Dear Investor:
The third quarter of 2022 has been particularly negative for world stock markets, with three quarters of declines, causing most indices to hit their lowest levels of the year. This is one of the worst market performances in the last 20 years.
The main reason for this market situation remains high inflation, which is at its highest level in decades. This has prompted central banks to start raising interest rates to try to keep inflation at bay. However, the rate hikes are leading to a slowdown in the world’s major economies and, worse, a likely economic recession. All this has been discussed in detail in previous quarterly letters (2QT2022, 1QT2022, and 4QT2021), and is the result of the ultra-expansionary monetary policies promoted by the main central banks over the last 14 years.
In this situation of market uncertainty, we are defending ourselves reasonably well, doing what we have always done, investing in:
Quality businesses: Companies with high ROCEs (close to 30% in the international portfolio and 25% in the Iberian portfolio), with solid balance sheets (net cash or very little debt), and with pricing power, i.e. able to pass on inflation and defend against it.
These are businesses that we know very well and are very cheap: Tracking these businesses over the last 5 years allows us to have a very high degree of conviction and certainty in valuations. Rarely in the last 30 years have we found companies of this quality at such undervalued prices, trading on average at 5-6x earnings.
Companies with good management teams and owners behind them the well-known “skin in the game” situation where managers and owners of companies use their own money to buy shares in the companies they run. In the end, this is like what we do when we invest our money in Cobas AM funds.
Again, rarely in the last 30 years have we found companies of this quality at such undervalued prices combined with such in-depth knowledge of the companies.
All the above, as a result of the work that the investment team has been doing, has generated the greatest upside potential in our portfolios in our history. We believe that our funds are worth between two and three times their current net asset value. This is a curious but logical phenomenon, for the following 3 reasons:
Despite the positive performance of the funds over the last 18 months, especially when compared to the rest of the market, the NAV is almost flat compared to what it was when we started Cobas 5 years ago and is therefore still far from the growth we expect.
At the same time, our companies have continued to generate value over time, which has been sequestered and waiting to be recognised. This pent-up value has been the main reason why the target price of our portfolios is at all-time highs.
Interestingly, the example of our LNG infrastructure companies (Golar, and Exmar) where despite very significant revaluations over the last year, business has continued to improve almost every day, resulting in an increase in our estimated value. Time works in favour of good businesses with good management teams, allowing them to increase in value. When and how the market will recognise that value is not in our hands, but we are very comfortable owning companies that are worth more every day.
Naturally, we have taken advantage of the recent market declines over the last few months to invest more in the worst performing companies that we know best, replacing others that have performed well, such as IPCO, Cairn and International Seaways. This has helped to increase the estimated value of our funds. We have also invested in some new companies, although this has been relatively marginal, as although they have valuations close to double their current price, many of them have not been able to enter the portfolio, as the businesses currently in the portfolio have much higher upside potentials.
Finally, it is important to stress the importance of not falling into the temptation of trying to predict what the market will do in the future, especially in times of high volatility and negativity such as the present.
Firstly, because it is impossible to know what the market will do, by definition, especially in the short term. Secondly, because it can lead us to make major investment mistakes that negatively affect our returns. As can be seen in the following table, investors who missed the returns of the ten best days of the S&P500 obtained significantly worse returns, even negative, compared to investors who remained in-vested without making any movements.
In conclusion, despite the volatility and uncertainty, we are more comfortable than ever with our portfolios, as well as very excited about the daily value creation we are seeing in our businesses. Periods of negativity such as the current one is always times of good opportunities for us, and we don’t think it will be any different now. We have always said that the most important thing for successful investing is patience, and we want to reiterate this message.
In the face of uncertainty, as we have seen, the best thing to do is not to make hasty decisions and to be invested in good assets such as those in our portfolios, strictly and rigorously applying the philosophy of value investing with a long-term time horizon.
Portfolios
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 which have their core operations in Iberian territory; and, finally, the Large Cap Portfolio, which invests in companies globally 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 30 September 2022:
Please note 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 securities that the managers believe are undervalued. However, there is no guarantee that they are undervalued or, if so, that their prices will perform as the managers expect.
International Portfolio
During the third quarter of 2022 our International Portfolio returned -5.2%, slightly worse than the -4.1% return of its benchmark, the MSCI Europe Total Return Net. Since the Cobas Internacional FI began investing in equities in mid-March 2017 it has returned -14.0%, while its benchmark has returned +19.4% for the same period.
During the third quarter we made some changes to the International Portfolio in terms of purchases and sales. We exited International Seaways (INSW, Financial), Cairn Energy, and International Petroleum (TSX:IPCO, Financial) completely (in June these companies had a combined weighting of close to 4%). And we have entered 3R Petroleum (BSP:RRRP3, Financial), Johnson Electric (HKSE:00179, Financial), Ichikoh Industries (TSE:7244, Financial), and Petronor E&P (OSL:PNOR, Financial). These companies at the end of September are trading on average at 4x their normalised cash flow and have a combined weighting of close to 3%. In the rest of the portfolio, we have reduced our position in Golar LNG (GLNG, Financial) and Aryzta (XSWX:ARYN, Financial) due to their good performance during the quarter. On the buy side, we increased our position in Maire Tecnimont (MIL:MT, Financial) and Atalaya Mining (LSE:ATYM, Financial) to take advantage of their falling share prices.
During the third quarter, thanks to the volatility of the market and the rotation we have made, the target value of the International Portfolio has increased by nearly 6% to €236/share, implying an upside potential1 of 174%.
As a result of this potential and confidence in the portfolio, we are around 98% invested. This is because the whole portfolio trades at an estimated P/E 20231 of 5.3x versus 10.5x its benchmark and has a ROCE of close to 30%. But if we look at the ROCE1 excluding shipping and commodity companies, we are close to 38%, which shows the quality of the businesses in the portfolio.
In short, we have done what we always do, taking advantage of volatility to buy what falls and sell what rises, resulting in a portfolio made up of very good businesses, which we have known for many years, trading at very low multiples.
Iberian Portfolio
The net asset value performance during the third quarter of 2022 of the Iberian Portfolio was -12.6%, slightly worse than its benchmark, -9.2%. If we extend the comparison period from when we started investing in equities in April 2017, to the end of September 2022, we returned -13.2%, while the benchmark returned +2.7% for the same period.
During the third quarter we made very few changes in terms of portfolio purchases and sales. We did not exit any company and only entered Acerinox (XMAD:ACX, Financial) and LĂnea Directa (XMAD:LDA), taking advantage of the falls in their share prices, companies that at the end of September had a combined weight of between 1 and 2%. In the rest of the portfolio the most important movements were on the sell side Logista (XMAD:LOG) and Mediaset España (XMAD:TL5), while on the buy side Atalaya Mining and Atresmedia (XMAD:A3M).
During the quarter and due to market uncertainties, we have preferred to be cautious on some companies and have slightly adjusted the target value of the Iberian Portfolio by about 4% to €222/share. Despite this, the upside potential stands at 156%, a more than attractive potential.
We are nearly 99% invested in the Iberian Portfolio, and the portfolio trades at an estimated 20231 P/E of 6.0x versus 10.2x of its benchmark and has a ROCE1 of close to 25%.
The summary is the same as in our International Portfolio, we have taken advantage of the volatility of the market to seed in good businesses at very good prices, prices that are difficult to see normally. But to this, we would add that the Iberian Portfolio is mainly made up of businesses that we have known practically all our lives.
Large Cap Portfolio
During the third quarter of 2022 our Large Cap Portfolio returned -6.8% versus +0.1% for the benchmark, the MSCI World Net. Since the Cobas Grandes CompañĂas FI began in-vesting in equities in early April 2017, it has returned -17.8%. In that period the benchmark index appreciated by 53.0%.
In the Large Cap portfolio, we also made very few changes in terms of purchases and sales during the third quarter. We exited completely from Gilead (GILD) which at the end of June had a weighting of just over 1% and entered: Atalaya Mining and Dick’s Sporting Goods (DKS). These companies at the end of June had a combined weighting of just over 2%. In the rest of the portfolio the most important movements were on the sell side Golar LNG and Aryzta due to their good performance during the quarter, while on the buy side Grifols (XMAD:GRF) and Heidelberg Cement (XTER:HEI).
During the quarter, as in the Iberian Portfolio, we have slightly adjusted the target value of the Large Cap Portfolio by about 2% to €217/share. This represents a potential upside of 164%.
We are about 98% invested in the Large Company Portfolio. Overall, the portfolio trades at an estimated 2023 P/E1 of 5.8x versus 13.8x its benchmark and has a ROCE1 of 31%.
As with the other two portfolios, the summary is the same: during the quarter volatility was our ally, allowing us to have a portfolio composed of very good businesses trading at very low multiples.
