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.
CNH Industrial’s share price responded favorably to positive developments throughout the quarter on the demerger of its IVECO (trucks and commercial vehicles) business, which becomes effective on January 1, 2022. In our view, CNH delivered excellent third-quarter earnings results, with 23% organic growth, 100% earnings growth and a 230 basis point margin expansion. In the agriculture equipment segment, strong industry combine demand across the globe drove 30% local currency growth. Anticipation for supply chain issues in the fourth quarter prompted management to lower its guidance for net sales to come in at the low end of the 24-28% range and for free cash flow to finish around $1 billion, though these figures are largely in line with our forecasts. Management has worked to fortify the balance sheet while protecting pricing. We believe the team is driven to create shareholder value through operational enhancements and other initiatives.
BNP Paribas delivered strong third-quarter earnings results as nearly all line items outperformed our estimates. Strength in domestic markets (+6.4%) and the commercial and investment bank (+6.4%) drove the company’s 4.7% total revenue growth. In December, BNP announced it had reached an agreement with BMO Financial Group for the sale of 100% of its U.S. retail and commercial banking activities in the U.S., conducted through its subsidiary Bank of the West, for a total consideration of $16.3 billion. We appreciate that this transaction was executed at a price that exceeded our expectations and reallocates capital away from a business that earned a sub-par return on tangible equity (ROTE) and toward buybacks and incremental growth opportunities that we think could earn a much higher ROTE. We also met with BNP’s CEO Jean-Laurent Bonnafé in the fourth quarter. We came away feeling increasingly comfortable with our assessment of the company’s underappreciation by the market relative to our perception of its intrinsic value given its best-in-class risk management and highly cash generative business model.
Glencore held its annual investor day in December, where the company reinforced its plan to emphasize low-cost, large-scale assets in future-facing commodities, while responsibly running down its coal business over time. We appreciate management’s focus on increasing risk-adjusted returns by exiting assets that require a lot of management’s time, are in high-risk jurisdictions, have limited mine-life or face other constraints while not being material financial contributors. Prior to the company’s investor day, we spoke with Chairman Kalidas Madhavpeddi who possesses a solid background within the industry, in our view. He emphasized his appreciation for Glencore’s anti-bureaucratic culture, which leads to innovative ideas from younger talent, and the focus on financial returns in decision making. We are optimistic about Madhavpeddi’s abilities and the company’s future.
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, Worldline delivered a good set of third-quarter earnings results, though the company’s share price declined following the release.
Worldline’s Board of Directors committed to selling the terminals business “in the short term” and deconsolidated the segment from financial results, which flattered the report, in our view. That said, we find the share price weakness from the delayed terminal sale to be an overreaction by the market as the business is a small portion of the company’s overall value and is also cash generative. At Worldline’s capital markets day, the company highlighted its ability to build a pan-European platform that will be largely technologically integrated by the end of 2024 and cloud-enabled to the degree possible, which will improve operating efficiency and time to market on new product development, among other benefits. In the fourth quarter, we also spoke with CEO Gilles Grapinet, who remained bullish on the company’s prospects and the merchant services business.
Shares of Vipshop Holdings fell following the company’s third-quarter earnings report. The company was tracking well for the trailing nine months; however, the report showed a large slowdown in the third quarter. We believe this is more attributable to the weaker macroeconomic environment in China than to the company itself as evidenced by the slowdown for other Chinese retail and e-commerce firms. Management offered slightly lower than consensus guidance for fourth-quarter growth, noting that the economic environment is unlikely to improve in the short term. In addition, management announced its intention to use the next couple of quarters to reduce some of the tangential brand relationships, which will negatively impact growth but improve focus for merchandising teams and the user experience. Despite the disappointing elements to the report, we believe the market over-penalized Vipshop Holdings and we remain optimistic about our investment over the long term.
During the quarter, we received shares of Daimler Truck Holding, which spun-off from our position in Daimler and we eliminated our holdings in AMP and Cenovus Energy.
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