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.
Peers of Humana began to release third-quarter earnings results and guidance in October, which prompted positive investor sentiment ahead of the company’s own third-quarter report in early November. While Humana’s third-quarter results were fine, in our view, management decreased full-year 2021 guidance by 5%, attributable to Covid-19 costs that are continuing to run at a higher level than initially expected. Humana’s members are 80% vaccinated, but the remaining 20% are seeing a 10 times higher hospitalization rate than the vaccinated membership base. As this is a temporary phenomenon, management reiterated that prior guidance is still relevant when considering future growth. Guidance for early 2022 pointed to 8% membership growth and earnings per share growth in line with its long-term target of 11-15%. In addition, the company announced a dividend of $0.70 per share to be issued in early 2022.
Shares of Berkshire Hathaway traded higher for the quarter. In November, the company released its third-quarter earnings report, which revealed earnings per share had finished slightly below expectations, while profits experienced a two-thirds decline from the year-ago period. The company repurchased $7.6 billion worth of shares in the third quarter, increasing the year-to-date amount to $20.2 billion. With Warren Buffett and Charlie Munger’s excellent track record as capital allocators, we view the sizeable cash on the company’s balance sheet as valuable for potential new opportunities. Due to the highly diversified operating businesses, excellent balance sheet and shareholder value-focused culture, we remain optimistic about the company’s long-term trajectory.
Alibaba Group’s second-quarter earnings report disappointed investors as growth meaningfully decelerated during the quarter and management lowered its full-year revenue growth guidance. Factors causing the slowdown in growth include a decrease in the retail spending environment in China, increased competition in e-commerce and Alibaba’s reinvestments into its merchant base, which coincided with recent increased regulation from the Chinese government. At the company’s investor day, we learned that it re-segmented its commerce business, providing greater transparency, and that a significant portion of its investment spend is going into two new initiatives: Taobao Deals and Taocaicai (community marketplace). Both businesses target lower tier cities where consumers are more price sensitive. We were also impressed by Alibaba’s presentation on its growing cloud business, where the company believes its technology lead is at least two years ahead of its peers. Despite the current headwinds facing the company, we remain shareholders of Alibaba as we believe it is an important driver of innovation in China and several of its businesses have yet to fully scale.
In our estimation, Fresenius reported solid results for its third quarter as both Kabi (hospital-based intravenous products) and Helios (hospital operator in Germany and Spain) delivered better than expected growth with decent margin performance. Management expressed confidence in the company’s ability to achieve the more than EUR 100 million of post-tax savings targeted from 2023 onward with sources of savings including the regional-to-business reorganization of Kabi, the streamlining of the German hospital portfolios and the creation of a new technology operating model at the corporate level. We spoke with Fresenius’ new Chairman Wolfgang Kirsch during the quarter and appreciated his recognition that there are self-inflicted issues (specifically at Fresenius Medical Care and Kabi) requiring resolution, which are being addressed by management today with a sense of urgency to get things on the right track. We continue to believe Fresenius is trading 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 Charter’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.
During the quarter, we initiated positions in Visa and Worldline. We also received shares of Daimler Truck Holding as part of a spin-off from our position in Daimler. We eliminated Automatic Data Processing, Moody’s, Richemont and Workday.
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