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.
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.
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.
Fresenius Medical Care’s first-quarter revenue and earnings were largely in line with our estimates and market projections, while earnings per share of EUR 0.85 were 6% better than market forecasts of EUR 0.80. Total organic revenue rose 1.4% from the prior year, mainly driven by growth in the Asia Pacific region where the earnings margin also expanded by 60 basis points. Improved pricing and expansion of value-based care arrangements in the key North American market partially offset services business revenue that fell 0.7%, driven by a drop of 2.6% in same-market treatments. The treatment decline was consistent with peers and was due to Covid-19 mortality among the high-acuity dialysis patient base. Home dialysis continued to expand to 14.6% of patients, and the expansion of Medicare Advantage in the business mix led to positive pricing in the U.S. We recently spoke with CEO Rice Powell who remains focused on recovering from temporary Covid-19 challenges. The recovery plan includes a holistic reassessment of how the company operates, what businesses it needs to own and how to propel the margin recovery as part of its FME25 restructuring plan. We believe the leadership team at Fresenius Medical Care is taking the right actions that can result in shareholder benefits.
The share price of Prosus declined in the second quarter following management’s announcement in April that it had reduced its stake in Tencent from 31% to 29%, raising $14.7 billion in cash, and agreed not to sell any additional Tencent shares for three years. The move was in line with our expectations as we believe it is a good time to sell shares and raise cash following its additional investment in Delivery Hero. Though the company indicated the sale proceeds would be used to make investments, investors appeared to be disappointed that it did not immediately announce a new share repurchase program. Later, Prosus made a voluntary exchange offer for up to 45.4% ownership of Naspers shares, including a 2.27 new Prosus share exchange ratio for each share of Naspers. Subsequently, Prosus issued a full-year trading statement that included total revenue of $5.12 billion and core headline earnings per share of $2.99, which both exceeded market forecasts. We remain confident in management’s commitment to closing the gap between the company’s current share price and our perception of its intrinsic value.
Even though Fiserv’s first-quarter earnings disappointed investors, we saw results as respectable considering the challenging operating environment. Results were largely in line with our estimates, and total revenue and earnings per share surpassed market expectations. More importantly, organic revenue grew 4% from the prior year, earnings rose 15% and earnings per share advanced 18%. In merchant acquiring, organic growth amounted to 8% and margins improved 650 basis points, while gross payment volume in Clover (cloud-based point of sale product) grew 36%, ecommerce transactions grew 24% and the company won a record number of new customers during the period. In addition, we were pleased that Fiserv executed $612 million worth of share repurchases in the quarter (or about 0.8% of it share base). Despite this solid performance, the share price of Fiserv fell for the quarter as a market analyst downgraded the company, stating that valuations may contract from slowing organic revenue growth in the merchant segment. We possess an opposing view and our investment thesis for the company remains intact.
First-quarter results from Booking Holdings fell short of investor expectations. Revenue remains depressed relative to pre-pandemic levels and declined 50% from last year. However, earnings per share were not as poor as feared and we saw some other signs of improving trends. Although the total number of room nights booked declined 20% in the first quarter from the prior year, growth in the U.S. became positive year-over-year, which is where Booking believes it is taking share. In Europe, summer bookings are now within 30% of levels achieved in the summer of 2019. As a result of the company’s push toward the “connected trip,” the relationship between gross booking trends and room nights booked is beginning to diverge as new services, such as flight bookings, appear to be off to a strong start. In addition, over two-thirds of bookings are now conducted via mobile devices and the majority of those were through the company’s app. Bookers on the app tend to be more loyal and exhibit much higher repeated behavior, so the increasing mix of app downloads should benefit marketing efficiency. Moreover, CEO Glenn Fogel believes that the alternative accommodation mix will be structurally higher post-Covid-19 as many consumers will permanently incorporate this option into consideration.
During the quarter we initiated new positions in Danone. There were no final sales during the period.
Past performance is no guarantee of future results.
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