After several quarters of rises, in the second quarter of 2022 we saw our International Portfolio fall by 8.2%, compared to an 8.8% fall in the MSCI Europe, and our Iberian Portfolio by 1.4%, a fall very similar to that of its benchmark index.
However, so far this year the International Portfolio has risen 6.0% and the Iberian Portfolio 3.8%. And all this in an environment in which the main world indices have suffe-red historical declines of around 20%. This was the second worst first half of the year for the Euro Stoxx 50 since its inception and the worst for the S&P 500 since 1970.
These falls are due to investors’ fears of a possible reces-sion. As we have discussed in our last few letters, the ul-tra-expansionary monetary policies of the major Central Banks in recent years have generated inflation levels of over 8%, figures not reached since the 1980s in the United States or Europe.
To tackle this inflation, the central banks, despite their initial reluctance, are having no choice but to raise interest rates. On June 15th, the US Federal Reserve approved a 0.75-point hike, the largest since 1994, and its chairman Jerome Powell reiterated his commitment to bring infla-tion back to the 2% target. As expected, in the face of the highest inflation levels since the Eurozone was created, the European Central Bank also announced a 0.5 point rate hike in July, breaking the trend of the last decade.
These actions by Central Banks, coupled with the geopolitical uncertainty generated by the war in Ukraine, have led more and more economists and investors to antici-pate a recession in the near future.
In our opinion, trying to make economic predictions does not add much value. No one has been able to pre-dict macroeconomic movements accurately and consis-tently, which is logical given the great complexity and uncertainty surrounding the global economy.
This does not detract from trying to understand what is happening, where we are in the cycle and what it might imply in the future. This is very different from trying to predict when it will happen, how severe it will be or even if such a recession will occur.
Looking at the past we see that in the case of deep reces-sions, where cumulative GDP declines have been greater than 3%, the US market fell on average by 34%. In the case of less severe recessions, with GDP declines of less than 3%, the declines were smaller, around 11%.
We cannot know what is going to happen, but with falls of more than 20% so far this year, it seems logical to think that the market has already largely picked up the bad news and we could be approaching the bottom.
ARE OUR PORTFOLIOS READY?
As we showed in our annual conference last May, our por-tfolios have a limited exposure to pure cyclical companies: 16% in our International Portfolio and 18% in the Iberian Portfolio. Of that 16% of cyclical companies, two thirds are companies with net cash and the rest are companies with debt, but with very solid financial situations (all with less than 1.5x net debt/EBITDA), which is fundamental in the event of difficult times. In addition, it should be noted that the cyclical companies in our portfolio have already suffe-red very significant falls; we are not buying cyclical compa-nies at the peak of the cycle.
At this point it is important to stress that when we buy sha-res, we are not speculating on whether their price will go up or down, we are deciding to buy a stake in a company. The success of our investment depends on the success of the company we buy. In the meantime, its shares may go up or down, and trying to guess when they will hit bottom makes little sense. We may buy a cyclical company too soon and its stock will continue to fall. In that case, we will simply buy more at lower prices and as always, wait patiently for the market to recognize its value.
And of course, we must also remember that these blocks and the composition of our portfolios are the result of individual purchase decisions on specific companies. In other words, investing where we find value, which is often where nobody wants to invest. The natural movement as our more defensive and energy-related stocks move upwards will be towards more cyclical stocks.
This is already starting to happen and during the second quarter we have started to reduce our exposure to energy companies from 46% to 40% of the International Portfolio, thanks to the excellent performance of some of them such as Golar, Kosmos and International Seaways. Despite this drop in weight, we continue to find value in the energy sector and have bought two Colombian energy companies, Canacol and Geopark, which still have a long way to go. Another destina-tion of sales in energy has been the purchase of old acquain-tances in the distribution sector such as G-III Apparel. In the next part of the letter, concerning the portfolios, you can see the main changes in the portfolios for this quarter.
THE CASE OF CURRY´S
Our main cyclical position is Curry´s Plc, formerly Dixons. This company, which we have talked about on numerous occasions (link to the video on the youtube channel) is the number one electronics retailer in the UK, the Nordic countries and Greece.
Because of the type of products it sells, which are discre-tionary purchases (TVs, household appliances, computers, tablets, etc.), it is a company whose business is influenced by the economic cycle and consumer confidence.
Due to this cyclical character, Currys´ shares have fallen more than 50% from the highs of £1.6 per share seen in 2021 and almost 40% so far this year.
The possibility of a recession occurring and therefore Cu-rrys’ sales and earnings suffering in the short term is real. With the stock trading at less than 5x our normalised earnings, we believe the market is already more than dis-counting that scenario. This is evidenced by the fact that following the company’s latest results, published in early July, in which it significantly lowered its sales and mar-gin estimates due to economic uncertainty, the share rose by 10%. The price is around £0.7 per share, a figure not far from the minimums it made during the worst moment of the pandemic, when uncertainty was certainly greater than in the current scenario. Since then, the company’s financial situation has improved and it now has net cash, has solved its problems with the cell phone business, is gaining market share and buying back shares.
Currys’ results are likely to suffer in the near future due to weak demand for its products, but in the medium to long term the company’s prospects remain intact. It is a company protected by barriers to entry, which will gene-rate cash even in the worst circumstances and is likely to gain market share as its weaker competitors are unable to withstand the difficult times ahead. We believe that the market has over-penalised it and that is why it remains an important position in our International Portfolio.
At the end of the day, this is the key to what we do. We don’t try to predict the future; we study companies and only then look at their share price. If the company research is correct, the valuation is accurate and we buy cheaply, then with patience the investment will be profitable.
Finally, we would like to emphasise that the market tends to act irrationally in times of crisis. The Cobas AM Investment Team remains focused on researching companies and looking for investment ideas, as difficult times are often a time for sowing seeds to reap good returns in the future.
At Cobas AM 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 have their core operations in Iberian territory; and, finally, the Large Cap Portfolio, which invests in companies globa-lly and in which at least 70% are companies with a market capitalisation of more than 4,000 million euros.
These three portfolios are used to construct the various equity funds we manage as of June 30th 2022:
We remind you that the target value of our funds is based on internal estimates and Cobas AM does not guarantee that these estimates are correct or will be achieved. Investments are made in stocks that the managers believe to be under-valued. However, there is no guarantee that these stocks are actually undervalued or, if so, that their prices will perform as the managers expect.
During the second quarter of 2022 our International Portfolio returned -8.2%, slightly better than the -8.8% return of its benchmark index, the MSCI Europe Total Return Net. Since the Cobas International IF began investing in equities in mid-March 2017 it has returned -9.3%, while its benchmark index has returned +24.5% for the same period.
We made some changes to the International Portfolio in terms of inflows and outflows during the second quarter. We have exited completely from TGS ASA (OSL:TGS, Financial) and Hyundai Home Shopping (XKRX:057050, Financial) (in March these companies had a combined weight of 1-2%). And we have entered in Academedia (OSTO:ACAD, Financial), Canacol Energy (TSX:CNE, Financial), DFS Furniture (LSE:DFS, Financial), G-III (GIII, Financial), Geopark (GPRK, Financial) and Taro Pharmaceutical (TARO, Financial). These companies at the end of June are trading at 5x normalised cash flow and have a combined weight of just over 5%. In the rest of the portfolio, we have reduced our position in International Seaways and Kosmos Energy due to their good performance. On the buy side we increased our positions in Curry’s (LSE:CURY, Financial) (ex Dixons) and AMG (AMG, Financial).
Thanks to market volatility and our rotation, during the second quarter, the target value of the International Portfolio increased by nearly 3% to €222/share, which implies a revaluation potential of 145%.
As a result of this potential and confidence in the portfolio, we are invested at around 99%, close to the legal maximum allowed. The portfolio as a whole trades at an estimated P/E 2022 of 6.2x versus its benchmark index at 11.6x and has a ROCE close to 30%, but if we look at the ROCE excluding maritime transport, and commodity companies, we are close to 39%, which demonstrates the high quality of the portfolio. In short, it is a portfolio of very good businesses trading at very low multiples.
The Iberian Portfolio’s net asset value performance during the second quarter of 2022 was -1.4%, the same as its bench-mark index. If we extend the comparison period from when we started investing in equities in April 2017 to the end of June 2022, we returned -0.7%, while the benchmark index returned +12.6% in the same period.
During the second quarter, we made few changes in terms of portfolio inflows and outflows. We have exited completely from ACS (XMAD:ACS, Financial) and Acerinox (XMAD:ACX, Financial) which at the end of March had a combined weight between 1 and 2% and entered in Atresmedia (XMAD:A3M) and Global Dominion (XMAD:DOM) which at the end of June also had a combined weight between 1 and 2%. In the rest of the portfolio the most important movements have been: on the buy side Almirall (XMAD:ALM) and Atalaya Mining (LSE:ATYM), while on the sell side Inmobiliaria del Sur (XMAD:ISUR) and Galp Energía (XLIS:GALP).
During the quarter the target value of the Iberian Portfolio increased by just under 2% to €232/share, bringing the po-tential for revaluation to 133%.
We are nearly 98% invested in the Iberian Portfolio, and as a whole the portfolio trades at an estimated 2022 P/E of 7.1x versus its benchmark index at 12.0x and has a ROCE of 28%.
Large Cap Portfolio
During the second quarter of 2022 our Large Cap Portfo-lio returned -5.3% while its benchmark index, MSCI World Net, returned -10.8%. Since the Cobas Large-Cap Fund be-gan investing in equities in early April 2017, it has retur-ned -11.8%. In that period the benchmark index apprecia-ted by +52.8%.
The Large Cap Portfolio is the portfolio where we made the most changes during the second quarter in terms of inflows and outflows. We exited from Teekay Corp (TK), New Fortress Energy (NFE), British American Tobacco (BTI) and Dassault Aviation (DUAVF) which at the end of March had a weight of just over 4% and entered in: Samsung Electronics (XKRX:005930), Fresenius Medical Care (XTER:FME), Harbour Energy (LSE:HBR), Heidelberg Cement (XTER:HEI), Lear Corp (LEA) and SKF (OSKO:SKF B). These companies trade at 6-7x normalised cash flow and at the end of June have a combined weight of just over 6%.
In the rest of the portfolio, the most important movements were: on the buy side Affiliated Managers Group and Curry’s (ex Dixons), while on the sell side Repsol (XMAD:REP) and INPEX (IPXHY).
During the quarter, the target value of the Large Cap Portfolio increased by just under 3% to €221/share, bringing the potential for revaluation to 151%.
We are 98% invested in the Large Cap Portfolio. Overall, the portfolio trades at an estimated 2022 P/E of 7.0x ver-sus its benchmark index at 14.5x and has a ROCE of 31%.
This document is of a commercial nature and is provided for informational purposes only, and can in no way be con-sidered as a contractual element, a recommendation, per-sonalized advice or an offer.
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This document includes or may contain estimates or fo-recasts concerning the development of the company in the future and financial results, which come from the ex-pectations of Cobas Asset Management, S.G.I.I.C., S.A. and are exposed to factors, risks and circumstances that could affect the financial results implying a difference with the estimates and projections.
Cobas Asset Management, S.G.I.I.C., S.A. has no obligation to publicly update or communicate the update of the con-tent of this document if the facts are not exactly as they are collected here or if there are changes in the information it contains.
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