Daiwa Securities Group, Japan’s second-largest broker, was the top contributor to performance over the past 12 months, returning 139%. As discussed in previous letters, Daiwa has benefitted from the Japanese stock market rally and the weakened yen that followed talks of economic reform. Daiwa’s fiscal 2012 results were very strong: net operating revenues increased by 24% while operating costs decreased by 7%. The most recent quarterly numbers also exceeded our expectations. The retail business achieved operating margins around 50%, and the quarter’s EBIT was more than half of what we estimated for Daiwa’s entire fiscal year. Although Daiwa’s stock price has almost tripled over the past year, we continue to believe the company’s stock has significant upside and will remain a good investment for our shareholders.
Another top contributor was Lloyd’s Banking Group, the dominant retail bank in the U.K., which returned 90% over the past twelve months. Over the past year Lloyd’s has removed substantial amounts of risk from its balance sheet, and it is disposing of its non-core assets ahead of expectations. Lloyd’s is projected to have less than 70 billion pounds in non-core assets and a Core Tier 1 of greater than 10% by the end of 2013, a year ahead of previous guidance. During the first half of 2013, Lloyd’s core expenses were down 3%, compared to the first half of 2012, and management anticipates further cost savings. Lloyd’s loan book quality has also improved due to a decline in non-performing loans. We are encouraged by Lloyd’s strengthening balance sheet and believe it is well positioned for the future.
The largest detractor from performance over the past twelve months was Orica, an Australian mining-services company, which declined 24%. Shares reacted negatively to the news that the company’s net profit in fiscal year 2013 would not meet expectations. Much of this was due to macro weakness and a weaker commodity environment, but numerous isolated incidents also contributed. Minova, the company’s ground support business, which generated A$109m in EBIT last year, is only expected to breakeven on an EBIT basis due to restructuring, two isolated customer issues and a dispute with a supplier. Indonesia operations will suffer due to two large customers temporarily suspending operations, as well as a more difficult competitive environment. Finally, slower than expected growth will impact the Australian business. We believe many of these issues are one-off in nature and are likely to reverse next year. Synergy gains from integrating Minova with the rest of the business, continued growth in Australia, and weakening of the Australian dollar should significantly boost Orica’s earnings growth in fiscal year 2014.
There was a lot of portfolio activity during the past quarter--we sold our positions in ASSA ABLOY, Amcor, Bank of Ireland, Grupo Televisa and Roche. We added four new names to the Fund: Pernod Ricard, the second largest worldwide producer of spirits; Samsung Electronics, a consumer and industrial electronics manufacturer; Sanofi, a pharmaceutical company; and WPP, a leading advertising and communications services company.
Geographically we ended the quarter with 78% of our holdings in Europe, 14% in Japan and 5% in Australia. The remaining positions are in North America (Canada), South Korea and the Middle East (Israel).
We continue to believe some global currencies are overvalued. As a result, we defensively hedge a portion of the Fund’s currency exposure. Approximately 35% of the Australian dollar, 29% of the Swedish krona, 24% of the Swiss franc and 7% of the Japanese yen were hedged at quarter-end.
We continue to adhere to a long-term value philosophy that has enabled us to build a portfolio of high quality names trading at discounts to our estimate of intrinsic value. We thank you, our shareholders, for your continued support.
David G. Herro, CFA