COMMENTARY
Rising levels of inflation and interest rates around the world, lockdowns in China, the ongoing war in Ukraine, and growing concerns about the prospect of what could be a more serious than expected recession, led to increased volatility in global equity markets in the second quarter. As a result, a number of equity markets worldwide are now firmly in or near bear market territory, down over 20% year-to-date.
While the Tweedy, Browne Funds were not immune to these challenges during the quarter, they, for the most part, held up much better than their benchmark international and global indices. Our flagship, the International Value Fund, underperformed its hedged benchmark by 57 basis points, but outperformed the standard unhedged MSCI EAFE Index by 666 basis points. The Fund’s hedging policy provided significant protection against return dilution from declining foreign currencies. This was also the case for the hedged Value Fund, which bested both the hedged and unhedged MSCI World Index, by 611 and 818 basis points, respectively. It should be noted that it has been difficult of late for the hedged Tweedy, Browne Funds to best their hedged benchmarks, in light of their policies of hedging their perceived currency exposure, their significant underweightings in Japanese equities, and the recent weakness of the Japanese Yen. In spite of those impediments, the Value Fund handily beat its hedged benchmark index, and the International Value Fund came within 57 basis points of doing so. Both the International Value Fund II – Currency Unhedged and Worldwide High Dividend Yield Value Fund, which do not hedge perceived foreign currency risk, also bested their benchmarks by 494 and 680 basis points, respectively. With valuation-related discount rates on the rise and increasing concerns about a slowdown in growth in corporate earnings, the rotation of investors away from more growth-oriented equities to more value-oriented equities that began in September 2020 appears to remain firmly in place.
It is impossible, of course, to know whether markets have hit bottom, but if the past is prologue concerning previous major market inflection points, this may go on for a while. The good news is that these volatile markets, in our view, continue churning up new investment opportunities. We remain hopeful that this challenging environment and the pricing opportunities it presents could set the stage for the resurgence of value.
PERFORMANCE ATTRIBUTION
Please note that the individual companies discussed herein were held in one or more of the Funds during the quarter ended June 30, 2022, but were not necessarily held in all four of the Funds. Please refer to each Fund’s portfolio page, beginning on page 7, for selected purchase and sale information during the quarter and the footnotes on page 16 for each Fund’s respective holdings in each of these companies as of June 30, 2022.
Most stocks across our Fund portfolios faced declines in their share prices during the quarter; however, there were several bright spots as well. Some of those included good absolute results from the Funds’ Chinese holdings, a strong return from the Funds’ sole oil & gas holding, TotalEnergies, good results from a couple of their branded consumer products companies, good returns from two defense contractors, and solid results from several of the Funds’ Japanese industrial holdings. With regulatory rhetoric from the Chinese government easing during the quarter and lockdowns coming off near quarter-end, Chinese companies such as Dali Foods, Uni-President, WH Group, Shanghai Mechanical, and the platform technology companies, Baidu and JD.Com, all perked up, producing a solid contribution to absolute results. TotalEnergies’s near-term earnings power buoyed by high oil prices continued to drive better returns in its stock. Consumer stocks such as Coca-Cola FEMSA and Unilever, and a couple of the Funds’ pharma holdings, GSK, Vertex, and Johnson & Johnson, also had positive returns for the quarter. UK-based BAE Systems and Germany’s Rheinmetall, two defense contractors, produced attractive returns as near term earnings received a boost from rising defense concerns spawned in part by the war in Ukraine. The Funds also benefitted from good returns in a number of their Japanese industrial companies as Japan’s inflation levels remain relatively better and its monetary response more benign. This includes attractive returns in companies such as Nabtesco, Sumitomo Heavy, Kamigumi, Nifco, Transcosmos, NGK Spark Plug, and Kuraray. In addition, AutoZone, Standard Chartered, Inchcape PLC, Orange SA, and FedEx (a new holding) were significant positive contributors to the quarter’s results.
Despite better results from the Japanese industrials, overall, the industrial component of the Funds’ portfolios suffered somewhat, due in some instances to margin compression associated with rising inflation and interest rates and the increasing prospects for a recession in the near term. This led to disappointing results for CNH Industrial, BASF, Safran, 3M, CK Hutchison, and Howden Joinery Group. These same concerns also led to relatively poor stock price results in the Funds’ financial holdings, including banks such as Bank of America, Truist, Wells Fargo, United Overseas Bank, and DBS Group, and in other financial and insurance holdings such as Berkshire Hathaway and SCOR, the French reinsurer. Progressive, the US-based auto insurer, and Standard Chartered, the UK-based bank, were the only financial companies in the Fund portfolios to produce positive returns during the quarter. In addition, Intel, Roche, Nestlé, Diageo, and Megacable also produced disappointing returns for the quarter.
PORTFOLIO ACTIVITY
With market volatility ever present during the quarter, we established several new positions including FedEx, the US-based shipping company; German based Deutsche Post, which, in many ways, is FedEx’s counterpart in Europe; China Bank Corp, a small Philippine-based commercial bank; Howden Joinery, the UK-based kitchen designer; Nabtesco, the Japanese manufacturer of precision parts for the aviation, railroad, and robotic industries; Nifco, another Japanese manufacturer of synthetic fasteners and plastic components for automobiles; Paramount Global, the US-based media and entertainment company; and Samsung Electronics, the Korean semi-conductor and consumer products manufacturer. All these companies at purchase were trading at significant discounts from our conservative estimates of their intrinsic values and, in our view, had solid balance sheets and strong prospects for future growth. In all but Nabtesco and Nifco, there was also recent insider buying in their shares at prices comparable to what we paid for the Funds’ shares. We also took advantage of pricing opportunities to add to the Funds’ portfolio positions in Kemira, SKF, Uni-President, and Safran.
On the sell side, a number of Fund positions were sold or trimmed back during the quarter, including US-based companies such as 3M and Carlisle, and non-US holdings such as Astellas Pharma, Standard Chartered, A-Living, Bollore, Samchully, Coca-Cola FEMSA, Diageo, and Roche, among others. The shares of Vivo Energy, the UK based distributor of petroleum products, held in both our International Value Fund and International Value Fund II, were sold after Vitol, a large existing shareholder, made a bid to take the company private.
ADDITIONAL COMMENTARY ON TWO NEWLY ESTABLISHED POSITIONS
Deutsche Post (XTER:DPW, Financial) is a logistics conglomerate based in Germany with leading, global positions in most of its businesses.The company is named after its German Post (mail) and Parcel segment, but its largest and most valuable businesses are the DHL branded ones: Express, Freight Forwarding and Supply Chain Management which are part of a global oligopoly which includes US based UPS and FedEx. Those businesses and a recently created one, e-Commerce Solutions, comprise ~80% of Deutsche Post’s operating profit, and benefit from trends in e-commerce, outsourcing and global trade. The German mail business is in a structural decline which we believe should be mostly offset by e-commerce related growth in that segment’s parcel business.
The company transformed itself after the 2008 financial crisis. The current CEO, Frank Appel, abandoned DHL’s attempt to compete with UPS and FedEx in the US domestic market, and re-focused it on the international express business. Since 2013, DHL Express has improved its segment operating margins by nearly 900 basis points, and grown its volumes by 8% annually. The company also has successfully managed the decline in its mail business and has developed a good supply chain management business. However, Deutsche Post’s freight forwarding segment has struggled.
All in all, primarily due to the DHL Express business, Deutsche Post’s operating margins have improved by over 400 basis points, and the company has now generated a consistent 20%+ ROE including goodwill. In addition, the current management has changed the culture and mindset at the company, as it has been focusing more on returns on capital and free cash flow generation. It also has a program to repurchase 2 billion euros of its shares by the end of 2024.
According to the company, its post and parcel business aims to have stable or flat operating profit, and its freight forwarding business should be able to grow its revenue at a GDP-oriented rate over time. However, the company’s other businesses have secular growth drivers (largely e-commerce), and we believe those businesses should be able to grow their revenues at mid-single digit rates, or better, organically over the longer longer-term.
At or around initial purchase, Deutsche Post was trading at roughly 6.8x EBIT on its 2021 and 2022 estimated EBIT, less than 10 times 2022 estimated earnings, and paid an annual dividend yield of around 5.1%. Management expects EBIT to increase from ~8 billion euros to 8.5 billion euros by 2024. If one were to use a more conservative estimate of 6.2 billion euros (EBIT) after normalizing the freight forwarding business and making some other adjustments, it would imply a 8.9x EV/EBIT valuation. Private market transactions for comparable express and freight forwarding businesses transactions have occurred at high multiples. Two directors, the current CEO, and the company’s Chairman all bought shares at prices between $34-$37 per share before the Funds’ initial purchases of stock at around $35.
Nabtesco (TSE:6268, Financial) is a small to medium sized Japanese industrial company that manufactures precision parts for a wide rangeof motion -control applications including robots, aircrafts, railway equipment, and construction equipment. 46% of its revenue is directly derived from sources outside of Japan. Pandemic related slowdowns in aircraft and construction equipment component sales offered the Funds a pricing opportunity early in the quarter in this rather above average Japanese business. The company’s products include reduction gears that allow industrial robots to make precise movements – sort of like the movements of a human elbow or wrist– and hydraulic pistons for applications such as construction machinery. Such products are typically critical to Nabtesco’s customers, with extremely demanding, world-leading specifications and a requirement for durability, allowing Nabtesco to enjoy a long term relationship with these customers. The company has also built significant market share in aircraft actuation systems, marine control systems, railway door systems and certain food packaging systems, establishing itself as the reference in motion control technologies.
Nabtesco enjoys stable margins, has had roughly 5% revenue growth over time, has compounded its intrinsic value at an estimated 7% including its dividend, and would appear to have the wind at its back because factory automation is a growth market. At initial purchase, the company was trading at approximately 13.5 times normalized earnings, which translates into an earnings yield of approximately 7.4%, comparing quite favorably to the 0.18% yield on the Japanese 10-year government bond. The company has also bought back shares on occasion.
ESG INITIATIVES
During the quarter, our investment team evaluated numerous ESG issues associated with existing and prospective holdings, three of which merit mentioning.
We continue to be active in the Funds’ position in Industrias Bachoco (IBA, Financial), the Mexican chicken company, arguing aggressively against a proposed voluntary tender offer under consideration by the Robinson Bours family. We believe the offer made by the controlling family is well below fair value and unfairly benefits the family at the expense of minority shareholders. We sent a letter to make our objections known. We also participated in an open letter along with other shareholders, collectively representing about 16% of the outstanding shares. We believe the offer has left shareholders with two bad options: be forced to embrace this poor offer well below our estimate of fair value; or not tender and face even less liquidity in an already thinly-traded stock. Also, shareholders who choose not to tender could be vulnerable later to a follow-on tender offer to mop up holdouts at an even lower price. As a result, we have made numerous efforts to put pressure on the controlling family through the press and combined efforts with other shareholders in hopes of achieving a better outcome.
We decided to sell the Funds’ remaining holdings in 3M (MMM, Financial), primarily due to recent litigation around product safety. There has been an extended running liability issue involving so-called “forever chemicals” getting into the public water supply, and a more recent issue involving earplugs made for the military. Damage awards in several early ear plug cases have been extraordinarily large and could be a drag on growth for 3M in the years ahead. While the stock remained reasonably priced, we felt it was more prudent to deploy the Funds’ capital elsewhere rather than trying to wait out years of legal wrangling.
We also voted against a proposal by SCOR (XPAR:SCR, Financial), the Funds’ French reinsurance company holding, to change the by-laws to allow the chairman, Denis Kessler, to stay in place until age 72 (from 70). We felt that his performance, specifically regarding his handling of the attempted takeover by Covea, and the fumbled SCOR CEO transition, did not provide the good corporate governance that we had become accustomed to in SCOR in past years. Given that this measure required a super- majority to pass, we felt it was the best opportunity we had to try to force his retirement from the Board. The vote unfortunately passed, and Mr. Kessler will remain chairman for two more years, after which he is expected to retire. SCOR’s stock price remains extraordinarily cheap in our view, more than compensating for Kessler’s continued service, which over the longer term has been quite satisfactory.
COMINGS & GOINGS
We are pleased to announce that Andrew Ewert, a six-year veteran of our analytical team and equity stakeholder in our firm, has been promoted to Managing Director and has joined our Investment Committee effective July 1, 2022. Andrew joined Tweedy, Browne in 2016 after having worked at other value investing firms such as Equinox Partners and Ruane, Cunniff & Goldfarb. He received a Bachelor’s degree in Business Administration from Emory University in 2000 and an MBA from Columbia University in 2007, where he completed Columbia’s highly respected value investing program. During his tenure at Tweedy, Browne, Andrew has been an extraordinarily productive analyst, researching both domestic and international equities. In addition, he has been responsible for a host of successful investments that have made their way into our portfolios in recent years. He is a clear thinker, of impeccable character, and day-in and day-out has exhibited the requisite temperament necessary for success as a value investor.
Andrew replaced Sean McDonald, who resigned from the firm effective June 30. Sean had been a member of our investment team since 2009, as well as a respected friend and colleague, and we were sad to see him go. We wish him success in his future endeavors.
We remain particularly proud of the strength and stability of our investment team, which consists of the seven members of our Investment Committee, Will Browne as senior advisor thereto, and three additional security analysts. This eleven-person team has logged 280 years at Tweedy, Browne (ranging from 6 to 48 years) for an average tenure of 25 years. Moreover, in Tweedy, Browne’s more than 100-year history, no member of the Management Committee of Tweedy, Browne has ever left to take another job elsewhere. We look forward to many more years of collaboration with this talented team of investment professionals.
PORTFOLIO POSITIONING AND OUTLOOK
The near-term environment remains challenging as markets come to grips with rising inflation and interest rates and the prospects for what could be a difficult global recession. While valuations have corrected somewhat, with many stocks down more than 20% from their highs, it remains to be seen whether it is enough, in light of the prospect for earnings disappointments on the near term horizon. Nevertheless, it remains clear that this is an excellent time to be “mining for value,” particularly in non-US equity markets, which to a significant degree, did not achieve the excesses in valuation experienced by their US counterparts. Accordingly, we continue to focus on companies that we believe have strong balance sheets and/or the ability to continue to deliver pricing power, and those where there has been recent insider buying in their shares by “knowledgeable insiders.” Rest assured that we will keep our nose to the grindstone, researching new and existing investments on a stock-by-stock basis, and refreshing our client portfolios for what we believe could be a period of relative prosperity for our style of investing.
Thank you for investing with us. Stay well.
Roger R. de Bree, Andrew Ewert, Frank H. Hawrylak, Jay Hill, Thomas H. Shrager, John D. Spears, Robert Q. Wyckoff, Jr.
Investment Committee
Tweedy, Browne Company LLC
J u l y 2022
This commentary contains opinions and statements on investment techniques, economics, market conditions and other matters. There is no guarantee that these opinions and statements will prove to be correct, and some of them are inherently speculative. None of them should be relied upon as statements of fact. The views expressed herein represent the opinions of Tweedy, Browne Company LLC as of the date of this commentary, are not intended as a forecast or a guarantee of future results, or investment advice and are subject to change without notice.
Tweedy, Browne International Value Fund, Tweedy, Browne International Value Fund II – Currency Unhedged, Tweedy, Browne Value Fund, and Tweedy, Browne Worldwide High Dividend Yield Value Fund are distributed by AMG Distributors, Inc., Member FINRA/SIPC.
This material must be preceded or accompanied by a current prospectus for Tweedy, Browne Fund Inc. You should consider the Funds’ investment objectives, risks, charges and expenses carefully before investing. The prospectus contains this and other information about the Funds. The prospectus should be read carefully before investing.
