Global equity markets continued their advance during the third quarter but faced a comeuppance near quarter end, largely related to continued uncertainty around the impact of the persistent COVID-19 Delta variant on underlying economic growth, and the prospect for rising inflation and interest rates. Since mid-May, concerns about the continued strength of the recovery have driven a substantial number of investors out of more economically-sensitive value stocks and back into more growth-oriented stocks, particularly U.S.-based technology stocks. This has allowed the growth component of the MSCI World Index to claw back a good deal of the ground it lost to the value component, when the rotation back into value stocks began in earnest during the last few months of 2020. However, as market volatility picked up around quarter end, in part due to inflation concerns and continued worries about the Delta variant, we were encouraged to see the value component rebound, if ever so slightly. This tug of war between value and growth-oriented equities is likely to continue in the near term as investors focus on the outlook for economic growth and wonder whether the recent increases in prices, inflationary expectations, and interest rates will prove to be temporary or permanent.
In this more growth and U.S.-centric investment environment, the Tweedy, Browne Funds produced marginally negative returns and trailed their respective benchmark indices during the quarter. That said, year-to-date through October 31st, the Funds have produced good absolute returns of between 9.92% and 15.12%, net of fees. On an even more encouraging note, over the last 12 months through October 31st, the Funds are up between 30.99% and 36.42%. During this same period, value stocks remained ahead of growth stocks.
PERFORMANCE ATTRIBUTION
Please note that the individual companies discussed herein were held in one or more of the Funds during the quarter ended September 30, 2021, but were not necessarily held in all four of the Funds. Please refer to each Fund’s portfolio page, beginning on page 6, for selected purchase and sale information during the quarter and the footnotes on page 15 for each Fund’s respective holdings in each of these companies as of September 30, 2021.
For the most part, Fund returns during the quarter were led by a variety of groups including U.S., U.K., and Singapore-based holdings and energy, materials, financials, and communication services holdings. Strong performers during the period included TotalEnergies, the French oil & gas company, which has benefitted from the recent spike in oil prices; machinery and equipment companies such as CNH and Krones, whose stock prices have been driven by the strong cyclical recovery; interactive media holding, Alphabet (Google), whose growth trajectory in search and other online businesses have remained extraordinarily strong; the Swiss media company, TX Group, which through a recent joint venture expanded its digital classified ad business; AutoZone, the U.S.-based specialty auto parts retailer, which has benefitted from disruptions in the automotive supply chain; AbbVie, the U.S.-based biotech firm, whose valuable new drug pipeline continues to drive investor sentiment; banks such as Wells Fargo, Truist, DBS Group, United Overseas Bank, and Bank of New York Mellon, which have been clear beneficiaries of the increase in financial activity, advisory fees and net interest margins; the Italian industrial gas company, SOL SpA, whose medical gases business has been a beneficiary of the pandemic and the more recent variant surge; the British defense-related companies, BAE Systems and Babcock International — BAE has recently de-risked its pension plan and continues to have an attractive mix of defense businesses in demand by the UK military, while Babcock International is in the midst of a turnaround by new management, which is gaining credibility amongst investors; and the French logistics and media company, Bollore, whose share price strongly benefitted from the recent spinoff of Universal Music by Vivendi.
In contrast, returns from emerging market holdings, pharmaceutical holdings, a number of industrial holdings, and a gas distribution holding proved to be a disappointment. This included poor returns from a number of our Chinese-and South Korean-based companies. In China/Hong Kong, holdings such as Alibaba, Baidu, A-Living, and CK Hutchison were negatively impacted by recent interventions in various industry groups by the Chinese government. One of the Funds’ South Korean holdings, LG Corp, was affected negatively because of battery recalls at its affiliate, LG Chem. Pharmaceutical holdings such as Novartis, Roche, and Astellas Pharma have, in part, been negatively impacted in the near term by provisions contained in the Biden administration’s proposed new stimulus bill. Industrials such as 3M, Safran, and Trelleborg have faced near term headwinds from the surge in the Delta variant and its impact on global economic growth. Rubis, the French gas distribution company, faced modest weakness in its Caribbean gas distribution business, in part due to COVID measures and a slowdown in tourism. In addition, the Funds’ continued underweight in Japan played a role in the Funds’ relative underperformance, as Japanese equities in general had a relatively strong quarter.
PORTFOLIO ACTIVITY
Despite rising valuations, we continue to uncover equities that we believe are undervalued, particularly in Europe and the emerging markets, but also in the U.S. We established a number of new positions in our Funds’ portfolios during the quarter, which included, among others, FMC, the U.S.-based agricultural and chemicals company; Tencent, the dominant Chinese social media and gaming company; Uni-President, the China-based instant noodles and beverage company; Norma Group, the German manufacturer of industrial joining and fluid handling products; Taikisha LTD, an air-conditioning systems company and Transcosmos, the call center and data processing company, both based in Japan; Vivo Energy, the UK-based petroleum distributor with significant operations in Africa; Chow Sang Sang Holdings, the Hong Kong-based jewelry retailer; and, near quarter end, Rheinmetall, the German-based defense systems and automotive components company.
All of these companies were trading at substantial discounts from our conservative estimates of intrinsic value, were financially strong, and in our view had good prospects for future growth. In addition, we added to a number of holdings, including Industrias Bachoco, LG Corp, Okamoto Industries, Rubis, and Dali Foods. To make room for the new acquisitions and additions, we sold and trimmed a number of holdings including Bangkok Bank, Hankook & Co., Coltene Holdings, Heineken Holding, Novartis, Roche, Alphabet, Johnson & Johnson, Standard Chartered, Trelleborg, AbbVie, and a host of others.
INDUSTRIAS BACHOCO (ALL FUNDS)
Industrias Bachoco (IBA, Financial), the Mexican poultry company, founded in 1952, is a roughly $2B market cap company that operates poultry production and distribution facilities primarily throughout Mexico, where it breeds, processes, and markets chicken, which accounts for the overwhelming bulk of its sales. It is the number one chicken producer and the number two egg producer in Mexico, with 35% and 5% market shares, respectively. While the chicken business is notoriously cyclical, with profitability varying significantly year-to-year based on the volatility of chicken prices, the company’s volumes steadily grow, and even in the company’s worst years, it has not lost money.
Over the last decade, the company has been able to compound its tangible book value per share including dividends by between 11% and 12% per year on average. At purchase, Bachoco had net cash constituting roughly 45% of its market cap (32.5 pesos per B share) and was trading at 8 times current P/E, 6 times normalized EBIT, around tangible book value, with a dividend yield of a little under 2%. It also had a normalized owner earnings yield above 12%. In August, a U.S.-based poultry company, Sanderson Farms, was acquired by a joint venture company put together by Cargill/Continental Grain in a 100% cash transaction. Other than having different geographic locations, Sanderson and Bachoco are directly comparable poultry businesses with similar long term records. In thinking about the value of Bachoco, if one were to extrapolate the multiples paid for Sanderson, it would imply an estimated intrinsic value for Bachoco that is more than double the average price the Funds paid for their shares.
FMC CORP. (INTERNATIONAL VALUE, INTERNATIONAL VALUE II, AND VALUE FUNDS)
FMC Corp. (FMC, Financial) provides crop chemicals for the agriculture industry. Crop chemicals protect farmers’ fields from insects, fungus, and weeds, which allows them to increase their crop yields. As a result, farmers are more than willing to pay a price premium for effective products. Similar to pharmaceutical companies, crop protection products also are often “patented,” which gives them pricing power. In addition, the development time and investment, combined with navigating the regulatory process in a variety of jurisdictions, and then achieving distribution at scale, provide immense barriers to entry in the industry. Small companies may be able to conduct research on active ingredients, but it will be difficult for them to “commercialize” them. Given all of this, FMC has enjoyed a high return on capital and has been a very profitable business, earning a 27% EBITDA margin and a 25% ROE including goodwill for the year 2020.
FMC is diversified geographically and by crop, which should serve to make it a less cyclical business. It also has, in our view, a very good new product pipeline, and aims to grow its revenues at 5% to 7% annually through 2023, and its EBITDA at 7% to 9% annually through 2023. The company also has had some insider purchases recently from both its CEO and CFO.
While FMC could face some ESG risk associated with increasing regulations that ban certain crop chemical products due to their environmental impact, we do not think it is likely that this risk will be material. To date, FMC has actually benefited from this dynamic. Many older crop chemicals, particularly certain insecticides, are “broad-spectrum,” and can be quite toxic to the environment because they impact everything that they come into contact with. As a result, regulators are increasingly prohibiting the use of the older, more harmful chemistries. In contrast, FMC produces a lot of “targeted” crop chemicals, which affect only the “targeted” pests, and therefore have a lower environmental impact. This has allowed these products to take market share from the older, more toxic ones that are being banned, allowing FMC to grow at nearly twice the industry growth rate. In this respect, rather than negatively influence our valuations, environmental impact concerns actually caused us to increase the multiples we used to estimate the company’s intrinsic value.
We valued FMC between 13 times and 14 times EV to EBITDA, although there have been a number of recent comparable industry acquisitions at multiples in the mid-to-high teens. At purchase, it was trading at roughly 10.5 times its 2022 estimated EBITDA, and at a relatively low price earnings multiple (12.2x 2022 estimated EPS) in part due to its low tax rate. It also had an “owner earnings” yield (net operating profit after tax/enterprise value) of approximately 7.6%.
ESG INITIATIVES
It has become abundantly clear to us that a company’s intrinsic value and its stock price can be significantly impacted by the way it addresses environmental, social and governance issues. Companies that are mindful of the future, protect the environment, treat their employees fairly, have a positive impact on their communities, and allocate capital in a rational and responsible manner often have more sustainable, resilient, and value-enhancing business models. Accordingly, we continue to incorporate ESG analysis into our security research and valuation process, and believe this is important in fulfilling our fiduciary obligation to our shareholders. Jay Hill, a Managing Director who serves on both our Investment and Management Committees, and Ben Whitney, our Director of Responsible Investment, recently became holders of the CFA Institute’s Certificate in ESG Investing.
OUTLOOK
Since the vaccine announcements last November, investors have been engaged in nothing short of an ongoing tug-of-war between the so-called “reopening trade,” which favors more economically-sensitive (often value) stocks, and the “stay at home” trade, which favors large technology stocks. Amidst this back and forth, rising vaccination rates around the world, coupled with the prospects for an eventual retreat of COVID-19, continue to fuel economic reopenings, corporate earnings, and, in turn, what has been an epic advance in global equities and other risk assets. As a result, global equity valuations remain elevated, as overworked acronyms such as FOMO (fear of missing out) and TINA (there is no alternative) continue to influence investor behavior. Also, economic storm clouds appear to be gathering on the horizon in the form of recent increases in prices, inflationary expectations, and interest rates. The question of whether this inflationary threat proves to be temporary or more permanent will likely continue in large part to drive investor sentiment and stock prices in the near term.
We continue to believe that a strong fundamental economic recovery, fueled by accelerated reopenings across the developed and developing world, significant valuation disparities between value and growth stocks, and the prospects for increasing rates of inflation, inflationary expectations, and interest rates will, over time, favor value stocks. We are hopeful that what we have referred to, at times, as the “great rotation into value,” which began roughly a year ago, is still ongoing and sustainable.
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.
