THE MARKET ENVIRONMENT
Major global markets finished largely higher in the fourth quarter in spite of a variety of macroeconomic concerns that ranged from inflation fears to supply chain disruptions along with yet another Covid-19 variant that took hold in the final three months of the year. As previously announced, the Federal Reserve slowed its pace of asset purchases in November. The tapering came as the rate of inflation in the U.S. quickened to 6.8% versus the year-ago period. The Fed’s dot plot now calls for three rate hikes each in 2022 and 2023. The Bank of Japan and European Central Bank echoed similar sentiments as they also left interest rates unchanged, while the Bank of England raised its main interest rate from 0.1% to 0.25% following a surge in U.K. inflation to a 10-year high of 5.1% annual growth in November.
Meanwhile, as the world attempted to return to normal from the depths of the global pandemic, energy suppliers rushed to ramp up production to meet growing demand. However, a supply shortage and bottlenecks at major U.S. ports sent U.S. oil prices in excess of $85 per barrel for the first time since 2014. Natural gas prices also spiked around the world, forcing the suspension of operations at factories in Europe and China. A shortage of semiconductors, in particular, significantly impaired worldwide automobile production. Simultaneously, the new and highly contagious Omicron variant of Covid-19 spread in the fourth quarter as countries across Europe implemented restrictions once again to combat the spread of the disease.
Although stock prices surged higher in many places across the globe, we are still finding pockets of value in the market. Once restrictions lift, we think pent-up demand and savings will drive business growth in places like Europe. That said, the world is learning how to live with the ever-changing risk of Covid-19, much like how investors must continuously monitor potential risk, potential return and the quality of the businesses when making investment decisions. We think our long-term investment horizon positions us well to observe and capitalize on these considerations.
Alphabet’s third-quarter earnings release resulted in the company’s share price moving higher throughout the quarter. Reported revenue growth amounted to 41% and operating margins (ex-other bets) expanded 670 basis points. In addition, search and YouTube advertising revenue both grew over 40%. Management bought back $12.6 billion worth of stock in the third quarter, which puts the company on pace to meet our expectations for the full-year period. Although Alphabet’s share price declined on news that YouTube TV subscribers lost access to Disney-owned entertainment options, the issue resolved itself shortly thereafter. We believe Alphabet remains an attractive holding with upside potential despite its recent share price appreciation.
In October, Hilton Worldwide released its third-quarter earnings report, which revealed continued progress toward what we believe will be a stronger than expected recovery. Leisure room night bookings are back to roughly in line with 2019 levels, while leisure rates now exceed 2019 levels. Business travel has also gained momentum as midweek occupancy and rates improved compared to the company’s previous quarterly results. Hilton Honors members grew 11% year-over-year, and engagement with members is nearly back to 2019 levels. We believe Hilton’s pricing power is a valuable strength as pricing power for corporates and groups are currently above 2019 levels and should expand as demand is reinforced going forward. In our view, Hilton is well positioned to grow units at an above-average rate for many years to come and has a competitive advantage that continues to widen, which adds confidence to our investment.
CNH Industrial’s share price responded favorably to positive developments throughout the quarter on the demerger of its IVECO (trucks and commercial vehicles) business, which becomes effective on January 1, 2022. In our view, CNH delivered excellent third-quarter earnings results, with 23% organic growth, 100% earnings growth and a 230 basis point margin expansion. In the agriculture equipment segment, strong industry combine demand across the globe drove 30% local currency growth. Anticipation for supply chain issues in the fourth quarter prompted management to lower its guidance for net sales to come in at the low end of the 24-28% range and for free cash flow to finish around $1 billion, though these figures are largely in line with our forecasts. Management has worked to fortify the balance sheet while protecting pricing. We believe the team is driven to create shareholder value through operational enhancements and other initiatives.
Citigroup’s third-quarter earnings report largely met market expectations and the company reiterated its full-year revenue and expense guidance. Later, Citigroup announced it expects to recognize about $1.2-$1.5 billion of cash charges over the course of 2021 and 2022 as a result of employee separation payments associated with the company’s exit of its South Korean consumer business. CFO Mark Mason noted that the economics of winding down operations in South Korea are “much more attractive than continuing to run the business” given the heavily regulated market with high labor costs and price controls. In December, Citigroup presented at a conference where it reiterated its full-year revenue and expense guidance. Trading guidance fell short of investors’ outlook, while fee revenue figures across the balance of the business exceeded analysts’ estimates. The company also announced a pause in share repurchases, which we found disappointing, though we do understand the company’s unwillingness to temporarily dip below its targeted CET1 ratio. In our view, Citigroup’s underperformance is attributable to the market’s unwillingness to look through near-term pressures, and we believe the company trades at a discount to our perception of its intrinsic value.
Charter Communications’ share price retreated throughout the quarter. Investors proved disappointed with the deceleration in the company’s broadband business as exhibited in the company’s third-quarter earnings results. Importantly, we appreciate the company’s history of transparency in the past when competitive intensity in the market increased and do not believe the slowdown in internet net additions is attributable to a reduced win rate. In addition, Charter’s adjusted earnings increased nearly 14%, and mobile net additions were solid, in our view. The company repurchased 8.1% of its share base in the year-to-date period, and our investment thesis remains intact.
Fresenius Medical Care delivered soft third-quarter earnings results as the Delta variant brought a surge of excess mortality and postponed the date at which the dialysis census returns to growth. That said, gross additions remain strong and should drive expansion of the pool once mortality normalizes. Moreover, unlike its peer Davita, which is anticipating a large investment into value-based care that will pressure earnings next year, Fresenius Medical Care’s early investment in the space positions the latter well. Following a call with CFO Helen Giza, we believe the FME25 restructuring plan possesses ample savings potential and its structural redesign makes sense. We like that the service and product businesses are separated into distinct units and the regional structure is dissolved. We find that performance improvement opportunity is palpable for international service and products, and Giza seems like a quality candidate to lead the FME25 transition as chief transformation officer.
During the quarter, we received shares of Daimler Truck Holding as part of a spin-off from our position in Daimler. There were no final sales.
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