacted to prevailing challenges facing economies across the world. Efforts by central banks to reign in elevated inflation by tightening financial conditions were at the forefront of financial discourse with investors reducing exposure to assets, such as equities, as interest rates climb at aggressive paces. In the U.S., the Federal Reserve raised its benchmark interest rate by 75 basis points in July and again in August to 3.00–3.25%. Importantly, rhetoric following each decision was noticeably hawkish as Fed Chair Jerome Powell looked to emphasize the Federal Open Market Committee’s commitment to regaining price stability with further rate hikes, even at the expense of economic hardship. The Bank of England, Bank of Canada and European Central Bank all increased their respective benchmark rates in September by 50, 75 and 75 basis points, respectively. China and Japan’s central banks opted for more accommodative policies. Major currencies including the pound, yen, euro, Australian dollar and Swiss franc all depreciated against the dollar throughout the quarter.

Late in the quarter, newly elected U.K. Prime Minister Liz Truss created some volatility in markets when she announced plans for an unfunded tax cut totaling GBP 45 billion per year in hopes of easing citizens financial burdens and spurring economic growth. The 30-year yield for a U.K. government bond jumped nearly 150 basis points in under a week to nearly 5% before settling at around 3.8%. The Bank of England reacted by purchasing gilts to stabilize the market and delayed its planned quantitative tightening program of selling gilts.

While we do not overlook the negative impacts the war in Ukraine, tightening financial conditions, energy crisis and volatile currencies will continue to have, we remain cognizant that a company’s value is derived from its longer term cash flows discounted back to the present day. As share prices fall across the board, we rely on our disciplined approach to identify exceptional businesses overpenalized by share price activity. In our view, risk is not synonymous with owning equities during times of market turmoil. Rather, we believe owning companies that meet our rigorous criteria at discounted levels offers an attractive opportunity on a risk to reward basis.

THE PORTFOLIO

Top Performers:
Pinteres
t’s second-quarter earnings impressed investors due to stabilizing engagement trends and guidance for mid-single digit revenue growth in the upcoming quarter, despite foreign currency exchange pressures and disappointing recent guidance from peers. In addition, mobile app users, which account for the vast majority of revenue and impressions, increased 8% year-over-year. CEO Bill Ready indicated that the company will return to “meaningful margin expansion” in 2023 and noted that he would evaluate how best to deploy the company’s $2.7 billion in net cash for the benefit of shareholders. Our conversation with Ready and CFO Todd Morgenfeld after the release furthered our belief that they have the capability and appropriate vision to benefit the company and shareholders over the long term.

HCA Healthcare’s second-quarter results were strong, in our view, with revenue and earnings that surpassed market expectations. Investors were positively surprised that management maintained its full-year guidance, especially in light of the pre-announcement that reflected underperformance from Universal Health Services and dampened health care sector expectations. HCA realized year-over-year same facility gains in equivalent admissions and revenues for equivalent admissions and inpatient admissions. Expenses for salaries, benefits and supplies were lower than market projections, which led to an earnings margin that was 140 basis points better than had been predicted. Management commented that the company’s various cost initiatives are working as planned and should alleviate concerns about labor cost pressure. In addition, HCA bought back $2.7 billion worth of shares in the second quarter and had $3.8 billion remaining under its current repurchase authorization. Finally, CEO Sam Hazen and CFO Bill Rutherford stated they are pleased with the progress made in contract negotiations with payers, particularly with respect to pricing for inflation over the next couple of years. Importantly, management reiterated confidence that HCA’s long-term growth and margin profiles remain unchanged. In our view, Fiserv delivered good second-quarter earnings results in July, including 12% organic revenue growth that remained ahead of analysts’ estimates. We appreciate that each segment performed well, led by the merchant acquiring business, which achieved 17% organic growth. In addition, the fintech segment grew 7%, and the payments and networks division accelerated to 8%. Despite a challenging inflationary environment that pressured margins, Fiserv anticipates a recovery in the second half of the year and also increased its 2022 organic revenue guidance.

In our view, Fiserv is benefiting from the continued secular shift toward electronic payments and digital banking. We think the mission-critical nature of Fiserv’s products and its positive track record in down markets gives us confidence in the company’s ability to withstand today’s headwinds and thrive into the future. We believe the company has been unfairly penalized by the market as “buy now pay later” and other payments companies have seen their multiples compressed. We see this as an attractive opportunity based on our belief that it is a solid business with an attainable path to healthy growth.

Bottom Performers:
Charter Communications reported second-quarter revenue of $13.6 billion and adjusted earnings of $5.5 billion, both of which outpaced market expectations. Revenue rose 6.2% from a year earlier and earnings grew 9.7%. However, investors may have focused on the company’s broadband subscriber net loss of 21,000 (which included the reduction of 59,000 government subsidy customers). Management attributes the weak broadband results largely to low residential relocation activity and the return of college seasonality. In addition, while capital expenses were 5% higher than the market had predicted, capital expenses from core cable operations continue to decline and are trending well below our maintenance forecast. Furthermore, just prior to the company’s earnings release, a Texas jury awarded $7 billion in damages to the family of a customer who was murdered by an off-duty technician. Later, a judge reduced the settlement to $1.15 billion. Charter plans to appeal and stated that a criminal background check conducted on the employee showed no arrests, convictions or other criminal behavior. We are following the situation closely and will adjust our metrics as appropriate.

Before releasing its fiscal first-half results, adidas issued a profit warning, citing a slower than expected recovery of business in China and the impact from clearing excess inventories through the end of the year. First-half results included revenue growth of 5.3% (unchanged in local currency), while the gross profit margin and earnings margin contracted by 170 basis points and 450 basis points, respectively. However, sales results differed significantly across regions. Western markets (which account for over 70% of revenue) grew by double-digit percentages despite supply chain challenges, while China remains under severe pressure and revenue declined 35% in the second quarter. Excluding China, total revenue in local currencies grew by 14% in the second quarter. Also, adidas has successfully implemented price increases and average selling prices advanced by 10% across the company due to a combination of pricing actions, product mix and channel mix. Lastly, we met via video with Kasper Rorsted who had previously announced he would be stepping down as CEO in 2023. Rorsted believes the company is poised for a robust business recovery as concerns over Covid-19 recede and the general economy improves.

Alphabet’s second-quarter results were better than previously feared as concerns over a slowdown in industrywide advertisement spending mounted in recent months. Compared with last year, total revenue grew 16% in constant currency to nearly $70 billion, driven by revenue increases in the Cloud (+39%) and Search (+18%) segments. YouTube advertising revenue also grew 9% in constant currency. However, operating income fell approximately 4% short of market expectations and earnings per share were 5% below projections. The total operating margin declined to 28% from 31%, mainly owing to investments across several segments, including research and development, sales and marketing, and general and administrative along with negative currency effects. When discussing the near-term outlook, management noted “pullbacks in spending by some advertisers” and “uncertainty in the global macro environment,” which may have unnerved some investors. By our measure, Alphabet’s fundamentals are solid and it remains an attractive holding.

During the quarter, we purchased shares of Richemont and eliminated Daimler Truck Holding from the portfolio.

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 Concentrated composite as of 09/30/2022.

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.