THE MARKET ENVIRONMENT
Major global markets finished lower for the first quarter as Russia’s invasion of Ukraine prompted unease among investors. In particular, major U.S. stock benchmarks delivered their worst quarterly performance since the onset of the Covid-19 pandemic. Throughout the first quarter, countries responded with sanctions on Russia in a nearly unified condemnation of the invasion. In China, concerns that its ties to Russia could result in sanctions from the U.S. pressured share prices in the country. However, a meeting of China’s State Council late in the first quarter effectively alleviated unease regarding its economic climate given the body’s pledge to support economic growth and stability.
Meanwhile, supply concerns stemming from the conflict sent prices of WTI crude oil in excess of $120 per barrel. In response, U.S. President Joe Biden announced the release of 1 million barrels of oil a day for the next six months from the U.S. Strategic Petroleum Reserves. In addition, OPEC confirmed its intent to increase production by more than 400,000 barrels per day.
As expected, the U.S. Federal Reserve raised interest rates by a quarter point in March for the first time since 2018. The Fed also struck a more hawkish tone than at its previous meeting. It now projects a total of seven rate hikes in 2022, an increase over the three projected rate increases in 2022 from its December meeting. In the following days, Fed Chairman Jerome Powell indicated that inflationary concerns further fueled by the crisis in Ukraine that led to a 7.9% increase in the consumer price index in February could lead to a more than one quarter of a percentage point hike at upcoming meetings. In the U.K., the Bank of England increased interest rates by another 25 basis points for its third rate hike since December. President of the European Central Bank Christine Lagarde pointed to a slower pace of rate hikes, despite a 5.9% inflation reading in February and a 7.5% inflation reading in March in the region.
As we have mentioned in time of previous crises, such as Brexit and the global financial crisis, we do not believe that share price movement reflects the long-term underlying value or quality of the businesses in which we invest. Our focus remains firmly on refining our value assessments as material, fundamental information flows from our companies and not on short-term, sentiment-driven share price movements. In our estimation, volatility is not synonymous with risk. Rather, it is an asset that can be utilized to optimize portfolio positioning for success over the long term.
Bayer reported strong earnings results for 2021, in our view, with growth exceeding expectations across divisions. Notably, the crop science division delivered 11% growth, staging a robust recovery following two years of an agriculture downcycle and competitive challenges. Management’s increased guidance for crop sciences in 2022 calls for 7% organic growth and a 25-26% margin, which we believe is a key positive for the segment as it signals a long-awaited favorable transition toward profitable growth. In the pharmaceuticals division, revenue growth of more than 7% also bested expectations, supported by a strong recovery of Eylea, continued growth of Xarelto and the ramp of new products. Moreover, Bayer’s pipeline enjoyed notable successes in the period, including a favorable read-out for cancer drug Nubeqa. We spoke with Bayer CFO Wolfgang Nickl during the quarter who noted that tailwinds are robust in the business today. Notably, he expressed confidence in both the pricing and competitive backdrop in the crop sciences business as rate increases are layering into sales growth and cost cuts begin to come through. Nickl also reiterated Bayer’s expectations for continued growth in pharmaceuticals, driven largely by new launches and technologies.
In our view, Glencore delivered a solid fiscal year 2021 earnings report as financial metrics improved materially year-over-year. In the marketing segment, earnings handily bested expectations ($3.7 billion vs. $3.48 billion). In metals, earnings increased to $2.5 billion from $1.7 billion for the year-ago period due to strong demand, supply constraints and inventory drawdowns. We recently met with CEO Gary Nagle and CFO Steve Kalmin and discussed the massive impact the crisis in Ukraine is having on Glencore’s markets. As customers bypass Russian oil, natural gas and coal, the tightened supply translated to large price increases. In particular, European nations are now buying coal at elevated prices as a replacement for Russian natural gas, leading to stronger than expected free cash flow. Management also noted that the company now has 27 assets either in sale processes or under consideration on top of the nine assets already sold as part of the portfolio simplification. We appreciate CEO Gary Nagle’s focus on efficiency and returns and believe the company trades at a large discount to our perception of its intrinsic value.
Berkshire Hathaway’s fourth-quarter earnings report showed strength across the board, in our view. We are particularly impressed with the 4% revenue and 8% adjusted earnings compound annual growth rates in 2019 through 2021 of the manufacturing, service and retail businesses. The energy business also impressed with around 10% organic earnings growth in 2021. CEO Warren Buffet indicated in his annual shareholder letter that the company maintains a cash position of nearly $144 billion due to an inability to find attractive enough opportunities to hold over the long term. The company repurchased $27 billion in shares in 2021 bringing the two-year total to $52 billion, or 9% of the float. We appreciate Berkshire’s diversified operating businesses and recent operational changes that are driving improved operational performance. The company’s strong balance sheet affords optionality to play offense even in difficult market environments, and we think Berkshire’s deeply ingrained shareholder-first culture will outlast its current management team.
Owing to its 29% stake in Tencent and the impact of the Russian invasion of Ukraine, Prosus’ share price declined in the first quarter. Tencent was negatively impacted by fears for increased regulation and a poor macro backdrop, which have negatively impacted fundamentals. We have spoken with numerous contacts on the changing regulatory landscape in China. While we believe structural growth at Tencent will be lower in the future as a result of the new regulatory environment, Tencent remains an excellent business with a high degree of innovation. Later during the quarter, Russia’s invasion of Ukraine weighed on companies with exposure to Russia. In Prosus’ case, its two Russian assets, Avito (the largest online classifieds company in Russia) and Mail.ru (the largest social media company in Russia), are now valueless, in our estimation, and resulted in our small reduction of our estimate of Prosus’ intrinsic value. While we are monitoring any new developments closely, we continue to believe Prosus remains extremely undervalued relative to its sum of the parts.
Late in January, General Motors (GM) announced that Ultium Cells, its joint venture with LG Energy Solution, will build a $2.6 billion plant for the production of battery cells. GM also announced a $4 billion investment to convert its Orion Assembly facility into an electric truck production site. The company later released its fourth-quarter earnings report revealing adjusted earnings, earnings per share and free cash flow all better than consensus estimates. Chip-related supply constraints improved, aiding volumes, and management is optimistic they will see continued improvement throughout the year. Additionally, Cruise announced it is now allowing members of the public to reserve driverless rides in San Francisco. In March, General Motors announced it is paying $2.1 billion for SoftBank’s current equity stake in Cruise and will make an additional $1.35 billion investment resulting in 80% ownership of Cruise once the transactions are finalized. The implied valuation of approximately $19 billion is down from the January 2021 mark of around $30 billion. CFO Paul Jacobson believes GM paid a very attractive price and was able to take advantage of SoftBank’s current desire to raise cash.
Early in the quarter, we were disappointed to see the departure of Chairman Antonio Horta-Osorio from Credit Suisse given his talents and the restructuring plan he initiated there. Later, the company delivered a disappointing fiscal year 2021 earnings report as a CHF 1.6 billion non-cash goodwill impairment exceeded our expectations and pressured results. Also of concern was the company’s weakened revenue generation as underlying fourth-quarter revenues declined CHF 860 million from the year-ago period due primarily to weakness in the investment banking division. Management provided limited guidance for 2022 but reiterated that it would be a transition year, with expectations for about CHF 17 billion in adjusted operating expenditures for the fiscal year. While the results were a bit disappointing and we understand that 2022 will be a transition year, we appreciate that the problems surfacing today are legacy issues and that Credit Suisse is taking the proper corrective action to improve its franchise and earnings power over the medium term. It is important to realize that Credit Suisse has made significant changes to both the senior management team and to the board of directors. Toward the end of the period, the company provided an update on its exposure to Russia which it reduced since the end of 2021. We believe the remaining exposure, including credit exposure from derivatives and financing from the investment bank, to have an immaterial impact on our estimate of the firm’s intrinsic value. Moreover, we remain hopeful that with the various management enhancements mentioned, especially in the areas of risk control and compliance, that Credit Suisse will live up to its potential and avoid the pitfalls of the past. In the appointment of Axel Lehmann as the new chairman, we hope with his experience, along with a timely execution of this new strategic plan, that Credit Suisse will not only be strengthened but revitalized.
During the quarter, we purchased shares of Iveco Group and Pinterest and eliminated Hilton Worldwide from the portfolio.
Past performance is no guarantee of future results.
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