Our hearts go out to the Ukrainian people and their loved ones as Russian forces continue to conduct a military assault on their country. The conflict has sparked extreme volatility in global equity markets as investors struggle to understand what it means for the global economy and stocks. And this is occurring on top of rising inflation levels and current and prospective central bank tightening around the world.
The MSCI World and EAFE Indices finished the quarter down -5.15% and -5.91%, respectively. As one would expect, this challenging environment favored value stocks, and all four of the Tweedy, Browne Funds outperformed their respective primary benchmark indices during the quarter.
While the Russian invasion has been deeply unsettling, like other crises in the past, our immediate response has been to remain calm and draw on our experience to assess the situation rationally. A vital benefit of successfully operating for over 100 years in the investment industry is having a balanced perspective when markets are highly reactive.
It is, of course, too early to know how or when this crisis will be resolved. However, we believe history can help provide reassurance that our Fund portfolios remain well positioned to weather the storm. Over the last several decades, the global stock markets have endured some pretty grim news, but in our experience, those who persevered generally prospered. We would not expect the outcome this time around to be any different. (Of course, past performance is no guarantee of future results.) In the interim, we remain focused on taking advantage of the pricing opportunities that inevitably present themselves in uncertain market environments like the one at hand. That is, after all, the essence of successful long term investing.
PERFORMANCE ATTRIBUTION
Please note that the individual companies discussed herein were held in one or more of the Funds during the quarter ended March 31, 2022, 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 March 31, 2022.
We do not have any direct holdings in Ukraine or Russia; however, our Fund portfolios have some indirect exposure to the region through their investments in companies that conduct business in these countries. Nevertheless, the “knock on” effects on the broader global economy and on equity markets have been material, and our Fund portfolios have not been completely immune to these effects. This was particularly felt in the Funds’ European-based holdings, as investors feared the impact on corporate margins of supply chain disruptions, rising input costs and inflation, economic sanctions, and skyrocketing oil prices.
As one might expect, returns in our Fund portfolios during the quarter were led in large part by more traditional value-oriented sector and industry groups such as financials, healthcare, and energy-related companies. This included strong returns from companies such as Berkshire Hathaway, United Overseas Bank, Progressive Corp, Vertex Pharmaceuticals, Enterprise Products Partners, and Total Energies. Coinciding with the rise in geopolitical tensions, the Fund portfolios also had strong results in two defense contractors: UK-based BAE Systems and German-based Rheinmetall. In addition, FMC, the US- based crop chemical company; CK Hutchison, the Hong Kong-based conglomerate; Orange SA, the French-based telecommunications company; and Zurich Insurance, the Swiss insurance company, also made strong contributions to the Funds’ returns during the quarter.
In contrast, our Fund portfolios had a relatively poor contribution to return from a number of consumer staples, industrial, and technology-related holdings. This included declines in our food and beverage holdings — companies such as Nestlé, Heineken, Unilever, and Diageo; industrial and material stocks such as 3M, BASF, CNH and Krones, and tech-related holdings such as Alphabet (Google), China based-Tencent Holdings, Baidu, and Alibaba. In addition, Autoliv, the Swedish automotive airbag and seatbelt manufacturer; Inchcape, the UK-based auto distributor; and Tarkett, the French commercial flooring company, also had poor returns for the quarter.
Concerning the Funds’ China-based internet holdings, we were particularly encouraged by recent messaging from the Chinese Vice Premier, Liu He, about the platform economy where he indicated that rectification work should be completed as soon as possible through standard, transparent and predictable regulation. He further added that this regulation should promote the steady and healthy development of the platform economy and improve its international competitiveness. While there are no guarantees that what Mr. Liu He has postulated will come to pass, his comments provide some hope that Chinese regulation might not be as heavy-handed going forward. Today, Chinese internet companies trade at extremely discounted valuations despite their strong market positions and attractive growth potential. Alibaba and Baidu sell for ~5x and ~4x our estimates of their core business’s operating income, respectively. Although Tencent trades at a slightly higher 7x figure of its core business operating income, it has, in our view, the strongest “moat” of the three businesses, and we believe it should have the highest earnings growth in a more normalized macro environment. Baidu has nearly 45% of its market cap in cash and equity investments, while Alibaba has over 30% and Tencent over 40%. Net of cash and equity investments, Baidu sells for 8.7x its forward earnings (or, estimated future earnings), while Alibaba sells for 9.2x its forward earnings. In contrast, Amazon trades for nearly 70x forward earnings. Even following its recent share price decline, Facebook still sells for 16x its forward earnings, net of cash. While the Chinese internet companies are deserving of a higher corporate governance and regulatory valuation discount relative to their Western peers, in our view, the current valuation differentials more than account for this.
PORTFOLIO ACTIVITY
The volatility since year-end generated a significant amount of trading opportunity for our Funds. On the buy side, we added 11 new names across our Fund portfolios including SKF AB, the Swedish-based ball bearing company; Sumitomo Heavy, the Japanese multi-faceted manufacturing company; Haitian International, the largest manufacturer of plastic injection molding machines in the world based in China; Kemira, the Finnish provider of chemicals for water intensive industries; Buzzi Unicem, the Italian-based global cement company; US-based Thor Industries, the largest maker of recreational vehicles in the world; Ionis Phamaceuticals, a US-based biotechnology company; Fagron, the Dutch pharmaceutical supply and formulations company; Winpak, the Canadian manufacturer and distributor of packaging materials and machines for the protection of perishable foods, beverages and dairy products; WH Group, the Chinese producer of meat products and processing services; and Luk Fook, the Chinese jewelry retailer. All of these new additions, at purchase, were trading at substantial discounts from our estimates of their underlying intrinsic values, and, in our view, are financially strong and well positioned for future growth. In addition, in many of them, knowledgeable insiders were buying shares at or around the entry point prices we paid. We also added to, sold and pared back a number of positions during the quarter. Additions, among others, included Intel, Kuraray, Tencent, and LG Corp. Sales and pare backs included Carlisle, Michelin, A-Living, Phillips 66, and Samchully, among others.
More about a few of the new buys during the quarter (data-points are approximate, and reflect conditions at or around initial purchase):
- Buzzi Unicem (MIL:BZU, Financial) (paid approximately €18.70 per share)»Geographically diversified global cement company. Nearnet cash balance sheet. Material insider buying (€27 million at average price ~€19.50 per share). Negatively impacted by higher energy input prices, but cement is a small portion of the cost of construction projects. A greater risk is overall construction activity. Paid 4x 2021 EBITDA and 6x our estimate of “normalized” EBITDA assuming 10-year average margins. Observed M&A deals at 10x to 11x EBITDA.
- Kemira Oyj (OHEL:KEMIRA, Financial) (paid approximately €11.80 per share)»Global provider of chemicals for water intensive industries.7x net debt to EBITDA. Material insider buying (€53 MM at average price of €13.88 per share). Majority of revenue derived from contractual pricing linked to cost input index. Price increases lag raw material input costs by 2 quarters, leading to short term margin compression in an inflationary environment. Paid under 7x EBITDA. 8 comparable M&A deals at average 10x EBITDA. ~5% dividend yield.
- Haitian International (HKSE:01882, Financial) (paid approximately HKD$21.60 per share)»Largest manufacturer of plastic injectionmolding machines in China. 40% Chinese market share, 13% global market share. Net cash balance sheet (38% of market cap). 3% dividend yield. Material insider buying at HKD$20 to $21 per share. Paid under 7x our estimate of normalized EBIT based on 5-year average EBIT.
- Thor Industries (THO, Financial) (paid approximately $94.30 per share)»Largest maker of RV’s in the world. 45% market sharein US/Canada, 22% in Europe. 1.5x net debt to EBITDA. Highly variable cost structure resulting in profit every year since 1980, despite cyclical end demand. Material insider buying ($31 million at $107 per share average price). Paid 7x trailing twelve months P/E, or 11x our estimate of normalized P/E (based on pre-pandemic sales and 10-year average margin).
ESG INITIATIVES
We continue to incorporate an evaluation of numerous ESG considerations into our research process. For example, ESG issues factored into our decision to establish a position in Kemira, a new holding in three of our Fund portfolios this quarter. Kemira is a global leader in sustainable chemical solutions for water intensive industries. Kemira’s products enable customers to improve product quality and deliver environmental benefits such as cleaner drinking water, treating wastewater for safe reuse or release into nature, reducing CO2 emissions, and improving recyclability (replacing plastics with paper). “Sustainability” is at the core of the business and at the center of product design. 54% of total revenue is generated from products that improve customer resource efficiency. Kemira’s products help ensure safe and clean water and help paper mills use less water. The most meaningful of Kemira’s ESG goals is to derive 500 million euros in annual revenue from bio-based products by 2030 (bio-based inputs replacing carbon based inputs). They have several other ESG-oriented goals related to employee safety, diversity & inclusion, water intensity, reduction in scope 1 & scope 2 emissions, etc. We valued the business at 9x to 10x EBITDA based largely on merger and acquisition comparables. We think the high end of the range encompasses a 1.0x multiple point premium based on ESG opportunities (like the universal goal of treating waste water for safe release into nature).
Nestlé, one of the Funds’ core long-term holdings, recently purchased wind turbines in Germany after soaring fossil fuel costs impacted expenses. The company plans to power all of its sites with 100% renewable energy sources by 2025. We believe this is an aggressive goal, but see it as a positive, incremental step. It may give the company some protection from energy price swings in the future, which could be a plus in helping to drive increases in intrinsic value.
Another one of the Funds’ more recent purchases over the last six months, FMC, the US-based crop protection business, was named by Barrons as one of America’s most sustainable companies. FMC was the only agricultural-related business on the list.
PORTFOLIO POSITIONING AND OUTLOOK
Macroeconomic issues, including the war in Ukraine and the surge in inflation and commodity prices, especially oil, have been discussed in virtually every one of our research meetings of late. And while these issues are rarely determinative in our bottom-up investment decision-making process, they are seriously weighed. Moreover, they can impact our portfolio construction and stock selection decisions, at the margin. Accordingly, in researching prospective and existing holdings, we have been increasingly focused on the following:
- Balance sheet strength;
- Pricing power in the face of rising input costs (albeit often with a lag);
- Risks to operating margins as a result of persistently high energy prices; and
- Increased consideration of “insight information” — using insider buying as a clue to opportunity and resilience in the businesses being researched.
In our view, pricing power and balance sheet strength will be critically important in an environment of persistent inflation. Central bankers have, unfortunately, been late in addressing the problem, particularly the US Federal Reserve, and are playing catch-up, which could ultimately lead to a recession. We believe that current market conditions should continue to support what has been an ongoing market rotation from growth to more value-oriented investments, as periods of rising inflation and interest rates tend to favor shorter-duration risk assets such as value stocks. In addition, for the most part, value stocks, particularly non-US value stocks, continue to trade at a discount to their more growth-oriented brethren. As we have said before, with money no longer free, price and valuation should matter again.
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
April 2022
The performance 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 lower or higher than the performance data quoted. Please visit www.tweedy.com to obtain performance data, which is current to the most recent month end.
