Dear co-investor,
Our first message is one of encouragement and support for those who have lost a loved one, and for those who are still suffering from the disease: our greatest wish is for our investors and their families and relatives to be in good health. We would also like to thank the health wor-kers and all those people in essential activities who are working in the fight against this pandemic.
The first quarter of 2020 has been one of the hardest I have ever experienced as an investor, both because of the personal situation we all find ourselves in and because of the potential economic impact of these circumstances.
We have always said that we do not have to worry if the prices of good stocks fall because we can take advantage of these falls in the long term. This is true, of course, but it does not prevent us from recognising that most of our investors are suffering significant losses in their savings, savings that have been built up over the years. And even though we know that the losses are temporary, this places a psychological burden on many that is difficult to bear.
We are trying to help in the best way we know how: with transparency, sincerity and looking to the future. I know of no other way we can help the people who trust us. Perhaps it can help us get through these times by treating our investments as if they were private, unlisted companies, where until we sell we don't know if we've made gains or losses. In these investments the only thing that interests us is the performance of the business, which is what will ultimately determine whether we will have good returns. That is the attitude that makes it easier to deal with this situation.
Personally, this impact on the unitholders is my only concern. And this is because, as we will see later, the companies in which we invest are going to see a relatively small impact on their future performance. And this is no accident. After many years of bull markets, we have sought out investments that are unaffected by economic cycles, and this is the case for most of our investments at this time.
Some wonder why, despite this, the crisis has affected our share prices so much when businesses are not affected, and we have no answer to that question. In times of crisis, the market exacerbates its irrationality, and it is difficult to escape it. This happened in 2008 and it has happened again. It is surprising to see the Teekay Group (TGP, Financial) (our largest investment at this time) undergo sharp price falls during this crisis when on 16 April Teekay LNG confirmed a 36% increase in its dividend; a unique situation, at a time when countless companies are eliminating the dividend. To our knowledge, there is no known company that has confirmed an increase of this kind in the last month. In the meantime, TGP has gone from a P&E ratio of 5x to 3x, etc.
After recent declines, our international funds have gone from a P&E ratio of 7x to below 5x. In each company you can explain the reason for the undervaluation, but we cannot avoid it for the time being, and it is essential to understand the cause and whether it will change. At least, in the most significant investments for us, management is aware of the problem and is working to solve issues that makes it difficult for the market to make a correct assessment vs. similar companies, and therefore to make a proper valuation. In several cases it is quite possible that such measures could be taken later this year.
We can complain about how unfair the situation may be, but only with patience can valuations be corrected. Others ask if we will take the opportunity to increase the quality of the portfolio. Yes, this is clearly a non-stop task that we continue to do. We already explained in our annual conference how we are selling the oil and derivatives shipping companies, a business evidently without entry barriers, replacing them with other businesses with higher barriers and returns on capital.
And we insist that we "own" quality businesses: which have long-term contracts that ensure us revenue in almost any circumstance, captive customers for whom they are essential, with technological leadership, etc. The fact that the infrastructure companies of LNG, CIR (MIL:CIR, Financial) and Babcock (LSE:BAB, Financial) are trading at significant discounts compared to companies that have similar businesses makes no sense, and we would only sell these shares if clearly better opportunities arose.
We insist, a discount compared to similar business, not to completely different business. In other words, among all our companies we find companies in similar businesses that are trading at reasonable prices, so we know that our companies will also eventually trade at their value.
We have indeed made sales in businesses where the future has become significantly bleaker, such as the banking sector. We have reinvested the proceeds in assets that have suffered similar losses, but where we see a clearer future performance and a more diversified risk in other countries.
And generally, the criterion for reinvestment of cash inflows and partial sales of some assets has been simple: companies with little debt, well known to us and which for some illogical reason have fallen as much or more than the market.
Finally, with respect to our portfolios, we have carried out a detailed examination in all companies measuring the impact of the crisis on the different businesses. We have been conservative and realistic (for example, at Renault we have reduced our valuation by 50%), resulting in a drop of just over 10% in our target prices for the different portfolios. In the following section we will show the breakdown by company for this year, but will I say before-hand that we believe this is a remarkable result during the biggest global recession in the last 50 years. With these new values, the upside potential is obviously increased, given that the falls in prices have been much larger, with upside amounting to three times the current prices.
The mechanism is simple: companies are trading at a P&E ratio of 5x and our overall valuation is a P&E ratio of 15x. That is, we are buying the portfolio at a third of its value.
We think that the current crisis will pass, as it is already doing in some countries. In China the sales of cars, gas and other products are already rising in April, and here we would recommend the video from our partner Mingkun issued a few days ago, which can be seen here. Some think that our behaviour, that of consumers, is going to change from now on. I do not know, but one has to be a little sceptical in this respect; we should remember that after the terrible flu of 1918 (and the horrific First World War) came the "roaring" 1920s, an unprecedented (economic) boom. Fortunately, our species tends to emerge stronger from crises.
However, the serious problem we face as a society is that the necessary assistance to people who are suffering job losses and other losses may affect the solvency of states, central banks and their currencies. Sadly, many states and central banks have gone into the crisis with very high debts and highly extended balance sheets, and the increases that are taking place may become unbearable for paper money.
We have already explained that the only defence against a potential loss of value of a currency is to own real assets: shares, real estate assets, etc. And this is our most urgent recommendation at this time.
Lastly, we would reiterate that the losses are temporary as long as we do not sell our positions, and this is extre-mely important: most of our companies are generating profits every day, therefore increasing their value every day, as we have seen with the increase of dividends of Teekay LNG. It is natural that when we want to sell, the value that is being created is being reflected in their share prices.
Before I conclude, a word of thanks: despite the fact that March was one of the worst months for the markets in living memory, we had net inflows of money and new investors in the funds in March and April, so I want to thank our unitholders for their trust.
Francisco GarcÃa Paramés
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