International Small Cap Strategy

December 31, 2022


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.


Top Performers:
Third-quarter results from Konecranes were strong, in our assessment, and the market was positively surprised. Total revenue rose 14.4% (+8.8% in local currency) from a year ago and was slightly ahead of our estimates. Compared with market expectations, revenue, adjusted earnings, earnings per share and orders received all meaningfully surpassed projections. Results were especially robust in the flagship service segment where sales grew by 8.8% in local currency propelled by broad-based growth in all three regions and for both spare parts and field service. Delivery capability improved as supply chain issues eased and labor challenges were well-managed, resulting in margins expanding to record levels for the segment in the third quarter. In addition, third-quarter order intake increases in industrial equipment (+8.6% local currency) and port solutions (+114.5% local currency) combined with high backlogs point to strengthening future revenue and profitability in these segments, in our view. Management announced a EUR 30-35 million cost savings plan targeted at the industrial equipment and service segments and also maintained full-year guidance.

Duerr’s third-quarter earnings release showed improving trends as product demand remained robust, despite continuing concerns about the macroeconomic outlook. Key metrics, including revenue, net income, earnings and orders booked, all surpassed market forecasts. Importantly, third-quarter revenue rose nearly 25% from a year earlier to EUR 1.12 billion and earnings increased 10% to EUR 63.4 million. For the fiscal nine-month period, revenue advanced approximately 22%, which was well ahead of our full-year estimates, and earnings grew roughly 9%. Management now expects full-year revenue to reach the upper end of its EUR 3.90-4.20 billion previously announced guidance range. Of significant note, the company’s order backlog increased to a new record of almost EUR 4.40 billion owing to strengthening demand across segments and particularly for automotive products related to electric vehicle production equipment, including a large EUR 200 million paint shop project in North America. For the second time this year, management raised its 2022 order guidance range to EUR 4.80-5.10 billion compared with prior guidance of EUR 4.40-4.70 billion. To us, the raised guidance points to management’s confidence that this performance will continue. We are also optimistic about ongoing positive developments.

Azimut Holding’s nine-month results showed strength, in our view, with net inflows still performing ahead of our expectations and management stating it sees robust flows both in Italy and abroad. Fee levels are broadly in line with expectations with a slight deviation by insurance, where there were little performance fees and there was the deconsolidation of Sanctuary. We were also encouraged that distribution costs and selling, general and administrative expenses came in below our forecasts. We believe Azimut continues to be a very cash-generative business with net cash increasing by EUR 76 million quarter-over-quarter to EUR 364 million, despite the company quietly buying back about 0.4% of shares during the quarter. CEO Gabriele Blei visited our office during the quarter and appeared pleased with how the organization is performing with strong net inflows in excess of most peers, decent asset performance against tough market conditions, and solid cost control. Blei noted client activity remains robust despite the unsupportive macro factors. Shortly after the release of the results, Azimut announced that it was acquiring a 35% stake in Kennedy Capital Management, an asset management firm focused on small- and mid-cap U.S. equities based in St. Louis. They manage about $3.6 billion and will take on an additional $700 million or so from Azimut following the transaction. Blei described the firm as performance-driven, with all 14 products having outperformed benchmarks on three- and five-year periods. He also noted that they are a good cultural match with Azimut. We believe this will give Azimut more direct capability to expand in the U.S. and a greater ability to do additional vertical integration.

Bottom Performers:
Sarana Menara Nusantara reported earnings results in November that revealed third-quarter revenue growth of 33% year-over-year and 3% quarter-over-quarter. In addition, total towers and total tenants increased by 37% and 36%, respectively, from the year-ago period, which were helped by recent acquisition activity. We met with the company’s CFO Steve Weiss at its headquarters during the quarter and gained a better understanding of how the company plans to mitigate impacts from the Hutch-Indosat merger and the positive effects of the passage of the late 2020 omnibus law. One key takeaway regarding the omnibus law is that by opening up the market to foreign capital, our research shows that recent tower transaction multiples involving foreign buyers have come at a premium to Sarana Menara Nusantara’s current trading multiples. This suggests the stock market may be undervaluing the company’s assets, in our view, and may introduce the opportunity for a transaction involving Sarana Menara Nusantara shares that we believe would be valuable to shareholders.

Nexi released fiscal nine-month results with organic revenue growth that was slightly ahead of our estimates. Total revenue for the nine-month period rose 109% year-over-year and organic revenue advanced 8.2% in constant currency, while adjusted earnings increased 16.5%. For the third quarter, total revenue grew 43% (organic +7.1% constant currency), earnings rose 12%, and both revenue and earnings were better than market projections. Growth was mainly driven by the merchant services business (the company’s largest revenue generator) where organic revenue was up 12.6% in constant currency for the full nine months and increased 9.6% for the third quarter. We were pleased that adjusted earnings margins have been improving thanks to synergy realization and the inclusion of higher margin merchant books related to the integrations of the SIA and Nets acquisitions that are progressing as planned. Management confirmed full-year guidance for organic revenue growth of 7-9% and adjusted earnings growth of 13-16%. Although Nexi’s share price climbed after the earnings release, it fell later in the quarter, likely owing to general market pressures.

Although Viaplay’s third-quarter total net revenue advanced roughly 30% from last year to SEK 3.97 billion, earnings (SEK -100 million) and adjusted earnings per share (SEK -0.63) both posted losses. We found results to be impressive as total organic revenue rose 25%, driven by the Viaplay segment where organic revenue jumped 64%. Total revenue in the company’s other two segments, linear subscriptions and advertising, also grew in the third quarter. The total Viaplay subscriber base advanced 78% and ended the quarter with 6.4 million members. While we found this progress to be solid, results lagged market expectations. The market anticipated that the activation of key new sports rights would enable price increases for linear carriage agreements and prompt high-value volume gains for the Norway Viaplay sports product (now authorized to provide Premier League football coverage). However, resulting gains were less than necessary to reach full-year guidance, which led management to reduce its 2022 organic revenue growth outlook by about 8% to 20%. Subscriber growth in the Nordic region was reduced slightly, though projections for total subscribers remained unchanged at 7.3 million. On a long-term basis, management’s updated targets largely align with our estimates, and our investment thesis for this company is intact.

During the quarter, we initiated new positions in MGM China Holdings and Melco Resorts & Entertainment ADR. We sold our position in the latter by the end of the quarter because its share price swiftly appreciated toward our sell target.

Past performance is no guarantee of future results.

The MSCI World ex U.S. Small Cap Index (Net) is designed to measure performance of small-cap stocks across 22 of 23 Developed Markets (excluding the United States). The index cover approximately 14% of the free float-adjusted market capitalization in each country. This benchmark calculates reinvested dividends net of withholding taxes. This index is unmanaged and investors cannot invest directly in this index.

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 Small Cap Equity composite as of 12/31/2022.

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.