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.
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.
The share price of Grupo Televisa jumped when the company revealed it is merging its content and media assets with Univision. In a call with shareholders, CEO of Televisa Alfonso de Angoitia and CEO of Univision Wade Davis provided details on the $4.8 billion agreement, which combines these leading media businesses in the two largest Spanish-speaking markets in the world. Overall, we think the deal makes strategic sense as streaming is the future in television and the new company will be the dominant Spanish language content streaming service globally when it is fully operational. Later, Televisa released first-quarter results with revenue that rose 3.2% from a year earlier and total EBITDA earnings that advanced 1.5%, driven by broadband growth and a rebound in advertising. However, business in the core cable segment slowed, illustrated by net subscription additions that declined roughly 34% from the same period last year. We discussed this issue with Televisa’s new CEO of the cable segment José Antonio González. While we are still getting acquainted with González, we like that he has a long-term focus, particularly for investments intended to stem competition.
Glencore’s share price increased after the company released its first-quarter production report late in April. The company’s copper production increased 2.7% year-over-year, and investors particularly welcomed this news as copper prices have risen in recent months. Furthermore, market commodity strategists anticipate copper demand and pricing will remain strong throughout 2021. In our assessment, copper demand can continue to accelerate owing to 1) broad infrastructure investment in China and elsewhere, 2) global industrial recovery, and 3) copper needed for environmentally favorable purposes, such as grid investment, renewables and mobility electrification. Glencore’s first-quarter production of ferrochrome also rose compared with last year, while output of other commodities (zinc, nickel and coal) fell, which was not surprising due to seasonality issues. Management reiterated production guidance across all commodities and stated expectations that long-term marketing segment earnings will be in the upper half of the $2.2-$3.2 billion range.
thyssenkrupp issued fiscal first-half results that were solid, from our perspective. Total revenue rose 2% in local currency compared with the same period last year (pre-Covid-19 effects), while the earnings margin also expanded by 480 basis points year-over-year and exceeded our estimates. Absolute results across nearly all divisions showed sequential improvement and were ahead of our expectations. Revenue and earnings margin advances were strongest in the industrial components, automotive technology and steel Europe divisions. While revenue declined year-over-year in materials services, a key revenue-generating division, earnings rose to EUR 126 million in the second quarter compared with EUR 29 million in the year earlier. Management increased full-year total revenue growth guidance and upgraded earnings guidance for the second time in the current fiscal year. Despite this robust set of results, thyssenkrupp’s share price declined as investors appeared disappointed that second-quarter earnings per share and earnings in some divisions undershot market forecasts.
Several developments influenced Naspers’s share price over the course of the quarter, beginning with management’s announcement that it reduced its stake in Tencent from 31% to 29%. Subsequently, the company raised $14.7 billion in cash and agreed not to sell any additional Tencent shares for three years. While this strategy aligns with our expectations, investors appeared disappointed that Naspers did not immediately announce it would use the proceeds to fund a new share repurchase program. Later, its share price suffered on news that Prosus is making a voluntary exchange offer for up to 45.4% ownership of Naspers. We see both positive and negative aspects to this transaction, and CFO Basil Sgourdos stated that though this plan is not a perfect solution, the long-term benefits outweigh the share exchange ratio. In addition, he indicated that the company will take additional steps to close the discount, including listing assets, executing share repurchases and improving profitability at various businesses. Lastly, Naspers reported fiscal full-year headline earnings per share that were roughly 6% ahead of market projections, while total revenue missed forecasts. The company’s negative operating income (-$1.19 billion) for the period regressed from the $720 million realized in the prior year, though it was better than market expectations. From our perspective, Naspers remains equipped to sustain growth and reward shareholders over the long term.
Prudential’s solvency remained strong at 343% compared with 329% at the end of 2020. Management provided additional information on the delayed demerger of Jackson National, which was originally scheduled for completion by the end of May. The company now expects to complete the demerger in the second half of the year, owing to extra time necessary for regulatory approvals. Management is still considering raising roughly $2.5-3.0 billion of new equity following the demerger. Investors may have found the delay concerning, which weighed on the company’s share price for the quarter. We continue to believe that Prudential is well positioned to reward shareholders over the long term.
During the quarter, we initiated a position in Fresenius. We eliminated Ashtead Group and Bureau Veritas from the portfolio.
Past performance is no guarantee of future results.
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