Commentary

Global Strategy

March 31, 2022

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.

THE PORTFOLIO

Top Performers:
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.

Halliburton’s fourth-quarter earnings results exceeded market expectations amid an improving end-market backdrop as earnings per share ($0.36 vs. $0.34) and revenue ($4.28 billion vs. $4.09 billion) bested analysts’ estimates. Pricing continued to strengthen across the business, attributed to increased customer urgency to secure equipment and services. In addition, Halliburton increased its quarterly dividend from $0.045 per share to $0.12 per share. Later, the company benefited from rising oil prices caused by the conflict in Ukraine and anticipation for increased demand for U.S.-produced oil. We believe the oil field service company continues to execute well in the early stages of an industry-wide recovery.

Bottom Performers:
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.

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.

BNP Paribas released its full year 2021 earnings report in February. Operating income and revenue grew year-over-year by 46% and 4%, respectively, both of which were in line with our estimates. Growth of 5.2% in domestic markets and 3.4% in corporate and investment bank segments offset weakness in the international financial services segment, which shrunk by 1.2%. Operating expenses were about 100 basis points higher than expected due to increased investment, which management attributed to business development initiatives across all three segments. Management addressed concerns surrounding negative operational gearing for the fourth quarter and said it expects to generate positive operational gearing in each of the next four years. Given management’s track record on cost management, we are optimistic on its ability to see these goals come to fruition. We spoke with management following the report and upon the release of its new 2025 financial targets. Our biggest takeaway is that we believe the company has conservative targets across the board, in part due to its assumption for no material movements in short-term interest rates, and we believe they are positioned well for the current economic environment.

During the quarter, we purchased shares of Amazon, BlackRock and Iveco Group. We eliminated Constellation Brands, General Dynamics and Naspers 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 composite as of 03/31/22.

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.