Dear Investor:
The second quarter continued the positive performance we have been seeing in our funds since the discovery of the Covid vaccines. We have been saying that our compa-nies, and the value sector in general, have little to do with the opening of economies, but this is the reality we have to live with in the short term.
We expect this positive evolution to continue, as histori-cally, when stocks trading at low multiples start to per-form positively, they do so for a long period of time. This is reflected in the table below, where both the average duration of the relative positive performance versus growth companies, 62 months, and the degree of that per-formance, +138%, are very strong.
As always, we do not know for sure if this will be the case this time, but we are optimistic about this evolution, as we understand that in the end cash generation is the only factor that counts in the long-term evolution of share prices. In our case, this quarter we had more oppor-tunities to rotate the portfolios (we sold companies that have performed well, replacing them with others with greater upside) which, together with the good performan-ce of the companies, has allowed us to increase the target value of the funds, placing the estimated value of the
Iberian Portfolio at historical highs, and the International Portfolio close to those highs.
This quarter we comment on the evolution of the oil sector, an essential sector for our lives in 2021 and possi-bly in 2040, despite its continued demonization. (In this regard, we recommend the latest book published by Value School: “The Moral Question of Fossil Fuels”, by Alex Epstein, which gives us an interesting and accurate pers-pective on the subject). We have slightly increased our exposure to it, accounting for just over 11% of the Interna-tional portfolio and 15% of the Iberian portfolio.
OIL (& GAS)
Demand
Demand before Covid was 100mn barrels/day (growing by more than 1mn barrels/day each year), levels that are expected to be reached again during 2022. Thereafter, continued growth is expected, probably less than seen in previous years, but growth nonetheless.
The most likely scenario in the medium term is that the sector's demand will continue to increase at least until the end of the decade, supported by the increase in population and economic growth, due to the development of emerging economies (for example, experts from the Bernstein analysis house suggest around 108mn barrels in 2030). It should be remembered that, although consumption for transport will be reduced in developed countries, certain industries (petrochemicals, for example) will maintain sustained growth over the coming decades. In transport, although it is foreseeable that the increased penetration of the electric car will reduce its demand from the second part of this decade onwards, it does not seem feasible that it can be replaced in ships or aircraft over the next few years. Diesel is not only consumed by some cars, but mainly by heavy-duty vehicles, such as trucks, industrial machinery, mining, construction, etc., where a massive substitution by another technology is not foreseeable in the coming years. Any alternative, and its mass use, will take more years, or at least that is what we foresee today. To conclude, even in more conservative scenarios than the one outlined above, it seems likely that demand will be reasonably stable at around 100Mn barrels/day by the end of this decade.
Supply
The last ten years have been characterised by the increase in production from US shale oil, which has been covering a large part of the increases in demand that have occurred during this period (1 million barrels per day).
In 2014 - 2015 there was a greater increase in supply than in demand, due to the intensification in the supply of shale oil production, which caused the price of oil to fall (from around $100/bbl to $30/bbl in 2016). OPEC, to protect itself, instead of defending prices and lowering production, decided to increa-se production to defend its market share, as it had a much lower marginal production cost. Faced with this scenario, oil companies began to reduce investment in exploration and production of new oil fields and a period of "drought" in oil, and gas investment began from 2015 to mid-2018.
In 2019 and early 2020, after a downward adjustment of its costs, the sector showed some stabilisation and improvement.
In this context, Covid burst in and overnight the economies were closed, and the demand for oil fell sharply, in an efficient market, the price also fell rapidly. In the short term, there was this gap between supply and demand, which further exacerbated the trend of falling investment that had already been occurring in the sector.
From now on, the lack of investment may lead to supply problems in the medium term:
- Demand will grow again, as we have seen.
- Funding for new investment has been drastically redu-ced, especially in the US shale, where despite the recent rise in oil prices, 60% fewer wells are being drilled than two years ago. This decline in the number of wells drilled has meant a drop in production of around 2Mn barrels this year (13mn barrels/day produced in 2019 vs 11Mn barrels/day in 2021) and today there are not enough indi-cations that US oil companies are strongly increasing the number of wells being drilled. There is some doubt as to whether US operators will maintain the discipline shown so far, but they seem to have a more rational strategy focused on cash generation. The modification of the incentive systems of their management teams away from the constant pursuit of growth of the past is another example of this.
- In addition to the expected growth in demand over the next few years, it is worth remembering that oil supply loses around 4-5% of its annual production (around 2mn bbls/day, excluding OPEC and the US) due to the natural decline rate of oil wells which is an unavoidable geological fact. If we stop investing (as has been happening, especially in the offshore part) and no new oil fields are discovered or developed, we will not be able to compensate for the natural decline of the fields that are already active.
Therefore, we could end up with a shortfall of 3mn barrels per day: 2mn due to the natural decline of the fields, which are no longer covered due to the drought of invest-ment in the sector over the last 5 years, and a slower growth of the US Shale, plus 1mn of increased demand when the economy returns to its growth path after Covid, which is already occurring. As the necessary prior investment has not been made, when demand is reacti-vated in a normalised way, the price will have to reflect this. On the other hand, we believe that OPEC should have the capacity to increase production in a disciplined way.
Let's remember that it takes, on average, 4-5 years to develop an oil field, so investments should have been made in 2015-2016, which was not done, to be able to face the structural problems we are facing now.
In addition to all the above, there is the recent rejection of oil and gas companies by the market for reasons of sus-tainability. In fact recently the International Energy Agency called for no new investment projects in the sector. To a large extent, the market considers these com-panies to be uninvestable, in fact, despite the strong reco-very in the price of crude oil, the companies have lagged in their share prices.
For the reasons we have explained, at Cobas AM we are detecting good investment opportunities in the sector: in companies with low risk, thanks to a healthy balance sheet, producers with low costs (breakeven cash flow around $30-35/barrel) and good management teams. All these companies are trading at 3x-5x earnings, which gives us a high margin of safety.
Portfolios
In Cobas Asset Management we manage three portfolios: the International Portfolio, which invests in companies worldwide, excluding those listed in Spain and Portugal; the Iberian Portfolio, which invests in companies listed in Spain and Portugal, or that have their operational hub on the Iberian Peninsula; and, last but not least, the Large Cap Portfolio that invests in global companies, 70% of which at least have over 4 billion euros in stock market capitalisation.
With these three portfolios we built the various equity funds under management as of 30 June 2021.
We remind you that the target value of our funds is based on internal estimates by applying multiples to normali-zed cash flows based on estimates of each company. Cobas AM does not guarantee that its calculation is correct or that they will be reached. We invest in assets that the managers deem to be undervalued. However, there is no guarantee that these assets are undervalued or that, even if they are, their price will move in the direc-tion expected by the managers.
International Portfolio
During the second quarter of 2021 our International Portfolio returned +9.2% compared to a return of +6.5% for its benchmark, the MSCI Europe Total Return Net. Since the Cobas International FI fund began investing in equities in mid-March 2017 it has returned -16.7%, while its bench-mark has returned 33.2% for the same period.
During the second quarter we exited GS Home Shopping (XKRX:028150, Financial), Matas (OCSE:MATAS, Financial), Israel Chemicals, Saipem (MIL:SPM, Financial), and Hoegh LNG (HMLP, Financial) which in March had a combined weighting below 6% and entered CK Hutchison (HKSE:00001, Financial), Inpex (TSE:1605, Financial), Panoro (OSL:PEN), Caltagirone (MIL:CALT), BW Energy (OSL:BWE), and Okamoto (TSE:5122) with a combined weighting close to 4%. Elsewhere in the portfolio, the main movements were: on the buy side, we increased our weighting in Golar LNG (GLNG), and Babcock International (LSE:BAB), while on the sell side, we lowered our weighting in AMG (AMG).
During the quarter we increased the target value of the International Portfolio by more than 10% to €186/share, implying an appreciation upside1 of 124%. This has been made possible by the fact that we have already started to rotate the portfolio, as price movements have allowed us to do so.
Obviously, because of this potential and the confidence in the portfolio, we are invested at 98%, close to the legal maximum allowed. The whole portfolio trades at an estimated 2021 P/E1 of 7.6x versus 16.3x its benchmark and has a ROCE1 of 28%, but if we look at the ROCE1 excluding shipping and commodity companies, we are close to 38%, which demonstrates the quality of the portfolio.
Iberian Portfolio
The Iberian Portfolio's net asset value performance during the second quarter of 2021 was +1.5%, compared to +4.2% for its benchmark. If we extend the comparison period from when we started investing in equities to the end of March 2021, it returned -5.0%, while its benchmark retur-ned +11.4% for the same period.
The takeover bid for Semapa (XLIS:SEM, Financial) ended in June, which we decided not to take part in as we considered the price offe-red was far from what we thought the company was worth, as we explained in the previous quarterly letter. During the quarter we made few changes in terms of portfolio entries and exits. We completely exited 2 companies Quabit (now Neinor (XMAD:HOME, Financial)), and Almirall (XMAD:ALM, Financial) which had a weighting close to 1.5% at the end of March as they had a potential below the portfolio average. In terms of entries, we re-entered Prisa (XMAD:PRS, Financial) with a weight of close to 0.5%. In the rest of the portfolio, we increased our weighting mainly in Galp (MEX:GALP), and Indra (XMAD:IDR); and decreased it in Tubacex (XMAD:TUB), and Metrovacesa (XMAD:MVC).
During the quarter we increased the target value of the Iberian Portfolio by nearly 8% to €198/share, which brings the upside for revaluation to 109%.
We are 98% invested in the Iberian Portfolio, and the port folio trades at an estimated 2021 P/E1 of 7.2x versus 16.0x for its benchmark and has a ROCE1 of 31%.
Large Cap Portfolio
During the second quarter of 2021 our Large Cap Portfolio returned +8.9% versus +6.8% for the benchmark, the MSCI World Net. Since the Cobas Large-Cap Fund began inves-ting in equities in early April 2017, it has returned -14.9%. In that period the benchmark index appreciated by 57.2%.
During the second quarter we continued the rotation initiated in the first quarter in the Large Cap Portfolio. We sold our entire positions in Exor (MIL:EXO), Catcher (TPE:2474), Technip (FTI), and Israel Chemicals, which at the end of March had a combined weighting of close to 6%. With these sales we finan-ced the purchase of Qurate (QRTEA), Organon (OGN), and Galp, which have an aggregate weighting of close to 5%.
In the rest of the portfolio, we mainly increased our posi-tions in Inpex (TSE:1605, Financial), and Golar LNG, although in the latter case it was largely helped by the share appreciation (+30% during the quarter); while, on the sell side, we reduced our positions in Viatris (VTRS), and Aryzta (XSWS:ARYN).
During the quarter, thanks to the rotation we were able to make, the target value of the Large Cap Portfolio increased by 8% to €180/share, representing an upside of 112%.
We are 98% invested in the Large Cap Portfolio. Overall, the portfolio trades at an estimated 2021 P/E1 of 7.1x versus 19.8x its benchmark and has a ROCE1 of 32%.
