A Hare was making fun of the Tortoise one day for being so slow. “Do you ever get anywhere?” he asked with a mocking laugh. “Yes,” replied the Tortoise, “and I get there sooner than you think. I’ll run you a race and prove it.”
- Aesop’s Fables
TO OUR SHAREHOLDERS:
Our hearts go out to the Ukrainian people and their loved ones as Russian forces continue to conduct a brutal and heartless military assault on their country. This attack has sparked extreme volatility in global equity markets as investors struggle to understand what it means for the global economy and stocks. And this is occurring on top of rising inflation levels, current and prospective central bank tightening around the world, skyrocketing energy prices, and Covid lockdowns in China. The probabilities of a recession in the medium term have certainly increased.
While the Russian invasion is deeply unsettling, like other crises in the past, our immediate response has been to remain calm and draw on our experience to assess the situation rationally. A vital benefit of successfully operating for over 100 years in the investment industry is having a balanced perspective when markets are highly reactive.
You can rest assured that the Funds do not have any direct holdings in Ukraine or Russia; however, our Fund portfolios have some indirect exposure to the region. Nevertheless, the “knock on” effects on the broader global economy and on equity markets have been significant, and our Fund portfolios have not been completely immune to these effects.This has been particularly felt in the Funds’ European-based holdings, as investors feared the impact on corporate profit margins of supply chain disruptions, rising input costs and inflation, economic sanctions, and rising oil prices. With equity valuations on the high side, and geopolitical and economic uncertainty escalating, it is no wonder that global equity markets had a comeuppance in the first quarter of this year. While we remain very concerned about the Russian invasion in Ukraine for humanitarian reasons and for what it may mean for equity markets in the near term, we do not believe that this threat is likely to impact our long-term approach to markets, nor do we believe that it will likely permanently impair the underlying estimated intrinsic values of the companies held in our Funds’ portfolios. Nevertheless, we will continue to closely monitor our Fund portfolios as the situation unfolds, and seek to take advantage of the inevitable pricing opportunities we expect will be presented by these challenging markets.
A HISTORICAL PERSPECTIVE
Looking back over the last several decades, our International Value Fund and the global stock markets have endured some pretty grim news, but have gone on to persevere and prosper. In 1997, there was a meltdown in both currencies and equities in the Far Eastern markets of Indonesia,South Korea, Malaysia, and Thailand, losing on average roughly 50% of their value. Following that was the Russian bond default and the subsequent failure of Long-Term Capital Management in 1998, which nearly brought the entire market to its knees. In 1999, there was extraordinary fear of a potential massive systems failure resulting from the digital concerns related to the Year 2000 (Y2K). In 2000, there was the burst of the technology bubble and the presidential “hanging chad” election crisis, followed by the terrorist attack on the World Trade Center and the collapse of Enron in 2001. In 2008, we had the subprime credit crisis, which led to the failure of some of our iconic financial institutions and nearly drove the country into a full-scale depression. Finally, the COVID-19 pandemic was perhaps our most challenging test yet. That said,for the last nearly 29 years (06/15/1993 to 03/31/2022), our flagship fund, the Tweedy, Browne International Value Fund, has persevered and prospered producing a cumulative, albeit lumpy, return of roughly 995%. This compares to a cumulative return for the MSCI EAFE Index (Hedged to USD) of approximately 500%, and for the MSCI EAFE Index (in USD) of approximately 352%.
HISTORY DOESN’T NECESSARILY REPEAT ITSELF BUT IT OFTEN RHYMES
The current market environment, in our view, rhymes somewhat with the mid-seventies and early 2000s. In both of those periods, speculative excess was followed by a comeuppance for overvalued equities that was quite severe. The highly regarded Nifty Fifty stocks of the ’70s collapsed as did the tech darlings of the late ’90s, and it took 15 to 20 plus years in many instances for those stocks to regain their previous highs. Several never made it back. In the ’70s the collapse was catalyzed by inflation, triggered in part by fiscal stimulus associated with the funding of Lyndon Johnson’s Great Society, and a supply shock (Arab oil embargo), which led to a quadrupling of oil prices. In contrast, the 2000 tech bubble stocks collapsed largely under the weight of their own excess valuations, and associated financial excesses. Will unexpectedly persistent and escalating inflation coupled with supply disruptions and an oil shock associated with the invasion of Ukraine be the catalyst for a similar comeuppance this time around? It’s hard to know, but we believe such a calamity should again favor value oriented investment strategies such as ours. (Of course, past performance is no guarantee of future results.)
LESSONS FROM BEN GRAHAM
Thanks to Benjamin Graham, we never lose sight of the fact that when we buy a stock for the Funds, we are purchasing an ownership interest in a business enterprise that has a value that is often independent of the price it trades at in the stock market. To Graham and us, the essence of investing has always been to seek to exploit discrepancies between those two prices … to buy bargains in the market. Over time, the stock price can be volatile, depending on any number of factors that can trigger reactions and overreactions from investors. In contrast, in our view, a business’s underlying estimated intrinsic value tends to be more stable. We focus our attention on our estimates of the business’s intrinsic value, and when we believe the stock market mis-prices that value, we pounce.When the stock market prices the business at a level that meets or exceeds our estimate of its underlying value, we will often trade our shares back into the market. In the interim, we seek to capture the spread between price and value and participate in the growth of the business’s intrinsic value.While we are not always correct in our assessment of a company’s underlying intrinsic value, this “business-like” approach to investment has served us well over time. The alternative approach of trying to predict the outcome of a crisis or its impact on the economy and equity markets, we believe, is a low probability exercise.
STAYING ON THE BUS
In times of economic and geopolitical turmoil like the present, challenging markets will invariably offer up opportunities, and taking advantage when they appear, is, in our view, the essence of successful long-term investing. However, the ability to have a successful investment experience depends in large part on the willingness of our investors to “stay on the bus.” The ride can be bumpy, but you have to stay on board to have any chance of reaching your destination. And you can rest assured that we are on board with you.As of March 31, 2022, the current Managing Directors and retired principals and their families, as well as employees of Tweedy, Browne, had more than $1.5 billion in portfolios combined with or similar to client portfolios, including approximately $154.4 million in the International Value Fund, $91.7 million in the Value Fund, $7.6 million in the Worldwide High Dividend Yield Value Fund, and $7.7 million in the International Value Fund II – Currency Unhedged.
PERFORMANCE
After nearly nine years of an incredibly difficult stretch for value investors, we believe that the pendulum is now swinging back in favor of what we do, and that is reflected in the returns of our Funds over the last year and a half . If one looks at performance results beginning 18 months ago (September 30, 2020), when the prospects for emergency use approval of vaccines and the prospect of a strong fundamental economic recovery sparked a strong rally in value-oriented equities, the Tweedy, Browne Funds have produced cumulative absolute returns of between 22% and 29%. Our two international Funds performed roughly in line with or outperformed their respective benchmarks,while our two more globally oriented funds trailed their benchmarks during this period, largely due to an underweighting in US equities and the impact of the Ukraine war on the relative performance of European equities .Three of our four Funds significantly outperformed the growth component of the MSCI EAFE and World Indexes, which produced returns for the 18-month period of 10.79% (MSCI EAFE Growth Index) and 23.23% (MSCI World Growth Index).The Worldwide High DividendYield Value Fund finished the 18-month period with a strong absolute return of 22 .18%, but marginally underperformed the MSCI World Growth Index.
Returns over the 12 months ended March 31, 2022 were not as robust. All four Funds underperformed their respective benchmark indices producing absolute returns of between 1.13% and 5.35% compared to returns of between 1.16% and 11.87% for their benchmarks. For our Funds and value stocks in general, returns had been quite strong from the first announcements of vaccines in the fourth quarter of 2020, right up until mid-May of 2021 , when the Delta and subsequent Omicron variants appeared, driving people indoors again. From that point forward, as case rates and hospitalizations rose, the “stay at home” technology and growth stocks once again surged, driving stock market returns for the rest of the calendar year. As the new year opened, increasing concerns regarding rising inflation and interest rates, and the invasion of Ukraine, led to rising market volatility and value stocks once again assumed market leadership.
The US dollar has remained remarkably strong over the last year against all major currencies, including the euro, the British pound, and the Japanese yen.This US dollar strength favors currency hedged funds, like our International Value Fund and Value Fund , which hedge their perceived foreign currency exposure, to the extent practicable, back into the US dollar. Significant gains in the value of the Funds’ forward contracts helped to soften much of the dilution in total return due to poor currency translations during the fiscal year.These gains also helped to propel the International Value Fund’s returns well ahead of the MSCI EAFE Index (in USD) for the fiscal year. However, the International Value Fund underperformed its benchmark, the MSCI EAFE Index (Hedged to USD) for the period. As you know, the International Value Fund and Value Fund seek to reduce their currency risk by hedging their perceived foreign currency exposure back into the US dollar based on our judgment of such exposure, after taking into account various factors such as the sources of the Fund’s portfolio companies’ earnings and the currencies in which the Fund’s securities trade.Therefore, the International Value Fund and the Value Fund will only partially hedge multi-national portfolio companies that earn revenues and profits in US dollars.Those companies’ exposure to US dollar revenues and earnings acts, in our view, as an implicit hedge. The MSCI EAFE Index (Hedged to USD) and MSCI World Index (Hedged to USD), on the other hand, are fully hedged back into the US dollar, irrespective of some of their constituents having material revenues and earnings in US dollars. In addition, the International Value Fund has had a significant underweight in Japanese equities (2.6% allocation as of March 31, 2022). When the US dollar is strong while the Japanese yen is weak, as has been the case over the last year, it becomes more challenging to outpace the hedged benchmark’s stronger relative performance. The benchmark’s outperformance, in part, is due to its relatively large weighting in the Japanese yen (23%) and its policy of hedging 100% of its nominal exposure back into the US dollar.With respect to the Value Fund, hedging gains were not enough to propel the Fund ahead of the hedged or unhedged MSCI World Index, as the Fund was disadvantaged by its relatively lower weighting in US equities.The unhedged Worldwide High Dividend Yield Value Fund also trailed its unhedged benchmark for the year in part due to a significant relative underweighting in US equities. As would be expected, during this period of US dollar strength, the International Value Fund II – Currency Unhedged was unable to perform on an absolute basis as well as the hedged International Value Fund, but did come very close to besting its unhedged benchmark producing a return of 1 .13% versus 1 .16% f or the MSCI EAFE Index in US dollars.
Over the last 28¾ years since its inception in June 1993 through March 31 , 2022, the International Value Fund produced a compound annualized return for its shareholders of 8.67%, net of fees, which translates into a cumulative return of 994.78%. By comparison, from May 31 , 1993 through March 31, 2022 , the MSCI EAFE Index (Hedged to USD) and the MSCI EAFE Index (in USD) compounded at 6.41% and 5.37%, respectively, translating into cumulative returns of 500 .01% and 352 .22% . Thus, an investor who had been invested in the Fund since its inception would have received a cumulative annual return of nearly twice that of the MSCI EAFE Index (Hedged to USD), and 2 .4 times that of MSCI EAFE Index (in USD) . Investors should never forget the power of compound interest. An investment of $1 million compounded at 8.67% over 28¾ years grows to $1 0,947,907.
If you believe that the volatility of a return stream is a reliable measurement of risk, the InternationalValue Fund produced its benchmark-besting returns while assuming relatively low levels of risk when compared to the MSCI EAFE Index (both Hedged to USD and in USD). For example, since July 1, 1993 (the first full month of the International Value Fund’s returns) through March 31, 2022, the International Value Fund had an annualized standard deviation of 12.15%, compared to 16.02% for the MSCI EAFE Index (in USD) and 14.22% for the MSCI EAFE Index (Hedged to USD). Further, as illustrated in the following chart (and for the same period), the Fund’s 1 2.15% standard deviation compares well to 16.37% for a peer group of foreign large cap funds in the Morningstar database, which ranks it at the very top (#1) of these foreign large cap funds in terms of standard deviation. In terms of Sharpe Ratio, which measures return per unit of risk, the Fund’s since inception ratio of 0.56 ranked it again at the very top (#1) of this same peer group.
As we have mentioned before, we believe that fellow value investor Howard Marks (Trades, Portfolio) was absolutely right when he stated that the true measure of a money manager’s skill is the manager’s ability to produce returns that are more than commensurate with the risks assumed. At Tweedy, Browne, we focus on stock prices in relation to various valuation multiples and earnings yields and fundamental factors such as earnings and sales stability in gauging the inherent risk of a prospective investment. We are encouraged by the fac t that this fundamental work has also produced statistically attractive risk adjusted returns.
While the International Value Fund’s positive returns over the last 28-plus years were earned while experiencing lower volatility than its for eign large cap fund peers, the path to achieving attractive risk-adjusted returns has not been without bumps along the way. Periods of underperformance are a normal part of a long-term index-besting performance record — the following table illustrates this . Since the International Value Fund’s inception, good index-besting periods have been followed by difficult periods , then good periods , etc . You’ll notice the latest difficult stretch of underperformance has been unprecedentedly long. If the past is indeed prologue, we would expect the recovery of returns this time around relative to our growth brethren and our global benchmark to be similarly robust, if not better. (Of course, past performance is no guarantee of future results.)
In many respects, Ben Graham’s “margin of safety” approach to investing can help an investor win over the longer term by losing less during periods of great market stress. That has certainly been reflected in the results of our flagship Fund over its 28-plus year history. As you can see in the following chart, since its inception in 1993, the International Value Fund has outperformed its benchmark index (in terms of annual total returns) in every calendar year in which the index had a negative annual total return. In fact, our Fund gained the most ground against its benchmark index during these challenging periods.
PORTFOLI O ATTRIBUTION & POSITIONING
Please note that the individual companies discussed herein were held in one or more of the Funds during the year ending March 31, 2022, but were not necessarily held in all four of the Funds. Please refer to footnote 6 at the end of this letter for each Fund’s respective holdings in each of these companies as of March 31, 2022.
While macroeconomic issues, including the war in Ukraine and the surge in inflation and commodity prices, especially oil, are rarely determinative in our bottom up investment decision-making process , they are seriously weighed and can have an impact at the margin on portfolio construction and stock selection. Before addressing the drivers of returns over the last year and specific portfolio actions we have taken, we thought we would share with you our views regarding the current macro and geopolitical environment:
- The risk of sustained higher inflation has increased. In addition to the cumulative impact of years and years of monetary and fiscal stimulus, elevated energy prices (Ukrainian war) and continued supply chain bottlenecks (China’s lockdowns from zero-Covid policy) are addingadditional inflationary pressure. Medium-term consumer inflation expectations are increasing, as are the risks for a wage-price spiral.
- There is an increased possibility that energy prices will remain structurally higher in the medium term, particularly in Europe.
- Many central banks , including the Federal Reserve, appear to be behind the curve, and are playing catch-up in raising interest rates and removing quantitative easing to fight high inflation.
- While difficult to predict, the probability of a global recession in the medium term has also increased.
- Factors above argue for more cautious near-term margin and earnings expectations.
- In discussions with the Funds’ portfolio companies, we have uncovered a good deal of optimism with respect to their ability to ultimately pass on increased costs via higher prices . Almost invariably, however, this occurs with a lag, resulting in near term margin compression. Moreover, with every business now attempting to simultaneously increase prices, some demand destruction should be expected.
- On the geopolitical front, the overwhelming global condemnation of the Russian invasion in Ukraine and the imposition of crippling economic sanctions has likely been a shot across the bow for the Chinese.
With respect to portfolio attribution, the strongest overall contributions to our Funds’ performance over the last fiscal year came from traditional value groups such as the Funds’ financial, consumer staples, healthcare, and industrial holdings . This included strong returns from the Funds’ banks, diversified financials, food and beverage, pharma and interactive tech media companies . It has been a particularly beneficial environment for banks such as Wells Fargo, DB S Group, United Overseas Bank, and Bank of New York Mellon, which have been clear beneficiaries of the increase in financial activity, advisory fees and net interest margins . Food and beverage holdings, Nestlé, Diageo and Coca- Cola FEMSA benefitted from economic reopenings around the world. Pharma companies such as GlaxoSmithKline and Roche continued to benefit from strong drug pipelines. Interactive media holding, Alphabet (Google) , whose growth traj ectory in search and other online businesses has remained extraordinarily strong, and Swiss media company, TX Group, which through a recent joint venture expanded its digital classified ad business, also produced strong returns for the period. The stock prices of British defense-related industrial companies, BAE Systems and Babcock International, also responded well during the period. BAE recently de-risked its pension plan and, in our view, continues to have an attractive mix of defense businesses in demand by the UK military, while Babcock International is in the midst of a turnaround by new management, which is gaining credibility amongst investors. The German defense contractor and automotive parts manufacturer, Rheinmetall, also delivered a strong performance during the year as the war in Ukraine increased interest in defense and security. The share price of Bollore, the French logistics and media company, benefitted from the strength in the freight forwarding market (driven by Covid-related supply chain disruptions) and the sale of its African port and logistics business . TotalEnergies , the French oil & gas company, one of the Funds’ few remaining oil companies , benefitted from the recent spike in oil prices.
A number of other holdings saw their stock prices advance during the year, including B erkshire Hathaway, the Warren Buffett (Trades, Portfolio) -led conglomerate, and AutoZone, the US-based aftermarket auto parts retailer, which has benefitted from disruptions in the automotive supply chain. Carlisle, the US-based commercial roofing company, also performed well in the period as it continues to benefit from a strong re-roofing backlog due to jobs deferred during Covid, and the increasing age of the commercial building stock in the US.
Corporate actions later last year in a few of our Fund holdings also had a positive impact on results for the fiscal year end. For example, La Banque Postale announced a tender last fall for the remaining shares of the French life insurer, CNP Assurances , which it did not already own. CNP is a longtime Fund holding, and the stock jumped up 36% on the news in late October. While the offer , in our view, was not at the company’s full intrinsic value, we decided to sell our Funds’ shares. The Swedish industrial company, Trelleborg, which is held in all of our Funds, also jumped up on the rumor last fall that a Japanese rubber company had offered $2 billion for Trelleborg’s wheel systems business . The stock hit a record high 237 krona shortly after the initial media coverage. In late March rumor became reality, as Trelleborg signed an agreement to divest its wheel systems division to Yokohama Rubber Company for $2.3 billion. Our weighted average cost in Trelleborg shares across our Funds is roughly 118 krona. Holdings of CNH Industrial also got a boost in the 4th quarter from the company’s plan to spin off its trucking and powertrain business , Iveco, early in 2022.
In contrast, several of the Funds’ consumer discretionary, utility, materials , and industrial holdings produced disappointing results for the fiscal year. This included portfolio holdings such as Autoliv, the Swedish automobile airbag and seatbelt company, and Norma, the German manufacturer of joining products for the automotive sector — both companies suffered from automobile supply chain difficulties (lack of semiconductors and harnesses), and were negatively impacted by raw material inflation; Safran, the French jet engine manufacturer whose results are correlated in part to passenger airline volume has yet to fully recover from lockdowns and Covid restrictions; Rubis was affec ted by rising energy prices; BASF was impacted by macroeconomic concerns as well as Russia exposure in its oil & gas subsidiary; Henkel was negatively impacted by the relatively slower growth in Europe due to the pandemic and the Russian invasion of Ukraine; Intel announced a plan to regain product leadership that was more expensive than investors had expected; 3M faced rising litigation costs; Comcast was affec ted by a slowdown in broadband subscriber growth post “stay-at-home” and by increasing competition; and Fresenius SE & Co, the German healthcare company, which experienced a declining patient population for their dialysis services due to Covid deaths. It remains our view that these companies are strong and resilient and should be able to weather the near-term geopolitical and economic uncertainty and the market volatility associated therewith.
The Funds’ emerging market holdings also faced challenges during the fiscal year, particularly those in China, as economic growth slowed and regulatory and governmental intervention continued to negatively impact certain industries and companies. This led to declines in Alibaba, Baidu, Tencent, and A-Living, among other Chinese holdings. Recent government imposed Covid lockdowns have only added to these concerns . That said, we were encouraged by recent messaging from Chinese Vice Premier Liu He, where he encouraged the adoption of standard, transparent and predictable regulation to promote the steady and healthy development of the Chinese platform economy and improve its international competitiveness. While there are no guarantees, Liu He’s comments provide some hope that Chinese regulation might not be as heavy-handed going forward.
As of mid-May, many Chinese internet companies were trading at extremely discounted valuations , despite their strong market positions and, in our view, attractive growth potential. Alibaba and Baidu were selling for ~2x and ~1.2x our estimates of their core business’s operating income, respectively. Although Tencent was trading at a slightly higher 7x our estimate of its core business operating income, it has, in our view, the strongest "moat" of the three businesses, and we believe it should have the highest earnings growth in a more normalized macro environment. Baidu has nearly 60% of its market cap in cash and equity investments, while Alibaba has over 43% and Tencent nearly 40% . Net of cash and equity investments, Baidu was selling for 6.9x its forward earnings (or, estimated future earnings) , while Alibaba was selling for 6x its forward earnings. In contrast, Amazon was trading for nearly 55x forward earnings . Even following its recent share price decline, Facebook was still selling for 17x its forward earnings, net of cash. Of course, these figures will be impacted by the recent Covid lockdowns in China, and our estimates might prove to be too optimistic. Nonetheless , we believe the valuation discounts at these businesses are extreme.While we recognize that Chinese internet companies are deserving of a higher corporate governance and regulatory valuation discount relative to their Western peers, in our view, the current valuation differen tials more than account for this. As of March 31, 2022 , the Funds generally had between 6.1% and 8.3% of total assets invested in Chinese and Hong Kong equities, and we are seeking to stay within the 5% to 10% range in these two countries (at cost) for the time being.
Looking forward, in researching prospective and existing holdings wherever they may be domiciled in the world, we are increasingly focused on the following:
- Balance sheet strength;
- Pricing power in the face of rising input costs (albeit often with a lag);
- Risks to operating margins as a result of persistently high energy prices; and
- Increased consideration of “insight information”; using insider buying as a clue to opportunity and resilience in the businesses being researched.
As Scott Galloway, the highly noted media and tech guru, recently opined in one of his newsletters , “ There are few fundamental truisms in the markets . One of them is fundamentals . Another is cyclicality. And in my view, the atmospherics , if not sheer probability, augur that we’ve entered the less appealing part of the cycle.” If Scott is correct, companies with fortress balance sheets and pricing power may continue to draw investor interest in this increasingly volatile market environment.
PORTFOLIO ACTIVITY
Despite rising valuations for much of the last year, we continued to be very active in adding to and pruning the Funds’ investment gardens.We uncovered numerous equities that we believe were undervalued, particularly in Europe and in some of the more developed emerging markets, but also in the US. We established a number of new positions during the fiscal year and added to many others, including Vertex Pharmaceuticals, the US-based biotechnology company; Kemira, the Finnish chemical solutions business; Haitian International, the largest manufacturer of plastic injection molding machines in China; Buzzi Unicem, the Italian cement company; Fagron, the Belgium based pharmaceutical compounding company; SKF, the Swedish ball bearings company; FMC, the US-based agricultural chemicals company; Sumitomo Heavy, the multi-faceted
Japanese manufacturer;Tencent, the dominant Chinese social media and gaming company; US-based Thor Industries, the largest maker of recreational vehicles in the world; Uni-President, the China-based instant noodles and beverage company; Winpak, the Canadian food packaging company; Tesco, the UK-based grocery business; and, near year end, Rheinmetall, the German-based defense systems and automotive components company. All of these companies, at purchase, were trading at substantial discounts from our conservative estimates of intrinsic value, were financially strong, and in our view had good prospects for future growth. To make room for the new acquisitions and additions, we sold and trimmed a number of the Funds’ holdings that had approached or exceeded our estimates of intrinsic value, including Bangkok Bank, Hankook & Co. , Alten, the German engineering company, Jardine Strategic, Kingboard Holding, Michelin, Novartis, Roche, Siemens, Carlisle Cos, Phillips 66, Bollore, Alphabet, AbbVie, and a host of others.
More on a Few Newly Established Positions During the Year
- Buzzi Unicem (MIL:BZU, Financial) (paid approximately €18.30 per share)~geographically diversified global cement company. Near net cash balance sheet. Material insider buying (€27 million at average price ~€19.50 per share) . Negatively impacted by higher energy input prices , but cement is a small portion of the cost of construction pro jects. A greater risk is overall construction activity. Paid 4x 2021 EBITDA and 6x our estimate of “normalized” EBITDA, assuming 10-year average margins. Observed M&A deals at 6x to 8x EBITDA.
- Vertex (VRTX, Financial) (paid approximately $1 87 per share) ~ US-based biotechnology company specializing in drugs for rarediseases . Dominant therapies in the treatment of Cystic Fibrosis . Enj oys pricing power and little competition. Material insider buying by the company’s CEO and lead director, in addition to a large buyback by the company. The Value Fund’s weighted average cost is $187, and at purchase, it was trading at roughly 14x current earnings and 9.9x enterprise value to EBIT.
- SKF (OSTO:SKF A, Financial) (paid between 149.1 and 1 62.1 Swedish krona (SEK) per share) ~Sweden-based pre-eminentmanufacturer of ball bearings with approximately 20% world market share. The Wallenberg family owns 14% of the company and significantly added to its position ($25 million in 2021 and $50 million in 2022), paying higher prices than we paid for our shares (as much as 229 krona per share). SKF has been a strong cash generator, has produced high returns on invested capital, and has compounded our estimate of its intrinsic value, on average, at 5 to 6% per year. Its balance sheet is rock solid, in our view, with a net debt to EBITDA ratio of 0. 55 . At purchase, assuming a price of roughly 160 SEK, the shares were trading at 8x our estimate of normalized EBIT, 6x our estimate of normalized EBITDA, 9.5x earnings, and had a current dividend yield of 4.5%.
- Thor Industries (THO, Financial) (paid approximately $94.30 per share) ~Largest maker of RVs in the world. 45% market share in US/Canada, 22% in Europe. 1 .5x net debt to EBITDA. The company’s highly variable expense structure (as demand falls, so do costs) has resulted in profit every year since 1980, despite cyclical end demand. Material insider buying ($31 million at $107 per share average price) . Paid 7x trailing twelve months P/E , or 11x our estimate of normalized P/E (based on pre-pandemic sales and 10-year average margin).
ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) INITIATIVES
As we have mentioned in previous reports , environmental, social and governance factors (ESG) can present both risks and opportunities when investing, and are becoming increasingly important to many of our shareholders and prospective shareholders. Over the last year, we incorporated into our research process an evaluation of numerous ESG considerations including the following:
- ESG issues factored into our decision to establish a position in Kemira, one of our new Fund portfolio additions. Kemira (OHEL:KEMIRA, Financial) is a Finnish-based global leaderin sustainable chemical solutions for water intensive industries. Kemira’s products enable customers to improve product quality and deliver environmental benefits such as cleaner drinking water, treating wastewater for safe reuse or release into nature, reducing CO2 emissions and/ or improving recyclability (replacing plastics with paper). “Sustainability” is at the core of the business and at the center of product design. According to the company, 54% of total revenue is generated fro m products that improve customer resource efficiency. Kemira’s products help ensure safe and clean water and help paper mills use less water. The most meaningful of Kemira’s stated ESG goals is to derive €500 million in annual revenue from bio-based products by 2030 (bio-based inputs replacing carbon based inputs) . They have several other E SG-oriented goals related to employee safety, diversity & inclusion, water intensity, reduction in Scope 1 and Scope 2 emissions, etc . We valued the business at 9x to 10x EBITDA based largely on merger and acquisition comparables. We think the high end of the range encompasses a 1.0x multiple point premium based on ESG opportunities (like the universal goal of treating waste water for safe release into nature).
- FMC Corp (FMC, Financial), the crop protection company, is an example of another purchase we made for the Funds over the last year where ESG considerations played a role in our research process. FMC Corp. provides crop chemicals for the agriculture industry. Crop chemicals protect farmers’ fields from insects , fungus, and weeds, which allows them to increase their crop yields. While FMC could face some ESG risk associated with increasing regulations that ban certain crop chemical products due to their environmental impact, we do not think it is likely that this risk will be material. To date, FMC has actually benefited from this dynamic. Many older crop chemicals, particularly certain insecticides, are “ broad-spectrum,” and can be quite toxic to the environment because they impact everything that they come into contact with. As a result, regulators are increasingly prohibiting the use of the older, more harmful chemistries. In contrast FMC produces a lot of “targeted” crop chemicals, which affect only the “targeted” pests, and therefore have a lower environmental impact This has allowed new products to take market share from the older, more toxic ones that are being banned allowing FMC to grow at nearly twice the industry growth rate In this respect, rather than negatively influencing our valuation, environmental impact concerns actually caused us to increase the multiples we used to estimate the company’s intrinsic value. In addition FMC was recently named by Barron’s as one of America’s most sustainable companies They were the only agricultural-related business on the list.
- Another of our more recent Fund investments is Rubis (XPAR:RUI, Financial), a French-listed business that distributes petroleum based products (gasoline and liquid petroleum gas “LPG”) in the Caribbean and East Africa We engaged with the company in the 4th quarter to get a clearer understanding of how Rubis was addressing its business’s environmental impact and the possible negative implications that impact may have on Rubis’s stock price and value compound. We had questions about what appeared to be according to a prominent financial reporting firm, a weak track record relative to its peers, with respect to disclosing environmental information. Rubis representatives disputed this believing that the reporting firm’s information was incomplete and some of it incorrect. They emphasized the company’s AA rating at MSCI and asked us to complete a survey to inform them of the ESG issues that are important to us We completed and submitted the survey and appreciated the company’s willingness to engage with us on this issue. We acknowledge that the company faces unusual environmental challenges from their operations in Africa and other emerging markets. For example Rubis supplies LPG to consumers in East Afri ca for home heating and cooking. These consumers do not have access to renewable sources of power, natural gas pipelines or reliable electricity networks The main alternatives to LPG for home cooking and heating include burning wood dung or cardboard which arguably produce more toxic emissions than that produced by cleaner gas-based fossil fuels. It is estimated that these non-fos sil fuel based alternatives kill about 700,000 people per year in sub- Saharan Africa from indoor air pollution. Economic development can help Africa out of this unenviable position but it also means Africans may require low cost fossil fuel in the nearer term to help pay for a more sustainable future In addition around quarter-end, Rubis announced a significant investment in a French solar power generation business whose efficacy we are currently studying We will continue to monitor Rubis’s behavior with respect to these complex environmental impact issues, but for now feel they do not compromise the company’s ability to compound its intrinsic value over time Furthermore, in our view the company’s discounted stock price more than compensates for these issues.
- More recently, we have engaged with the senior management of Industrias Bachoco (MEX:BACHOCOB, Financial), the Mexican chicken company which we own across all four of our funds, regarding an important minority rights issue In March, the Robinson Bours family which owns a controlling interest in the company announced a voluntary tender offer to buy out the remaining shareholders at approximately 81.66 pesos per share, which is a modest premium over the Funds’ original cost of approximately 71 pesos; however, we believe, as do a number of other shareholders that the price offered is well below any reasonable estimate of fair value, and unfairly benefits the family at the expense of minority shareholders. Prior to the announcement of the voluntary offer and in light of the significant discount at which the shares were trading in the public market we had encouraged the company to consider a share buyback, which, in our view would have accreted significant additional value to all of the remaining shareholders, not just the Robinson Bours family Instead they chose to attempt to buy out the remaining shareholders at a price which represents only a modest premium to where the stock had been trading prior to the deal announcement. If the intention of the family is to take the company private and delist we felt that they should at least make a realistic offer that reflects the inherent value of the business.
The tender offer has not yet been approved by Bachoco’s board. Shortly after the announcement we contacted the CFO of the company to express our dissatisfaction with the offer We also spoke with members of the press and several additional institutional shareholders In late April, together with 15 other minority shareholders whose ownership together with our stake represented 16 .23% of Bachoco’s outstanding shares and over half the outstanding float, we signed a letter to the board of directors of the company The letter called for an increased tender offer price, or the adoption of a share repurchase plan that would increase the value per share for all the remaining shareholders. As we write, we have yet to hear back from the company and we continue to evaluate our options. From a bigger picture perspective Mexican companies in general are often trading today at lower multiples than comparable companies in more business-friendly countries.
- Nestlé (XSWX:NESN, Financial) one of our core long-term holdings recently purchased wind turbines in Germany after soaring fossil fuel costs impacted expenses. The company has announced plans to power all of its sites with 1 00% renewable energy sources by 2025. We believe this is an aggressive goal, but see it is a positive, incremental step. It may give them some protection from energy price swings in the future, which could be a plus in helping to drive increases in intrinsic value.
THE DEFENSIVE POWER OF DIVIDENDS
"Offense sells tickets but defense wins championships." -Bear Bryant, former head coach of the Alabama Crimson Tide
There is no denying that dividend strategies have had a rough go of it in the “risk on” investing environment of the last 10 plus years . However, if the pendulum is indeed swinging back towards fun damentals as equity markets become more challenged, a dividend strategy might provide meaningful ballast in what could become a rather stormy sea. With expected total returns on equities coming down, the return from reinvested dividends could once again prove to be a significant contributor to total returns produced by equities in the nearer term, as it was fou nd to be for the 101 years ending in 2000 (Dimson, Marsh and Staunton, The Triumph of the Optimists : 101 Years of Global Investment Returns) . In addition, companies with long histories of growing their dividends might offer investors a partial hedge against declines in purchasing power associated with increasing rates of inflation.
There are many additional reasons why dividends remain important to investors. Stocks with high and sustainable dividend yields that are competitive with bond yields may be more resistant to a decline in price than lower yielding stocks because the stock is in effect “yield supported.” The reinvestment of dividends in additional shares of high yielding stocks during stock market declines can help lessen the time necessary to recoup portfolio losses.The ability to pay cash dividends is also a positive factor in assessing the underlying health of a company and the quality of its earnings. Dividends also, for the time being, may be tax advantaged (subject to certain requirements, such as minimum holding periods), particularly compared to the income from fixed income securities, which are generally taxed at ordinary income rates. And most importantly, there is an abundance of empirical evidence which suggests that portfolios consisting of high dividend-yielding securities may produce attractive total returns over long measurement periods.
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