Commentary

International Small Cap Strategy

December 31, 2019

THE MARKET ENVIRONMENT
The fourth quarter of 2019 brought a steady recovery in global markets following the volatility that afflicted indexes around the world earlier in the year. As was the case last year, 2019 featured extreme price movements as the latest news, including trade talks, Brexit, European Union political instability and even a political conflict between South Korea and Japan dating back to World War II, influenced stock prices. As an example, while global markets started the year off strong, a few tweets that fueled trade war fears in May sent indexes around the world tumbling. August also saw more measurable declines until markets began to recover and rebound based, in part, on more positive geopolitical headlines.

Other fears that weighed on markets were the possibility of a Jeremy Corbyn victory in the U.K. general election and continued uncertainty surrounding Brexit. With a large, historical victory by the Conservative Party in the U.K., investors’ fears of a Corbyn-led socialist-style government were alleviated for the medium term. Instead, Prime Minister Boris Johnson’s government acted quickly to move its Brexit bill through Parliament in an attempt to ensure a smooth exit from the European Union.

Meanwhile, China and the U.S. de-escalated their trade dispute with an agreement of a “phase-one” trade deal in the fourth quarter. These events boosted global equity market sentiment toward the end of 2019 and entering into 2020. These developments also provided more solid foundations for businesses to make capital allocation and investment decisions going forward as the news pushed key U.S. indexes to all-time high levels. In fact, all 11 GICS sectors in the S&P 500 Index gained value in 2019 and produced double-digit returns for the year. In China, the Shanghai Composite increased 22% for the year, while Japan’s Nikkei 225 Index finished 18% higher in 2019.

Despite the recovery in 2019, we still believe our investment approach offers good upside potential. In fact, our investment philosophy and team have been consistent throughout our history. We continue to look for opportunities to achieve higher returns by estimating business value and buying at a discount. We utilize this strategy with the goal of long-term outperformance for the benefit of our shareholders.

THE PORTFOLIO
Top Performers:
Duerr’s share price moved higher in response to the company’s third-quarter earnings results, which pointed toward stabilization and improvement across a number of business lines. HOMAG, the maker of wood processing machines for the furniture industry, saw an improvement in orders, including a large systems order in China, which has previously been a weak spot for the company. In addition, Duerr announced a restructuring plan for HOMAG, which intends to achieve significant cost savings once implemented. Across other business lines, we appreciate that orders increased and operational performance improved. Notably, in the paint and final assembly division, orders improved by 30% in the third quarter over the prior year and operating profit improved by over 9% after having declined versus the first half of the prior year. We still believe Duerr’s market positioning and effective management team make it an attractive investment.

Industrials company Travis Perkins benefited from positive reports on Prime Minister Boris Johnson’s progress toward securing a new withdrawal agreement with the European Union. The company released a third-quarter trading update, which we viewed positively as Travis Perkins continues to gain market share across all of its business lines. While its peers trimmed full-year guidance, the slowdown in the company’s core merchanting business was less than its competitors and allowed the company to reiterate its own full-year guidance. We also appreciated strong performance in the Wickes business, with 9.7% like-for-like growth and 8.3% total revenue growth in the third quarter. Later in the fourth quarter, Travis Perkins announced plans to spin off its Wickes business to shareholders in mid-2020. The company also received a boost following the general election in the U.K. as it provided clarity for the building sector in the country.

Azimut Holding delivered solid nine-month earnings results, in our view, including assets under management of EUR 44.6 billion, which is ahead of our estimates and driven by a higher pace of inflows and better asset performance. Total fees increased 28% year-over-year, and we think the company continues to impressively cut selling, general and administrative costs, down 2% year-to-date and 5.5% in the third quarter. In addition, management reiterated its guidance and appears well positioned to achieve its target of EUR 300 million in net profit for the year. We recently met with Azimut’s Global Head Gabriele Blei who indicated the company would release a new business plan that focuses more on profitability than assets under management, which we find to be a positive.

Bottom Performers:
Healius announced lower than anticipated fiscal year 2020 guidance at its annual general meeting in November, which added pressure to the company’s share price during the fourth quarter. However, after speaking with CEO Dr. Malcolm Parmenter, we found Healius’s guidance to be overly conservative. The pathology and imaging divisions, which account for over 75% of earnings and cash flow generation, are performing well and gaining market share, in our view, and there are initiatives in place to continue to grow revenues and lower costs across the company. In our estimation, the largest negative out of the fiscal year 2020 guidance update was in the medical centers division, where recent progress in recruiting general practitioners into the company’s clinics appears to have slowed. While we believe the division remains on the right strategic trajectory, we think the decision to change the division head of medical centers should help speed the company’s progress. Our investment thesis for Healius remains intact as we believe its management team is working to enhance shareholder value.

Early in the reporting period, industrials company Konecranes announced the replacement of current CEO Panu Routila with Rob Smith, formerly of AGCO, which was a surprise to us. Chairman Christoph Vitzhum discussed his appreciation for Routila’s work on delivering the material handling and port solutions integration and synergy realization, but noted that the company is ready for a new phase that calls for new skills from the CEO post. Konecranes now intends to focus on continuous operational improvement, service growth, digitalization and improving the supply chain. The company outlined Smith’s background and experience, which includes successes at a multibrand company (AGCO). Konecranes also highlighted his history working in a number of industrial businesses that use its equipment, substantial experience with service/aftermarket businesses, deep involvement with AGCO’s digitalization push and significant experience improving supply chains. Later, the company issued weak third-quarter earnings results, in our view, weighed on by macro pressures in the industrial equipment segment, though the order book remained 13% higher from the year-ago period. Konecranes also announced the launch of three new product factories: S-Series (standard cranes), M-Series (process cranes) and C-Series (chain hoists) in the industrial equipment business in an effort to refresh a large portion of the product lineup and improve profitability. Despite the management change, the key tenets of our investment thesis and strategy look to be intact.

Although Criteo’s third-quarter earnings results fell slightly shy of market expectations, investors were more disappointed with guidance for the company’s fourth quarter. While trends in new product growth are encouraging, progress in the evolution of the retargeting business is proving to be a concern. We believe positive growth in new products should continue, but Criteo is not capturing as much of the shift from browser to app usage in the retargeting business. The company also announced the appointment of Megan Clarken, formerly of Nielsen Media, as its new CEO. Criteo believes her knowledge will be a positive in helping the company transform its business into a wider array of marketing solutions to a broader variety of marketers. We look forward to meeting with Clarken in the near future, but we believe Criteo is trading at a sizable discount to our estimate of its underlying value in the meantime.

During the quarter, we initiated positions in BlackBerry, Gildan Activewear and Nordic Entertainment. We eliminated Bharti Infratel, Countrywide, HKBN Ltd and SKY Network Television from the portfolio.

Past performance is no guarantee of future results.