Commentary

International Equity Strategy

December 31, 2023

THE MARKET ENVIRONMENT

Major global markets generally showed strength during the fourth quarter, despite pressure in October when Hamas, an Islamist political and military organization, orchestrated an attack against Israel, shaking markets and the geopolitical landscape. The U.S. reported its strongest quarter of gross domestic product growth in nearly two years at 4.3% annualized, while economic data throughout Europe and China was mixed and provided reasons for both pessimism and optimism.
 
The U.S. 10-year yield reached as high as 5% in the quarter before declining and ending the period around 3.86% as investors continue to digest economic data and expectations on interest rates. In November and December, the U.S. Federal Reserve met and held its benchmark interest rate steady at 5.50%. Similarly, the Bank of England held its benchmark interest rate at 5.25%, and the European Central Bank held rates steady at 4.50% at its most recent meeting. Headline inflation in the U.S. and the U.K. declined during the quarter and ended at 3.1% and 3.9% in the most recent release, respectively. The Bank of Japan continued its accommodative monetary policy stance, although it took a step toward reversing the policy when it announced that the 1% cap on its 10-year government bonds would be considered a reference rate going forward. The yen reversed its recent trend and gained value during the quarter, ending the period at approximately 141 USD/JPY.

We believe our intensive research process and focus on the long term help us find opportunities despite the pervasive theme of the time. When the market does not separate the macro from the micro, there is an exploitable opportunity for long-term investors, such as ourselves. We use times of uncertainty and volatility to strategically position our portfolios for long-term success and believe this approach best positions us for achieving the protection and appreciation of our investors’ capital over the long term.

THE PORTFOLIO

Top Performers:
Ryanair Holdings, a European ultra-low-cost airline, was the top contributor this quarter. Ryanair released strong results for the first half of fiscal-year 2024 and was accompanied by an even stronger outlook, in our view. The company’s revenue grew 30% year over year, and average fares increased by 24% to EUR 58, driven by record demand and constrained capacity at European peers. Total passengers flown expanded 11% year over year to 105.4 million, and management is on track to maintain its target of 183.5 million passengers for 2024, depending on Boeing’s ability to meet its delivery commitments. Management is expecting full-year 2024 net income to be between EUR 1.85-2.05 billion ahead of the EUR 1.82 billion consensus estimate. The company’s strong free cash flow levels and balance sheet allowed Ryanair to reinstate a EUR 400 million dividend (35 cents per share). We spoke with CEO Michael O’Leary about additional uses for its excess capital and were happy to hear about an incremental EUR 1.5 billion return to shareholders starting in 2025. We continue to be optimistic about Ryanair’s future.

Continental was a contributor during the fourth quarter. The Germany-headquartered consumer discretionary company’s stock price rose in November following the announcement of Continental’s annual cost savings plan. Through measures taken to strengthen the competitiveness of its automotive sector, Continental plans to save EUR 400 million and reach the full extent of its annual cost savings plan by 2025. After having managed through a crisis and then going on to improve cost positioning, drive significant management and organizational structural change; and complete the spin-off of Vitesco, we believe these significant changes are achievable. During its capital markets day, Continental revealed that 2024 will begin the “era of execution” as the business delivers on short-term (two to three years) and mid-term (five year) targets for revenue and margins. Lastly, on a recent call, CEO Nikolai Setzer expressed his bright outlook for the automotive sector with an excellent growth potential, supported by a very strong order book. We continue to believe that Continental offers attractive upside.

Siemens was a contributor during the fourth quarter. The Germany-headquartered industrials company’s stock price rose in December following the commencement of an exploration to examine a potential demerger of its energy business into a separate entity. The board of directors approved the immediate incorporation of a fully owned subsidiary in Mumbai, India with certain conditions. We appreciate Siemen’s efforts over the past several years to consolidate its business into three focused areas: digital industries, smart infrastructure and mobility. We think this effort has improved the company’s execution and resulted in greater than market growth, project charge eliminations, and solid cash flow generation. We continue to believe that Siemens offers attractive upside.

Bottom Performers:
Worldline was a top detractor for the quarter. In October, the French multinational payment and transactional services company delivered a weaker than expected set of results, and the stock fell significantly on the news. Management reduced growth estimates citing two factors: (1) negative mix shift in Germany, as German consumers shifted from discretionary to non-discretionary purchases and (2) merchant terminations, driven by Worldline voluntarily and proactively cutting ties with certain online merchants at risk of violating new regulatory standards. We spoke with management after the results and confirmed both factors are transitory. We continue to believe the payments industry is a structurally attractive GDP+ growth market, and Worldline, as the European payments leader, has a very long growth runway given lower European cashless penetration and higher levels of bank payment in-sourcing versus the U.S.

Bayer, a life science company with pharmaceuticals, consumer health and crop science divisions, announced its decision to stop its OCEANIC-AF trial for asudenxian early due to lack of efficacy. The company was ordered to pay $1.5 billion to three plaintiffs in a recent RoundUp case. While both events were disappointments, the asundexian news is more relevant to us because we expected both wins and losses in the RoundUp legal saga and anticipate this recent verdict will likely be reduced significantly on appeal. Asundexian was Bayer’s largest late-stage pharma pipeline opportunity and had potential to be a next-generation Xarelto, but the trial was riskier than usual due to its data profile in earlier stages. We have modestly reduced our estimate of Bayer’s intrinsic value, but we still believe the stock is attractively priced, trading at around 6 times 2024 earnings. We continue to monitor the situation and will adjust our analysis, if necessary. We met with new CEO Bill Anderson after the news, and we are impressed by his thoughtfulness, strong background in pharma, and urgent desire to improve the areas of the company that have held it back from its full earning potential.

Alibaba Group was a detractor during the fourth quarter. In November, the China-headquartered consumer discretionary company released fiscal second-quarter results with a marked slowdown in its financial performance compared to the fiscal first quarter. Notably, Alibaba altered its strategy regarding the cloud business, opting to keep it within its core business as opposed to proceeding with a full spin-off, citing U.S. export restrictions as a factor. The cloud business continues to register a weak revenue growth of 2%, slowing further from the fiscal first- quarter’s growth of 4%. The core ecommerce business grew by 4%, driven by a 3% growth in customer management revenue (CMR), a 6% growth in direct sales and an 18% growth in wholesale. The 3% growth in CMR is a meaningful slowdown, in our view, from its 10% growth in the fiscal first quarter. Lastly, we are apprehensive of Jack Ma’s foundation selling 10 million shares of Alibaba. Following the fiscal second-quarter results, we have reached out to Alibaba and are awaiting the company’s response. We have adjusted our revenue expectations in the ecommerce business as well as our estimate of growth in the cloud business but we continue to hold the name.

During the quarter, we eliminated Vipshop Holdings ADR from the portfolio. There were no new purchases.

Past performance is no guarantee of future results.

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 International Equity composite as of 12/31/2023.

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.