Commentary

U.S. Equity Strategy

December 31, 2021

THE MARKET ENVIRONMENT

U.S. stock market indexes finished higher for the quarter as gains in October and December offset a retreat in November when news of the Omicron variant began to surface. Strong corporate earnings and generally mild symptoms reported from patients with the new variant supported the rally in U.S. equities.

Inflation remained a focus point for investors, policymakers and financial media. It accelerated to 6.8% year-over-year growth in November, following a rise to 6.2% year-over-year growth in October. Supply chain constraints, labor shortages, surging demand outpacing supply, and high material and commodity prices all contributed to the increases in prices. The U.S. Federal Reserve left the federal funds rate unchanged at its December meeting while accelerating the pace of its asset purchase tapering. At the current rate, asset purchases are now on track to cease by the middle of March 2022. In addition, the Federal Open Market Committee continued its recent trend of appearing increasingly hawkish, with the dot plot revealing the median of members’ expectations at three 25 basis point rate hikes in 2022, three in 2023 and two in 2024.

Meanwhile, President Biden’s $1 trillion bipartisan infrastructure bill passed in the House of Representatives in November and was signed into law shortly thereafter. The deal provides funding for various projects, including roads, bridges, railways, broadband access, clean water and electric grid maintenance. On the other hand, although the roughly $2 trillion Build Back Better Act passed in the House of Representatives in November, it ultimately stalled in the Senate with a formal vote expected in January. The bill includes funding for various programs, such as universal pre-K, Medicare expansion, renewable energy credits and affordable housing.

With seemingly constant uncertainty in politics, economics and market sentiment, we focus on finding undervalued and well-managed companies that will benefit from economic tailwinds while proving capable of weathering difficult environments. We believe this approach best services our goal of growing and protecting our investors’ capital over the long term.

THE PORTFOLIO

Top Performers:
In November, Mantle Ridge took a $1.8 billion position in Dollar Tree in an effort to drive improved performance at Family Dollar and efficient execution of Dollar Tree’s multi-price point strategy. Later, Dollar Tree posted third-quarter earnings results that largely met analysts’ estimates, while management raised fiscal-year guidance for earnings per share and revenue. Moreover, the company announced plans to move the majority of the store’s offerings to a $1.25 price point with a complete nationwide rollout by the end of the first quarter in 2022. Management expects the price adjustment to provide sufficient cover to get the Dollar Tree banner back to the company’s long-term 35-36% gross margin target next year. The price change to $1.25 does not change the company’s plans regarding the Dollar Tree Plus initiative ($3/$5 price points). Our investment thesis for Dollar Tree remains intact.

Alphabet’s third-quarter earnings release resulted in the company’s share price moving higher throughout the quarter. Reported revenue growth amounted to 41% and operating margins (ex-other bets) expanded 670 basis points. In addition, search and YouTube advertising revenue both grew over 40%. Management bought back $12.6 billion worth of stock in the third quarter, which puts the company on pace to meet our expectations for the full-year period. Although Alphabet’s share price declined on news that YouTube TV subscribers lost access to Disney-owned entertainment options, the issue resolved itself shortly thereafter. We believe Alphabet remains an attractive holding with upside potential despite its recent share price appreciation.

Peers of Humana began to release third-quarter earnings results and guidance in October, which prompted positive investor sentiment ahead of the company’s own third-quarter report in early November. While Humana’s third-quarter results were fine, in our view, management decreased full-year 2021 guidance by 5%, attributable to Covid-19 costs that are continuing to run at a higher level than initially expected. Humana’s members are 80% vaccinated, but the remaining 20% are seeing a 10 times higher hospitalization rate than the vaccinated membership base. As this is a temporary phenomenon, management reiterated that prior guidance is still relevant when considering future growth. Guidance for early 2022 pointed to 8% membership growth and earnings per share growth in line with its long-term target of 11-15%. In addition, the company announced a dividend of $0.70 per share to be issued in early 2022.

Bottom Performers:
Investors expressed disappointment in October as Thor Industries announced the closing of a $500 million notes offering, which was higher than the $400 million offering size announced earlier. Thor indicated it would “remain committed to our previously communicated capital allocation priorities, including reinvesting of the business, repaying debt, growing our dividend and opportunistically pursuing strategic initiatives and share repurchases.” Later, the company posted strong fiscal first-quarter earnings results, in our view, as revenue ($3.96 billion vs. $3.46 billion) and earnings per share ($4.34 vs. $3.24) bested consensus expectations. Gross margins also improved 170 basis points to 16.6%, and the backlog moved 100% higher year-over-year and 7% sequentially to $18.1 billion. Management expects Thor “to continue to outperform the market and to grow at a higher rate than the Recreational Vehicle Industry Association projects for the industry as a whole.”

Citigroup’s third-quarter earnings report largely met market expectations and the company reiterated its full-year revenue and expense guidance. Later, Citigroup announced it expects to recognize about $1.2-$1.5 billion of cash charges over the course of 2021 and 2022 as a result of employee separation payments associated with the company’s exit of its South Korean consumer business. CFO Mark Mason noted that the economics of winding down operations in South Korea are “much more attractive than continuing to run the business” given the heavily regulated market with high labor costs and price controls. In December, Citigroup presented at a conference where it reiterated its full-year revenue and expense guidance. Trading guidance fell short of investors’ outlook, while fee revenue figures across the balance of the business exceeded analysts’ estimates. The company also announced a pause in share repurchases, which we found disappointing, though we do understand the company’s unwillingness to temporarily dip below its targeted CET1 ratio. In our view, Citigroup’s underperformance is attributable to the market’s unwillingness to look through near-term pressures, and we believe the company trades at a discount to our perception of its intrinsic value.

Charter Communications’ share price retreated throughout the quarter. Investors proved disappointed with the deceleration in the company’s broadband business as exhibited in Charter’s third-quarter earnings results. Importantly, we appreciate the company’s history of transparency in the past when competitive intensity in the market increased and do not believe the slowdown in internet net additions is attributable to a reduced win rate. In addition, Charter’s adjusted earnings increased nearly 14%, and mobile net additions were solid, in our view. The company repurchased 8.1% of its share base in the year-to-date period, and our investment thesis remains intact.

During the quarter, we initiated positions in Amazon.com, Global Payments, Mastercard and Willis Towers Watson. We eliminated Automatic Data Processing, Nasdaq and Workday from the portfolio.

Past performance is no guarantee of future results.

The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.

The Russell 1000® Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000® companies with lower price-to-book ratios and lower expected growth values. 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 U.S. Equity composite as of 12/31/21.

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.