THE MARKET ENVIRONMENT
Major global markets generally experienced relief in the fourth quarter after equity markets had declined meaningfully throughout the first three quarters of 2022. Conditions in markets turned more favorable as there were early signs that central bank increases in interest rates, improving supply chain conditions, and lower energy prices would lead to reductions in the level of inflation in many countries. International equities benefitted from most international currencies strengthening relative to the dollar during the quarter, though most major currencies still ended the year down 5-15% versus the dollar. European equities led the world in returns in the fourth quarter by being up almost 20%, or about double those in the U.S. and emerging markets.
The size of the U.S. Federal Reserve’s hikes to its benchmark interest rate slowed in December to 50 basis points, following 75 basis point increases in June, July, September and November. The Bank of Canada increased its benchmark rate by 50 basis points in October and December, while the European Central Bank and Bank of England both hiked their respective rates by 75 basis points in November and 50 in December. The Bank of Japan continued its accommodative policy stance on interest rates, but surprised markets by doubling its cap on 10-year yields from 0.25% to 0.50%. The Japanese central bank said the reason was to enhance the sustainability of monetary easing, but many investors speculated it to be a sign of a potential exit from its decade-long stimulus policy. As a result, the yen appreciated against other currencies and Japanese government bonds fell. Elsewhere, China backpedaled from its “Zero-Covid” policy and subsequently saw a sharp increase in the number of positive Covid-19 cases.
While we recognize the challenge facing investors with the current state of financial markets, we believe that the lower and more widely dispersed valuations in the market today have allowed us to redeploy capital into increasingly attractive investments. We are optimistic that these decisions will sow the seeds of future outperformance. As always, we remain focused on building a high conviction portfolio of undervalued businesses that we believe will provide both a margin of safety and the potential for attractive risk-adjusted returns over the long term.
Intesa Sanpaolo released fiscal nine-month results that we saw as strong and clearly demonstrate both its interest rate leverage and the conservative business model of the bank. Notably, net income for the nine-month period reached EUR 3.28 billion, which paces the company to surpass our full-year net income estimates. Along with the results, management raised guidance to greater than EUR 4 billion of net income, and when excluding costs incurred for reducing exposure to Russia and Ukraine, Intesa would be on pace to exceed the EUR 5 billion original business plan target for 2022. It is apparent that rising interest rates have benefited Intesa as net interest income grew by nearly 20% compared with a year ago and by more than 14% compared with the prior quarter. We also like that operating costs remain well controlled and, despite inflation, have declined 1.8% year-to-date. With another 4,400 voluntary staff exits set to be completed by the first quarter of 2025, Intesa should be well-placed to offset inflationary impacts on its operating costs. Finally, Intesa’s capital position remains robust. We met with CEO Carlo Messina and CFO Stefano Del Punta in November and reviewed the bank’s top near- and mid-term priorities. We came away from the meeting pleased that our objectives for the bank align with that of Intesa’s leadership team and believing that the bank is well-positioned for success in the future.
BNP Paribas reported third-quarter total revenue of EUR 12.31 billion and net income of EUR 2.76 billion, which both outpaced market expectations. More importantly, we were pleased that for the full fiscal nine-month period, the company’s key metrics were in line with our estimates. Excluding the Bank of the West subsidiary results, nine-month revenue rose 9.3% from the same period last year to EUR 36.3 billion and operating income advanced 16.8% to EUR 10.2 billion, while the cost of credit fell 5.3% to EUR 2.3 billion. Notably, despite more difficult market conditions, revenue generation was strong across the core operating divisions, driven by the corporate and institutional segment and commercial and personal banking, which saw year-over-year revenue increases of 14.9% and 9.8%, respectively. In addition, compared with last year, loan and deposit volumes were quite robust in BNP’s primary markets as France (loans +4.3%; deposits +5.7%), Italy (loans +2.7%; deposits +10.3%) and Belgium (loans +14.8%; deposits +9.5%) all experienced a significant acceleration in activity. Lastly, the company’s capital position remains solid with a fully phased common equity Tier 1 ratio of 12.1%. We are satisfied with BNP’s fundamental performance.
Third-quarter results from Allianz were solid, from our perspective, and exceeded our expectations for operating profit and solvency. Both net income and operating profit were also ahead of market forecasts. Notably, total operating profit advanced 7.4% year-over-year, driven by the property and casualty segment where organic operating profit advanced 8.8%. Profits were helped by price increases that management implemented to counteract cost inflation of between 5% and 6% in the third quarter. Nearly all underlying operating entities are growing with the most significant advances occurring in the credit insurance, Allianz Partners (travel) and Allianz Global Corporate & Specialty (business and specialty risk insurance) units as well as in higher inflation geographies. Although the life and health insurance and asset management segments are seeing challenges that weighed on operating profit, we believe these issues can be rectified within the next couple of quarters. In addition, the company’s solvency capitalization ratio is now 199%, which we assess to be very healthy. Management now believes that full-year operating profit will reach the upper end of its EUR 12.4-14.4 billion guidance range. Lastly, Allianz announced a new EUR 1 billion share repurchase plan and indicated that significant capital returns can continue at current levels.
Credit Suisse Group’s third-quarter headline results of a CHF 4.03 billion net loss for the quarter included a CHF 3.7 billion impairment of deferred tax assets (DTA). The DTA is attributed to the group’s securitized products segment, which is expected to be spun-off from the company and prompted the charge. Outside of the DTA write down, we believe the third-quarter results show the core franchisescontinue to perform acceptably despite the uncertainty associated with the strategic review and constant negative headlines. In our view, Credit Suisse’s recently announced restructuring plan appears to be quite methodical and well contemplated, reinforcing our belief that the new leadership team is a material upgrade. We appreciate that the company is increasing the amount of capital allocated toward the higher quality franchises and away from the lower quality investment bank, which we believe will result in a stronger franchise with greater earnings power. We were disappointed that the capital raise was larger than we had expected. However, given the size of the DTA impairment and the desire for a new investor to come in, we believe this will leave Credit Suisse in a strong capital position. We have lowered our intrinsic value estimate following the announcement, partially driven by the dilutive capital raise the company plans to issue.
Third-quarter earnings from Philips were well short of our estimates and market expectations, which led management to reduce full-year earnings guidance by nearly 40%. Philips is experiencing operational issues that mostly center around its supply chain as the company has been unable to procure the necessary componentry to fulfill orders already booked. We met with new CEO Roy Jakobs and a number of other senior managers in November and believe the management team understands the challenges facing the business, though an operational turnaround is likely to take some time. In addition, Philips is embroiled in an extensive FDA mandated recall at its sleep and respiratory franchise. Management has been in negotiations with the FDA over a consent decree related to this business, which is likely to result in the franchise being materially less profitable when it eventually returns to the market. A positive development is that late in the year, management disclosed encouraging test results related to its Dreamstation 1 sleep device that suggested the reason for the recall is unlikely to lead to adverse health impacts. Given the large amount of recent news flow, we have made a significant adjustment to our estimate of intrinsic value for Philips as we incorporated higher operational and capital expenses as well as modest market share loss to competitors in its imaging and patient monitoring business.
Grupo Televisa’s third-quarter revenue increased in the TelevisaUnivision (+5%) segment since the merger was completed in February 2022. In addition, compared with last year, third-quarter revenue rose in the cable (+3%) segment, while Sky segment revenues fell (-9%). Unfortunately, adjusted earnings declined across segments and were much weaker than our estimates. Although revenue growth at TelevisaUnivision decelerated since the second quarter, we think growth in the fourth quarter will trend up given the World Cup and elections in the U.S. Results in the cable segment were mixed, with overall net subscription additions of 339,000, which was the strongest acceleration of additions from prior quarters, while segment margins contracted 240 basis points due to higher cost inflation and weak revenues. Lastly, new management in the Sky segment is purposefully transitioning the business to remove lower quality subscribers by eliminating promotional pricing. As a consequence, revenue-generating units fell in the quarter, which depressed both revenue and earnings. Management expects to finalize this process by the end of the year. Even though Grupo Televisa’s third-quarter total revenue met market expectations and net income outpaced forecasts, its share price fell likely due to financial market factors.
During the quarter, we initiated positions in Akzo Nobel and Sandvik. We eliminated Brambles, H&M Cl B, Trip.com Group and UPM–Kymmene from the portfolio.
Past performance is no guarantee of future results.
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