Commentary

Global Strategy

March 31, 2020

THE MARKET ENVIRONMENT
At the start of 2020, it appeared market activity would continue in familiar fashion and would largely support global benchmark levels achieved from prior bull market advances. However, by mid-January, developments concerning the coronavirus came to light. What began in late 2019 as an outbreak localized to China spread swiftly and by mid-March, the World Health Organization officially deemed the coronavirus a global pandemic. Equity markets declined precipitously in conjunction with increasingly dire news about the accelerating rate of illness.

The virus quickly disrupted economic activity across geographies and sectors from large global enterprises to Main Street businesses. Significant travel restrictions, the shutdown of typical group gathering activities and orders by officials in many countries for citizens to stay home upended daily life. Even the 2020 Olympic Games were postponed. Unemployment began to rise, with the U.S. seeing a record three million jobless claims filed in a one-week period and the United Nations estimated that virus-prompted job losses could exceed 25 million worldwide. To stem the economic impact, policymakers around the world enacted significant economic stimulus measures and leaders of industrial nations vowed to work in tandem to support the global economy. Though some funding levels have already reached trillions, economists expect that even more stimulus may be necessary.

Over our decades of experience, we have witnessed other market-rattling crises, each uniquely different from each other. No one knows how this particular issue will be resolved as there is not enough data today to reach specific conclusions. Yet please be assured that our framework for dealing with exogenous risks like this is to attempt to determine the impact on business value rather than extrapolate near-term costs in perpetuity. In our assessment, equity share price declines have reached levels that are in excess of the actual value declines of businesses we hold. One proactive action we adopt under adverse circumstances is to rebalance our client portfolios. We take advantage of lower equity prices to increase share weightings of companies that, according to our estimates, have become even more undervalued. Although the current situation is changing rapidly, as long-term investors, we focus on rational decision-making and avoid making emotionally driven investing choices. Our investment team remains on vigilant watch for appropriate opportunities today that we believe can yield shareholder rewards over our typical five- to seven-year holding timeframe.

THE PORTFOLIO
Top Performers:
Regeneron Pharmaceuticals issued fourth-quarter results that were stronger than our estimates as well as market forecasts. Total revenue rose 13% from a year earlier to $2.17 billion, propelled by U.S. EYLEA® revenue that grew 13% for the quarter and advanced 14% for the full year. Dupixent® revenue growth was also strong and increased 136% on a global basis in the fourth quarter. Despite a notable increase in operating expenses from drug pipeline expansion and launch investments, full-year earnings climbed 4%. In addition, management conducted its first stock repurchase in the fourth quarter, buying back $250 million worth of shares. Later, news surfaced that BEOVU®, developed by Novartis as a competitor product to EYLEA, was found to cause serious side effects. Investors reacted favorably to market analysts’ reports that this development effectively negates BEOVU’s ability to meaningfully compete with EYLEA. Furthermore, Regeneron has made progress creating a medication to treat coronavirus. With Sanofi, it has entered into a clinical trial program for KEVZARA®, which targets patients diagnosed with severe disease conditions. We are hopeful that Regeneron’s efforts can produce positive outcomes.

Agilent Technologies reported fiscal first-quarter revenue and earnings per share that aligned with market expectations. Total revenue of $1.36 billion reflected growth of 5.7% from last year, driven by recurring revenue that climbed 7%, and adjusted earnings per share rose almost 7% to $0.81. The company’s recent acquisition of BioTek Instruments, a manufacturer and distributor of life science equipment, positively added to results as sales in this unit advanced over 20%. While fallout from the coronavirus pandemic will likely impact Agilent’s near-term results, we think the company can weather the storm better than most due to its solid balance sheet, strong cash flow and resilient customer base. In addition, demand for tools used in quality control testing is highly correlated with production volumes of the world’s largest food, drug and beverage companies, which we believe should continue at a healthy pace. Management has repeatedly stated expectations for total revenue to continue increasing at low single-digit rates even through a recession, owing to the company’s ability to generate robust recurring revenue.

Late in 2019, Prosus released its first set of financial reports and its share price rose early in the first quarter. The company also engaged in a high-profile bidding war to acquire Just Eat in recent months and in January, the company received positive reviews from some market analysts. We subsequently decided to exit this position in favor of other investments that we believe offer better upside potential.

Bottom Performers:
Glencore’s full-year results included total revenue that missed market expectations and earnings per share that met market forecasts, while earnings (both EBITDA and EBIT) exceeded market projections. However, year-over- year total earnings declined as earnings from industrial operations fell 32.5% (EBITDA) to $8.96 billion and marketing earnings (EBIT) dropped 1% to $2.37 billion. The company finished the year with net debt of $17.56 billion and total capital expenditures of $5.37 billion, which were both larger than market expectations. Management stated the company remains focused on reducing total net debt to a range of $14-15 billion. From a production perspective, copper, coal and oil full-year output exceeded market estimates, while zinc and nickel output underperformed estimates. Management’s 2020 production guidance was also lower than market forecasts for copper, zinc and nickel. As we have remarked recently, market conditions for Glencore have been challenging. We met with CEO Ivan Glasenberg and CFO Steve Kalmin during the quarter and learned that although metals pricing remains volatile, fortunately the coronavirus pandemic has not caused significant disruption to the company’s operations. We continue to believe Glencore is well positioned to provide shareholder benefits going forward.

BNP Paribas issued full-year results that we saw as solid. Revenue rose 4.9%, which surpassed our estimates, and increases of both operating income (+10%) and net income (+8%) aligned precisely with our forecasts. Pre-tax operating profit rose across domestic markets, international financial services and corporate banking by 31%, 43% and 26%, respectively, while operating expenses grew only 1.8% (at constant scope and exchange rates), which enabled BNP to generate operational leverage across all three segments. The company continues to benefit from its 2020 Transformation Plan, which has generated cumulative recurring savings of EUR 1.8 billion since 2017, and management expects incremental savings to continue in the current year. Capital generation was better than we had expected, owing to a sequential fourth-quarter decline of EUR 8 billion in risk-weighted assets, which propelled the common equity Tier 1 ratio to meet management’s target of 12.1%. Despite this positive performance, management reduced the 2020 return on tangible equity (ROTE) target for the second time in two years, citing pressure from negative interest rates. Even at the revised rate, the company’s ROTE forecast reflects an increase from the prior year, and we find the new rate acceptable.

CNH Industrial released fourth-quarter results with revenue that missed market expectations, while earnings per share met market forecasts. Overall, results for the full year were weaker than our estimates as revenue and earnings from industrial operations declined from the prior year. In the key agriculture segment, revenue declined in excess of both our forecasts and management’s expectations, in part owing to lower market volumes for row crop equipment. However, CNH successfully managed its row crop inventory position in North America, which was 16% lower year over year. Concurrently, row crop net pricing stayed consistently strong and remained over 2.5% higher in 2019. In other segments, construction and powertrain results were also weak, while results in the Iveco segment outperformed our estimates. Later, CNH announced the resignation of CEO Hubertus Mühlhäuser and CFO Max Chiara. Board of Directors Chairwoman Suzanne Heywood assumed the role of interim CEO until a permanent CEO is identified and Oddone Incisa was appointed CFO after leading the company’s financial services segment since 2013. We spoke with Heywood who explained the board’s intent to improve execution, especially with regard to immediate issues, such as trade wars, cost reductions and now the coronavirus pandemic. We think new leadership can build on prior incremental progress and bring about better shareholder value.

During the quarter, we initiated a position in Agilent Technologies and eliminated Prosus from the portfolio.

Past performance is no guarantee of future results.