Dear Investor,
I have the honour of greeting you for the first time as Bestinver’s investment director. My role within the firm is to coordinate one of the best teams of managers and analysts in Europe, with a single objective: to achieve the highest returns in all of our funds.
In recent years, the company has completed its product range with the launch of new funds and the creation of an area specialising in alternative investments. Our shareholders therefore have an attractive variety of vehicles available to them to invest in different assets and geographical areas following the same philosophy. A philosophy that has more than 35 years of history and that has made Bestinver the leading independent fund manager in Spain.
My appointment coincides with one of the most exceptional three-year periods that I have ever encountered in my 36-year professional career. This has been marked by the pandemic and its main economic sequel: inflation. This infation has led to central banks implementing the most aggressive monetary policy change in the last four decades, putting an end to a cycle of ultra-low interest rates that has been unprecedented in history. This tightening of monetary conditions should be welcome, as it fosters the desired rebalancing between supply and demand, which is needed to reduce current infationary pressures.
The markets have the year with some corrections that, in my opinion, already discount the possible impact of interest rate increases on economic growth in the coming quarters. They are therefore starting out in 2023 from highly favourable valuation levels that lay the foundations for what ought to be good returns in the future.
As you will see by reading the newsletters from each fund that follow this editorial, our portfolios are poised to capitalise on the tremendous opportunities available in today’s global markets. In this sense, I’d like to highlight the exercise carried out by Bestinfond (Trades, Portfolio) and Bestinver International managers to demonstrate that assets’ starting valuations are essential in order to determine their long-term profitability. As explained in their commentary, they started out in 2023 from very attractive levels that should provide excellent returns in the future. This attractiveness hasn’t gone unnoticed by the administrators of the companies in the portfolio, who have aggressively bought back their own shares. The magnitude of these buybacks —the largest in the history of both funds— only confirms the good level of prices at which they are trading and my confidence in the magnificent performance that can be expected from our fagship funds in the coming years.
In its commentary, the Bestinver stock exchange management team explains the opportunity that exists in the Iberian market, one of the cheapest in Europe and, therefore, in the world. Its portfolio is full of good, globally competitive, well-funded companies that nevertheless trade at very significant discounts compared to their international competitors. In my opinion, this market has significant tailwinds thanks to interest rates and the investment cycle needed for the energy transition.
With regard to fiixed income, the harsh adjustment over the past year has placed expected returns at the highest levels in the last decade. Thus, with IRR or expected annual return of 3.3% in Bestinver Corto Plazo, 6.5% in Bestinver Renta and 8.5% in Bestinver Deuda Corporativa, the most conservative investors have a good alternative to deposits and other traditional savings products in our fiixed-income funds.
During the last three months, alongside the investment team, I have studied the companies in our portfolios. These companies operations performed well in 2022, although this is not reflected in the evolution of their prices. As a result of this divergence, the spread between the price and the value of Bestinver’s funds is today one of the widest in our firm’s history of more than 35 years.
I also invite you to read the management commentary on our portfolios. You will have the opportunity to learn from managers about their outlook for the future, the investment cases of their companies and the main movements that have taken place over the last few months.
Corporate Information
Bestinver began investing in alternative assets in 2020, with the launch of Bestinver Infra, FCR.Our infrastructure team’s good management has enabled the fund to achieve 80% of its target size in less than three years, with 240 million euro committed by more than 580 investors. I am pleased to announce that the company’s marketing and acquisition of commitments will continue until its final closing, which will take place during the first quarter of 2023.
To complete the offer in alternative investments and continue committed to the company’s transformation into a leading independent group within the Spanish financial sector, a new area was launched during the final quarter of 2022 focused on the real estate sector. Enrique Sánchez-Rey and Marta Herrero have been hired to lead it, two professionals with extensive experience in the sector and an excellent reputation.
Lastly, we’d like to express our appreciation for the good reception of Bestinver North America, our equity fund focused in the North American market. In just three months, it has gained the trust of 580 investors and manages assets worth 40 million euro. In order to explain its investment strategy in detail, a webinar will be announced in the coming weeks in which all of your questions will be answered.
I say farewell thanking you for the trust placed in Bestinver and wishing you a happy 2023.
Yours sincerely,
Mark Giacopazzi
Bestinfond (Trades, Portfolio) commentary
Bestinfond (Trades, Portfolio) ends the year with a return of -16.98%, despite the 10.64% increase in net asset value recorded in the final quarter of the year.
The good performance obtained in recent months has reduced some of the losses of this difficult 2022.Fortunately, the huge differences between the intrinsic value of our companies and the price at which they trade have begun to narrow. This is only the beginning of a long path of hidden profitability that requires a balanced portfolio, made up of leading companies in their sectors that are well managed and whose earnings will grow significantly in the coming years. Their profitability will be driven by the good operating performance that is forecast for our businesses, as well as by the attractive valuation with which they are currently listed.
The year 2022 has been another extraordinary year (that makes three in a row…)
It was marked by contraction in the valuation of our companies on the stock market. Bestinfond (Trades, Portfolio)’s net asset value reached its all-time high thirteen months ago (the end of November 2021).Since then, this has fallen by approximately 20% while the earnings of the companies that make up the fund have grown by more than 20%.The result of this great divergence? Highly contracted valuations that weighed on the portfolio’s profitability during 2022, but which should provide excellent revaluations in the future.
In the last twelve months, practically all financial assets have recorded notable losses, with the exception of the dollar and the sectors related to energy and raw materials, which have seen a spectacular year.
The year 2022 should have been the year of exit from COVID-19 and consequent economic recovery. In the end, it turned out to be war in Ukraine, lockdown in China and, above all, the biggest rise in interest rates in the last 40 years due to runaway infation.
Periods when central banks raise interest rates are usually not bad for shares. The higher return required by investors or the lower Price Earning Ratio (PER) is more than offset by the growth in corporate earnings. The year 2022 has been an exception. We knew that some corners of the market were vulnerable due to some highly demanding valuations. What wasn’t expected is that many shares —with attractive starting valuations and yields that have actually been very good— would contract to all-time lows in their Price Earning Ratios.
These were the discretionary consumption companies or sectors considered cyclical. The market hasn’t even wanted to look at this type of company (until a few weeks ago), despite the fact that their earnings recovery after the exit from COVID-19 has been spectacular and that they are much more profitable and solvent businesses than they have been in the last decade. You can already imagine the reason: we are facing an economic downturn (the most-anticipated in history, by the way) that hurts this type of business compared to those considered more defensive.
The reasoning is correct, in the first derivative. The reality is that there are a few second derivative questions that every investor should ask before selling a good company at a good price: How deep will the economic downturn go and how long will it last? If it does occur, how much long-term value will be destroyed for shareholders? And above any other consideration, what is its valuation? What scenario discounts the share price?
In 2022, it wasn’t possible to interpret how short-term the market could be, although we’re certain that the potential for increase in share value is very significant. We don’t think it’s the best time to sell them. Despite the macroeconomics, 2023 is the time to buy them.
Will the economy experience a hard or soft landing?
We’re not going to repeat ourselves in this final newsletter of the year, but since the war broke out, it has been considered that households’ and companies’ healthy balance sheets, how well capitalised the commercial banks are and the undeniable impulse of the end of the pandemic would be forces powerful enough to offset the increase in energy prices, tightened monetary policies and the uncertainty created by geopolitical tensions arising from the confict. In the final months of the year, it seems that the market has begun to come to terms with this soft landing scenario for the economy. Better-than-expected economic data —despite tightened financial conditions and the energy shock— seem to have somewhat blurred the gloomier scenario that prevailed for a good part of the year.
Beyond these short-term macroeconomic factors, it must be pointed out that there are other types of very important considerations when making long-term investment decisions. These include companies’ adaptability, investors’ positioning in the markets and, of course, asset valuations. These aspects may not be important in the short term, although they are absolutely vital in our performance as savers with a longer time horizon.
When considering economic agents’ confidence level (below the Eurozone crisis or the worst moments of the pandemic in 2020), the investors’ extreme positioning (with the greatest exposure to cash and commodities against stocks and bonds of the last decade) or the valuation, for example, of the cyclical sectors against the non-cyclical ones (at minimums of the last 40 years), it is understandable why the price of assets has been falling for many months, anticipating a recession that doesn’t yet exist. The question, therefore, is not whether a period of economic downturn is coming, but whether it will be worse than what share prices are already discounting.
And what will happen in 2023?
The markets are not willing to value companies’ long-term earnings and they won’t do so until they see light at the end of the current macroeconomic tunnel. The kind of outcome investors are looking for isn’t clear, although we do believe that interest rates, which were the main drivers of the contracting Price Earning Ratios in 2022, have already covered a large part of the way they had to go and many of the imbalances that led to being in this position are clearly in decline.
The consensus continues that monetary tightening and the energy shock are inevitably heading the economy towards a recession. The general opinion is that the markets could bottom out in the second half of the year anticipating, as they always do, the economic recovery that is expected by 2024. As expected, this set-up would seem appropriate to investing without fear in the coming months, although there is the possibility that the central banks will go too far raising interest rates —the economic downturn will therefore be deeper— and a resurgence of the war confict with unexpected consequences cannot be ruled out either.
Faced with this type of uncertainty, the analysts’ consensus tends to consider the worst case scenario —especially when the recent past hasn’t been good— and with apparently sophisticated arguments, they recommend taking refuge in assets that have done well recently (cash, raw materials, arms companies and those that benefit from rising interest rates) and at all costs avoid anything that made them lose money in recent months (equities in general and in particular businesses that depend on the economic cycle or that are affected by interest rate increases, such as the so-called growth companies).
The list of extraordinary events in recent quarters (years) makes it impossible to anticipate the stock market future of any business in the short term. Although keep in mind that the performance differences in 2022 were absolutely historic. Sectors such as defence, energy and mining, with 70-80% returns for many companies, contrast with very large falls (40-50%) in real estate, technology, consumer companies and many industrial companies. If there were any valuation gap between the different groups, the macro and the war have wiped it away in one fell swoop.
Price Earning Ratios have contracted, now earnings need to fall
The year 2022 was characterised by contracting Price Earning Ratios caused by a sharp rise in interest rates in a relatively short space of time. For 2023, the consensus expects a year marked by falling corporate earnings.
The approach is correct and it is difficult to be constructive in the first derivative. However, in this second derivative world, we may ask ourselves: How much do companies’ earnings have to fall before their valuations are unattractive in the long term? In this sense, it is interesting to recall the example of European companies in the period from 2011 to 2015, when earnings fell by more than 25% and their shares rose 50% on the stock market, going from trading with a Price Earning Ratio (PER) on those earnings from 13 times to 25 times.
We wouldn’t like to say that the same thing will happen now and it’s important to point out that a company’s value is not determined by the results of a financial period, but by the earnings that it could generate throughout its life discounted at an appropriate rate. In other words, demanding a return from those earnings that includes a reasonable growth and infation estimate and the possibility that something may go wrong along the way. In any case, going back to the initial question, the answer in the case of Bestinfond (Trades, Portfolio) is clear: the earnings of our companies would have to fall a lot in 2023 for our portfolio not to generate good returns in the long term. Much more than expected.
A very simple theoretical exercise explains it. But before going into details, remember that our portfolio has a potential of more than 100%, as was mentioned in detail in the newsletter for the second quarter of 2022. A value increase of 100% that would be explained by the growth that projected in the earnings of our companies (if the current Price Earning Ratio remains constant), to which an additional “extra” would have to be added that could be greater than 50% if they were listed at 15 times earnings, the average historical Price Earning Ratio of the stock market..
Returning to the financial period proposed, we start from the minimum investment that anyone can make in our fund (€100).By doing so, we have become the owners of a company (Bestinfond (Trades, Portfolio)) whose listed businesses provide earnings amounting to €11.50 per share. The average Price Earning Ratio over these earnings (PER) at which our companies are listed is 8.7 times, hence the value of €100 of our single share (8.7x11.5=100).
If we wanted to infer how much the results of our companies would have to fall for the Price Earning Ratio (PER) to be around 15 times, which is the historical average for the stock markets, the result would be a hefty 42%.We don’t believe that the Bestinfond (Trades, Portfolio) companies are at their peak earnings for the cycle, nor do we believe that they will fall by more than 40%.Even in this scenario, our long-term net asset value should not suffer (although in the short term the outcome is absolutely unpredictable).
Although second derivative mathematics doesn’t stop there. It turns out that the average PER of the last 100 years of 15 times is constructed by averaging between the low Price Earning Ratios (10 times) of the peak earnings of the economic cycle and the high Price Earning Ratios (20 times) of the trough earnings of the same. Therefore, if a PER of 20 times is applied to the floor earnings of 2023, the value of Bestinfond (Trades, Portfolio)’s shares should rise by 34%.
Not only that. If we believe that economic recovery would come after a difficult 2023, earnings in 2025 could be anticipated at 15% above those recorded in 2022 (the projections used for our companies are higher than that figure).Applying them, now that the historical average Price Earning Ratio of 15 times that mentioned, the money would be doubled in the coming years.
As can be seen in this theoretical exercise, the short term and the first derivative seem to paint a complicated picture for 2023. It absolutely cannot be ruled out. However, thinking in the longer term —being aware that the future is not projected linearly on an Excel sheet— and knowing that our companies are doing their homework, protecting margins and taking advantage of the strength of their balance sheets to continue investing and growing, there is no choice in the coming months but to do the opposite of life: take advantage of the bad times while they last.
A market totally dominated by macro
In equity markets, interest in macroeconomics rises systematically when the going gets tough. We’ve always said that we’re all investors in bull markets and economists in bear markets. Surely this interest in the economic situation is an attempt to rationalise the falls in share prices.
It seems clear that in the coming months, investors’ sentiment will continue to infuence their decision-making. A sentiment that will mainly depend on their short-term expectations regarding inflation, central bank policy, the geopolitical climate and another series of macro variables that cannot be predicted consistently. Therefore, it cannot be ruled out that there will be new falls in the value of assets. These are dips that should be taken advantage of by long-term investors like us who base their decisions on fundamental analysis. Bargains in the markets are found in these types of environments, not when everything seems rosy.
Bestinver doesn’t make macroeconomic forecasts, although it does know that recession is the best antidote to end inflation. If this materialises, corporate profits will undoubtedly suffer for a few quarters, although it mustn’t be forgotten that central banks —unlike in the last decade— have plenty of ammunition to sweeten the economic cycle and boost asset values in the markets. Conversely, if the reopening of China, lower energy prices or the good financial health of economic agents prevent the recession from materialising, then infation could remain relatively high and interest rates could remain at current levels. It will then be corporate earnings that provide support to the markets that no one anticipates at this time.
Shareholdings are increased in our businesses (without specifying a value in euro)
We don’t want to sound like hopeless optimists. What we are is convinced long-term investors. Will temporary dips in the markets continue? Of course, although the operating performance of our companies has been excellent and their investment theses remain intact. The recent market decline has made valuations more attractive and significantly improved the future return potential of our portfolios..
We have never had a solvency position such as this (at an aggregate level, there is more than 15% net cash in the portfolio).A strength in the balance sheets of our companies that ensures operational stability —whatever happens with the economy in the short term— and the certainty that they will continue to invest in the businesses in the long term. A solidity that provides recurring dividends (more than 4.5% return) and that has enabled our companies to buy back their own shares, taking advantage of the low valuations in the markets. This is surely the most important proof that portfolio company managers share our opinion about how cheap their shares are.
When a company buys back shares and cancels them, it is by de facto raising the value of its shares in circulation. If a company has 100 shares and we own 10, we have 10% of the company. In other words, 10% of its assets and the profitability generated. If 30 shares are bought back and cancelled, our 10 shares would represent 14.3% of the company and our share in its assets would have risen by 43%. This is mathematics, although what is truly relevant, as previously explained in this recently-published analysis, is to determine the value that is being acquired. In other words, the profitability offered by their own shares that will be bought back.
And therefore, if the buybacks are made when valuations are attractive, as is the case with our companies, there is a value transfer from the sellers of the shares to us, the owners of the companies. This is precisely what has been happening in 2022 in companies such as Pandora, Harley, Holcim, Heidelberg, Univar, BMW, BP, Shell and the banks in our portfolio, etc. All of them trading well below 10 times earnings and aggressively buying back shares, in some cases for the first time in their history.
More than 50% of Bestinfond (Trades, Portfolio) companies (representing almost two-thirds of the portfolio) are reducing their number of shares in circulation. An absolutely incredible figure, never seen in Bestinver’s history, which means that Bestinfond (Trades, Portfolio) shareholders have a greater proportion of their assets and the earnings that they will generate in the future. A capacity to generate profits that, without putting up a penny, we have acquired at very attractive valuations, despite the fact that the market hasn’t wanted to recognise it in recent times.
Portfolio movements
This quarter has once again provided the opportunity to continue increasing the potential of the fund and, at the same time, improve its balance sheet. How did we do it? Mainly by buying more shares in companies whose value and share price have diverged and by adding some ideas that increase the strength of the portfolio.
We have increased our positions in Bayer (XTER:BAYN, Financial), a company whose investment case was detailed in our previous quarterly newsletter. More deeds have been acquired from Intesa (MIL:ISP, Financial) and ING (ING, Financial). Their accounts will continue to benefit from higher interest rates, while the risks of a severe default cycle have been diluted following the corporate bailouts announced by European governments in recent months. The acquisitions have been funded by reducing exposure to companies that have performed much more positively, such as Harley Davidson (HOG, Financial), Berkshire (BRK.B, Financial), Holcim (XSWX:HOLN, Financial), Prosus (WBO:PRX, Financial) and Informa. Similarly, exposure has been reduced to oil companies BP (BP, Financial) and Shell (SHEL, Financial) after their stellar performance in the year.
IFF: de-leveraging and synergies in a very attractive sector
Throughout the quarter, we have started investing in IFF (IFF, Financial), the world’s largest consumer ingredients company. The American company manufactures a wide range of ingredients and fragrances for producing perfumes, household and personal care products. It also produces enzymes and pharmaceutical excipient components.
IFF has experienced a difficult few years after an acquisition (Frutarom) didn’t go as expected, with significant problems integrating different cultures and business models. A complex acquisition —it was particularly large by industry standards— that took management’s attention too far away from the core business. However, just as they were beginning to see the light at the end of the tunnel, they announced an even larger acquisition: DuPont Nutrition & Biosciences.
The degree of market scepticism about the company is understandably high, although we believe that this new acquisition has the potential to change the sector’s competitive landscape, benefiting IFF disproportionately. In a base-case scenario, there should be strong cost synergies from combining two highly complementary businesses. Being a little more constructive, the revenue synergies should place IFF in a prime business position within an industry whose volumes grow 4-5% annually on a recurring basis.
IFF was acquired at a 50% discount over its peers (Christian Hansen, Novozymes, Givaudan, Symrise), because of scepticism about the integration as well as many investors’ concern about the high level of debt on the balance sheet. We believe that the fears are completely unfounded. The first and most important aspect is that IFF generates cash in a stable manner and the debt structure (at a fiixed rate and with very long-term maturities) doesn’t entail any risk from an operational point of view or the ability to reinvest in the business. IFF has also announced a divestment plan that should bring debt down to absolutely reasonable levels, in line with industry standards.
In this sense, there was good news a few weeks ago. IFF announced the sale of Savory Solutions Group for US$900 million. This operation was carried out with at an attractive valuation (14x EBITDA), which should boost business margins (the division sold had 13.5% EBITDA margin, well below current group levels of 20-21%) and reduce leverage until it is very close to the targets recently announced by the company (<3x by the end of 2024).
The reorganisation of the divisions, the changes in the board of directors and the profitability and growth objectives drawn by The new management team —professionals specialised in business integration— seems to be laying the foundations for a promising future. IFF will become the only North American company within an oligopolistic sector of defensive growth that can compete with the few European players that dominate the business. Some characteristics make it a highly attractive company that, in our opinion, is not well reflected in its current valuations (15 times normalised earnings or a 7% return on cash fow).
Heineken, growth and margin expansion
The Dutch group is the world’s second largest brewer by volume. It has good geographical diversification (Europe represents one third of its profits, although none of the 70 countries in which it is present accounts for more than 12% of sales) and it has renowned international brands such as Amstel, Desperados, Sol and Tiger, in addition to its fagship brand Heineken (XAMS:HEIA, Financial).
We like the brewery sector. The brewing industry is renowned for its resilience in the face of macroeconomic shocks —volumes fell by only 1% during the 2008 financial crisis—. This is partially due to the concentration of the sector, which gives brewers pricing power. Heineken is experiencing growth that outpaces its competitors and is cheap, much more so than it has been in the last decade. At current prices, we’re paying less than twice next year’s sales, which, with operating margins of around 15-16%, translates into a Price Earning Ratio of around 14-15 times.
Heineken was last trading at these prices in 2010-11, when growth was significantly lower. At that time, Europe accounted for almost half of sales and operations were very tight (investment as a percentage of sales was at an all-time low, at 5% vs 8.% now. What did happen then, as now, is that its costs (transport, aluminium, glass and barley) rose significantly. Heineken was able to pass on prices —in a much weaker and more competitive environment than today— and when commodities started to fall, margins increased quite significantly.
Heineken has just increased its presence in South Africa with the acquisition of Distell and increased its shareholding during COVID-19 in the largest Indian brewer (Kingfisher) to 60%.A market in which beer consumption per inhabitant stands at 5-10 litres/year (compared to 95 in Germany, 60 in the US, 50 in Spain and 40 in China).From now on, with majority control, we’re sure that the Dutch company will undertake investment programmes in marketing and distribution that will significantly increase consumption in a market with almost 1.4 billion inhabitants. It has successfully used this roadmap in countries such as Mexico, Nigeria and Vietnam and is guaranteed to produce solid results in the next ten years.
It has been a difficult year for those who have shares in Bestinfond (Trades, Portfolio). The price of our companies has fallen, despite the fact that their operating performance has been magnificent and they have continued to generate value for their owners. The result is very low valuations that have weighed on the portfolio’s performance during this unusual year, but which should provide excellent revaluations in the future.
We say farewell thanking you for the trust placed in Bestinver and wishing you a happy 2023.
Yours sincerely,
The Investment Team.
