The roll-out of vaccines all over the world, coupled with optimism around prospects for a strong post-Covid economic rebound, fueled by unprecedented levels of fiscal and monetary stimulus, continued to trump investors' concerns about valuation, increased speculation, rising inflationary expectations and the prospects for higher interest rates. This, in turn, has helped to propel equities around the world to record highs just after quarter end. Value-oriented equities and non-U.S. equities continued to outperform their growth and U.S. brethren in the first quarter, offering confirmation of the market's rotation that began back in November of last year, when the efficacy of the vaccines was first announced.
In this continued risk-on environment, the Tweedy, Browne Funds produced strong returns of between 4.96% and 7.72% for the quarter, with three out of our four Funds besting their benchmark indices. The Tweedy, Browne Global Value Fund, which finished the quarter up 7.14%, modestly trailed the MSCI EAFE Index (Hedged to US$), its benchmark index, by less than 50 basis points. For the last two quarters cumulatively, all four Tweedy, Browne Funds produced returns of roughly 20% or more and outpaced their benchmark indices by 25 to as much as 364 basis points.
What would appear to be a long overdue market rotation from growth stocks back towards value stocks that began in earnest last November continued into the first quarter with more economically sensitive market sectors such as financials and industrials assuming market leadership. The Tweedy, Browne Funds have been beneficiaries of this change in market leadership.
Results during the quarter in the Tweedy, Browne Funds were in large part led by the Funds' bank, insurance, machinery and industrial conglomerate holdings, including banks such as Bank of America, Wells Fargo, DBS, and UOB; insurance companies such as CNP Assurances, SCOR and Zurich Insurance; machinery holdings such as CNH Industrial and Trelleborg; and industrial conglomerate holdings such as Jardine Matheson, CK Hutchison, and Siemens. The financials were in part helped by the rise in inflationary expectations and in turn interest rates, which generally translates into improved net interest margins for banks, while the industrials were propelled by the prospects for a strong post-Covid economic recovery. On the interactive services and information technology side, Alphabet (Google), Intel, and Cisco also produced strong double-digit returns. In addition, AutoZone, the U.S.-based specialty auto parts retailer; Berkshire Hathaway, the U.S.-based conglomerate; BASF, the German chemical giant; and Total, one of the Funds' few remaining energy companies, were also up nicely during the quarter.
While most stocks performed well during the quarter, there were a few disappointments, including consumer staples holdings such as Heineken, the Dutch beer company; Dali Foods, the Chinese snack food business; and Unilever, the Dutch food and personal products company. Babcock International, the UK-based defense services company, also had a challenging quarter, as did Alibaba, the Funds' rather new Chinese internet retailing holding; Tarkett, the French industrial flooring company; and GlaxoSmthKline, the UK-based pharmaceutical company.
Despite rising valuations, which in part led to overall net security sales for the quarter, we continued to uncover pockets of undervaluation around the world. We established a number of new positions in the Fund portfolios during the quarter, including Fresenius SE, a healthcare conglomerate in Germany; Industrias Bachoco (IBA, Financial), a Mexican poultry company; Concentrix (CNXC, Financial), the U.S.-based outsourcing business specializing in technical support and customer care; and Progressive, the U.S.-based auto and homeowners insurance company, among others. At purchase, these companies were trading at significant discounts to our conservative estimates of intrinsic value, had strong competitive positions, and in our view, good prospects for future growth. We also took advantage of pricing opportunities and added to a number of positions, including more recent entrants into the Funds' portfolios such as A-Living Smart City Services (HKSE:03319, Financial), Dali Foods (HKSE:03799, Financial), Megacable (MEX:MEGACPO), Orange (XPAR:ORA), Alibaba (BABA, Financial), Okamoto (TSE:5122), and Rubis (XPAR:RUI).
In terms of sales, we sold the Funds' remaining shares in Ebara (TSE:6361), Goldman Sachs (GS), Yamaha Motor (TSE:7272), and Zeon (ZEON), all of which were trading at or near our estimates of their intrinsic values, and had produced solid returns for the portfolio.
Fresenius SE
One of our new buys in all but the Worldwide High Dividend Yield Value Fund during the quarter was Fresenius SE (XTER:FRE, Financial), a global healthcare conglomerate based in Germany. Its various businesses provide dialysis services (Fresenius Medical Care), generic injectable drugs, clinical nutrition and other intravenous products (Kabi). It also owns private hospitals in Spain and Germany. The dialysis and injectables/intravenous businesses operate in somewhat consolidated markets with high barriers to entry, while the hospital business is a less differentiated asset.
All of these businesses benefit from the secular demand growth of aging demographics and increasing per capita healthcare consumption. Over the medium term, management expects the company to grow its earnings at a mid-to-high single-digit rate. The company typically generates a low teens operating margin and earns a low double-digit ROE including goodwill. Its current dividend yield is 2.3%. Fresenius also has had substantial insider buying recently.
We bought Fresenius at ~10x EV/EBITA on a look-through basis. Alternatively, it was at ~70% of our estimated intrinsic value on a sum of the parts basis.
Progressive
One of our new buys in the Worldwide High Dividend Yield Value Fund during the quarter was Progressive Corporation (PGR, Financial), the third largest personal automobile insurance carrier in the U.S., with a market share of 13% as of December 31, 2020. While the Company has a successful history of expanding into new markets (like commercial auto insurance), personal auto insurance still dominates its profit and loss statement ("P&L"), representing 89% of Progressive's pre-tax underwriting profit in 2020.
Progressive is a best-of-breed auto insurance carrier. The company has a long track record of innovation, market share gains, industry-leading profitability (lowest 10-year average combined ratio) and generating high returns (19% average operating ROE). Over the 16 years ended December 31, 2020, the value compound (defined as growth in book value per share plus cumulative dividends per share) was +13.3%. The Company seems to have clear competitive advantages: direct distribution (low expense ratio) and superior data analytics (low loss ratio).
At purchase, we paid between $85 and $87 per share, or roughly 15 times estimated 2021 operating earnings per share (excluding net after-tax gains/losses realized on securities), approximately 75% to 80% of our conservative estimates of intrinsic value. Moreover, Progressive has paid an above average dividend in the form of a regular quarterly dividend and a discretionary additional variable dividend paid annually. In 2019 and 2020, the total dividend declared per share was $2.65 and $4.90, respectively.
As we write, global equity markets have rallied aggressively, driving capitalization-weighted indexes to record levels. The Shiller CAPE Ratio (cyclically adjusted price earnings ratio) recently hit 37, its highest level in the post war era (with the exception of the tech bubble of 2000, when it hit 44). Inflationary expectations are on the rise, as are intermediate-term interest rates in the U.S., fueled by the prospects for a continued surge in aggregate demand coupled with supply disruptions. The vaccine rollout in Europe remains halting, although improving, and geopolitical tensions, while down from the Trump era, are still elevated. Speculation is also on the rise in capital markets, fueled by continuing unprecedented levels of fiscal and monetary stimulus. The conventional wisdom, supported by recent market action, would appear to suggest that equity valuations have further to go to the upside, particularly for more cyclically-oriented equities, in light of continued low interest rates, an inflationary threat that is viewed as transitory, massive levels of stimulus around the globe, and the prospects for an explosive post-Covid economic recovery. We hope the market soothsayers are right. However, the market is a discounting mechanism, and one has to wonder how much further this game of musical chairs has to go.
Despite rising valuations, we continue to uncover attractively valued equities, as pockets of undervaluation still remain from the bifurcated markets of the last year. As value investors, we are encouraged by the rotation that began in earnest last November post the vaccine announcements, and are hopeful for what this may mean for future relative performance of value-oriented equities, and non-U.S. equities, which are less impacted by technology stocks.
Are the green shoots for so-called value stocks that have been appearing of late an indication that central bankers may finally be losing control of the bond market? Will rising inflationary expectations lead to higher interest rates that prove not to be transitory, and instead, hazardous for the value of longer-duration growth stocks? Will a vigorous vaccine-induced economic recovery supercharge the near-term earnings of "older economy" value stocks and their non-U.S. brethren? Will the COVID-19 virus ultimately prove to be a serendipitous top for technology stocks, at least in the near term? We simply cannot know the answers to these questions, but if one or more do come to pass, it could mean long-overdue redemption for value-oriented investors.
Thank you for investing with us. Stay well.
Roger R. de Bree, Frank H. Hawrylak, Jay Hill, Sean McDonald Thomas H. Shrager, John D. Spears, Robert Q. Wyckoff, Jr.
Investment Committee
Tweedy, Browne Company LLC
The performance data shown above represents past performance and is not a guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than the performance data quoted.
Please note that the individual companies discussed herein were held in one or more of the Funds during the quarter ended March 31, 2021, but were not necessarily held in all four of the Funds. Please refer to the footnotes on page 14 for each Fund's respective holdings in each of these companies as of March 31, 2021.
