Dear Investor,
Seventy-five years ago, Benjamin Graham said that the movements of markets follow a manic-depressive pattern(1). And in view of how they have evolved over the last two years, we must agree —once again— with the father of Value Investing. In this period, stock markets have gone from discounting a severe recession —triggered by inflation, rising interest rates and the war in Ukraine— to trading at all-time highs. Although the environment has been markedly inflationary, with high interest rates and geopolitical instability, the world economy has not gone into recession and corporate profits have not collapsed.
Over the past year and a half, the economy has performed unevenly in different regions of the world. On the one hand, growth in the US has consistently beaten the forecasts, thanks to resilient consumption, demand for services and employment.
This strength contrasts with China's weakness, which has dragged Germany and other northern European countries into recession. On overall terms, however, global economic activity has outperformed market projections, and GDP estimates have been mostly revised upwards.
The same has been true for inflation, which has been more persistent than expected due to stronger economic growth. As a result, expectations of interest rate cuts in 2024 have moderated significantly in recent months. Unlike two years ago, when the market reacted with falls in response to any hint of higher rates, this time such expectations have been greeted with strong upward movements on the stock exchanges. Why? Because in the current environment, high rates are perceived as a symptom of good economic health and, in a healthy economy, companies' profitability increases.
This outlook of higher returns has been particularly favourable for our companies, and funds such as Bestinver Internacional, Bestinver Consumo Global and Bestinver Norteamérica have ended the quarter with gains exceeding 11%. Overall, our equity funds have averaged a return of 10%. Fixed income securities also performed extraordinarily well, overcoming a difficult environment in which 50% of their competitors incurred losses over the quarter. At quarter end, Bestinver Corto Plazo was up 1%, Bestinver Renta was up 2% and Bestinver Deuda Corporativa rose by 4%. These results reflect another of Benjamin Graham's key lessons: for long-term investing, what really matters is the performance of companies' earnings and the valuation of their shares.
Looking ahead, our funds' performance should maintain this positive trend, driven by the strong fundamentals of our companies. In this respect, we consider relevant the statements of a number of managers indicating that business productivity is improving rapidly thanks to technology. If this phenomenon spreads across sectors, the economy could enter a period of sustained growth, controlled inflation and positive interest rates, which would be very favourable for stock markets. Therefore, beyond short-term uncertainties, such as the outcome of the US elections, developments in monetary policy or geopolitical tension, we see a major opportunity for investing in quality companies with attractive valuations.
As Benjamin Graham explained, the market being manic-depressive is not a problem; we simply need to be aware of it and not be driven by the same instincts. Therefore, rather than trying to predict short-term stock market movements, value investors use them to invest in good businesses, buying when their shares fall and are cheap, and selling when they rise and cease to be cheap. This is the strategy which, in accordance with the teachings of Benjamin Graham, we have followed at BESTINVER for more than 35 years.
On another note, I am pleased to announce that last February we launched Bestinver Bonos Institucional IV, F.I., which will continue to be marketed until June this year. In this fund, we aim to offer an estimated portfolio IRR of 4% —with an estimated net investor APR of 3.9%— while maintaining a credit quality of BBB+, maturing in June 2028.
I invite you to read the letters from our managers below, and thank you for your trust in us.
Sincerely,
Mark Giacopazzi
Dear Investor,
Bestinfond (Trades, Portfolio) ended the quarter with a return of 9.8%.
The market continues to reward the excellent performance of our businesses with very positive returns for the portfolio.
It is interesting to think of our fund as a company. A holding company that invests in various sectors, buying profitable and well-financed businesses that are trading below their fundamental value. Businesses that will generate results which, over time, will allow us to grow our capital and make it profitable.
In this respect, it is important to note that in 2023 the revenues of Bestinfond (Trades, Portfolio) companies increased by 4.5%, which is a more than reasonable performance after the massive 29% growth in turbulent 2022. The global economy has slowed significantly in real terms and much more so in nominal terms. Business activity has slowed after the strong cyclical recovery following the end of Covid, and inflation, thanks to high interest rates, has receded from exceptionally high levels. Understandably, our companies' results have followed a similar trajectory.
The cash they generated, i.e. what remained after investing in everything they needed to maintain and grow their businesses, increased by 3.3% in 2023 after a hefty 25% in 2022. An excellent performance that has enabled them to further strengthen their solvency (net cash represents 11% of Bestinfond (Trades, Portfolio)'s value) and to continue increasing shareholder remuneration via dividends and share buybacks.
Most interestingly of all, however, thanks to the portfolio rotation we have implemented (a matter we will discuss in this newsletter), the earnings growth we are projecting for 2024 and 2025 represents a clear acceleration compared with the year just ended. In this respect, we expect our companies' sales to grow by around 8% per annum over the next two years, and free cash flow to grow by a solid 20%. We have achieved this operational improvement without sacrificing the solvency of the portfolio (13.5% expected average net cash) or the remuneration we estimate for the fund from the companies that comprise it.
At Bestinfond (Trades, Portfolio) we are shareholders in companies that are world leaders in their sectors. According to our analysis, their solvency position is enviable and they are run by first-class professionals. Their ability to adapt in the face of enormous difficulties in recent years has reinforced their outstanding competitiveness. Today, in a largely normalised environment, our companies are gaining market share and enjoying significantly higher margins than their competitors.
We have a balanced portfolio, both by geography and by business type, comprising solid companies trading at a significant discount to their fundamental value. This combination of factors does not guarantee immediate results, but should provide good returns in the coming years. In the long run, share performance depends much more on causality than chance.
It is asset prices that dictate the market narrative, never the other way around
The most interesting development in the last quarter has been the evident improvement in sentiment following the spectacular rebound in stock markets since the end of 2023. Renewed optimism has been driven mainly by investors' belief that the downturn in economic activity is bottoming out and therefore earnings growth will accelerate in the future. This radical change in perception reminds us, once again, that it is asset prices that dictate the markets' narrative, never the other way around.
Our vision of the investment environment at BESTINVER over the past few years (a much more constructive one compared to the consensus) is now shared by a larger number of investors. Consequently, many stocks have achieved significant rebounds and their valuations are no longer as attractive as they were a few months ago. We do not detect an excess of optimism that would justify being much more cautious than we have been in recent times, but it is possible that our perception is conditioned by the attractive valuation of the companies in our portfolio.
It is true that certain corners of the market are achieving intimidating appreciations (i.e. anything related to artificial intelligence). Similarly, cyclical sectors continue to perform exceptionally well on the stock market, which contrasts with many companies with recurrent and visible results which are less closely linked to the economic situation, whose shares have slumped.
An observer of the events could summarise the quarter by saying that supposedly expensive stocks have become more expensive, while the discounts at which apparently cheap ones traded have increased. This analysis would be a little superficial, but it would not be far from the truth.
Veblen assets and necessary portfolio rotation
Drawing conclusions about potential investment successes (or failures) based on the whimsical behaviour of short-term price movements is generally not a good idea.
There is no doubt that we are all happier when the portfolio accumulates good gains, but as value investors our work has to focus on connecting the dots between share prices and real business performance. In other words, trying to distil what is important from what seems urgent but is not so important. What is our objective?
To take investment decisions based on a fundamental analysis and seek to take advantage of daily market noise to benefit the portfolio's future performance.
At BESTINVER we do not try to predict short-term market fluctuations. It is extremely difficult to get this right and hugely damaging to get it wrong. Of course, there will always be investors who pay no attention to us, despite all the studies that show that it is a fruitless exercise. Their intentions are laudable, but remain illusory
We have all heard on countless occasions phrases such as “the market is expensive, I should get out temporarily” or the famous and recurrent “I don't think this is a good time to invest in the stock market”. The reasons given change from one year to the next, but they always boil down to the same mistake: not investing in companies that generate value for their owners in the long term for fear of macroeconomic or other eventualities which, of course, are transitory in nature.
But this does not mean that, as investors, we should not act when rises in share prices reduce our safety margin. A good company is not necessarily a good investment. The return we earn as owners of a listed company depends on the performance of the business and its valuation in the markets.
This is something that not all investors take into account, as shares behave as if they were Veblen(1), goods, i.e. demand tends to increase as their prices rise. In other words, investors' interest in the stock market grows as valuations expand and expected future returns shrink.
At Bestinfond (Trades, Portfolio) we are very disciplined about the returns we demand on our capital. We rotate the portfolio seeking to maximise the long-term performance of our investments. This strategy, which is not the easiest to implement when the dominant factor in the markets is “momentum”(2), requires reducing the relative importance of companies whose safety margins have shrunk and increasing it in companies with a higher appreciation potential, provided that their risk profile is similar to that of the company we are selling.
Prudence, discipline and the application of a method that has been working for more than 35 years
When we enjoy periods of very positive returns, we should look in the mirror and ask ourselves how we would feel if we were experiencing losses of a similar magnitude. We say this because such situations are dangerous for investors. They generate excessively optimistic (or pessimistic) expectations that can lead us to make irrational extrapolations of the recent past, due to the influence it has on our way of projecting the future.
This consideration applies perfectly to the example of Pandora, an idea that we will revisit in this quarterly newsletter. A fantastic company whose investment case we detailed 18 months ago, in a very different stock market climate to the one we now enjoy. We have reread the Bestinfond (Trades, Portfolio) newsletter in which we explained its tremendous undervaluation and we cannot resist cutting and pasting some of the paragraphs we wrote at the time. We find them truly instructive on the problem of extrapolating the recent past:
Interest rates have already covered much of the ground they had to cover (at breakneck speed) and many of the imbalances that have brought us to this point are in full retreat. The end of this intense journey, which in record time has gone from euphoria over the end of the pandemic to post-Covid depression, is closer than it seems.
It is vital to be aware of where we are in the stock market cycle. We say this because our companies are very cheap. We are not sure when we will be able to enjoy the full benefits they offer but what we do know is that when the right circumstances are in place, the gains will be very significant.
The decisions we make in the coming months will determine our performance as savers in the years to come.
Everyone has a plan to buy shares when they fall by 40%…except when they have already done so. At that point, we will always find reasons to explain their price and inevitably there will be a lot of negative narratives that will make it extremely difficult to stick to the original strategy. Making a smart plan when we are calm is useless if we fail to carry it out when we are not so calm.
To enjoy long-term investment success, we must be able to navigate through periods of difficulty. This challenge is caused not so much by the (temporary) losses that are often incurred but because bad news will make us increasingly fearful, fuelling an incessant negativity that will make us believe that the economic situation and the future profitability of our investments go hand in hand, when the opposite is true.
Bear markets are a test of temperament, not intelligence. How successfully we emerge from difficult periods like the current one will depend on our ability to make rational decisions. We must not forget that downturns are nothing more than a revaluation of future profits generated by the businesses we own. The underlying value of these businesses hardly changes, it is the price of their shares that fluctuates (considerably) in a short space of time.
We should recall that that more money is lost preparing for a recession than when one actually arrives. We should also remember that, while in bull markets equity valuations expand to levels that compromise their future returns, in in bear markets the opposite is true: the foundations for excellent future returns on the shares are laid.
Our portfolio has a potential of well over 100%. In BESTINVER's 35-year history, there have been a few occasions when, due to a recession, a war or an unexpected event, the spread between the price and the value of Bestinfond (Trades, Portfolio) has been as wide as it is today. All of them represented the prior stage of what were to be magnificent returns in the years that followed.
How things have changed in just a few months! In that time, Bestinfond (Trades, Portfolio)'s accumulated appreciation has been over 50%. It is essential to remember that emotions are not a good guide to investment decisions. We all become risk averse when we are losing money, just as greed is a silent enemy that can erode our gains if left unchecked in bull markets. Prudence, discipline and the application of a method that has been working for more than 35 years are key to finding the balance needed to navigate the financial markets safely and profitably.
This way of doing things explains the portfolio rotation referred to above. As a result, we continue to have a similar appreciation potential in Bestinfond (Trades, Portfolio) as we did 18 months ago.
We make this estimate using exactly the same methodology as then: projecting the operational improvement we expect for our businesses over the next four years. When are these potential appreciations going to happen? We do not know, but it is clear to us that to make money in the stock market it is not necessary to anticipate what the macro-economy will do in the coming quarters. It will depend exclusively on whether we are able to buy companies below their fundamental value and to do so with as wide a safety margin as possible. Not forgetting patience, of course.
In this respect, at BESTINVER we focus exclusively on gaining an important advantage over the market regarding the factors that are fundamental for those of us who are long-term savers in the stock market. What are we talking about? We are referring to the in-depth analysis of the companies and the people who manage them, which is an absolutely essential condition for being able to appraise them accurately. As we have said before, investment success comes not from buying good things, but from buying the right things.
Pandora, the value of the most important intangible asset of all
The case of Pandora (OCSE:PNDORA, Financial) perfectly exemplifies the method we have just described. This investment has been very profitable for BESTINVER (with our fair share of suffering, as could not be otherwise) and highlights the value of the exhaustive analysis carried out by the Investment Team, not only of the Danish jewellery company's business model, but also of the most valuable intangible asset that any company can have: the talent of the people who run it.
We are referring to Alexander Lacik, Pandora CEO, who since joining Pandora in 2019 has managed to grow the company's sales by 29% (despite Covid) and earnings per share from DKK 30 to DKK 55. The price of our shareholding has more than tripled. This value creation has been possible thanks to the unusual confluence of three factors: Lacik's strategic vision, his skill as a capital allocator, and the low valuation of Pandora shares when we acquired them for Bestinfond (Trades, Portfolio).
Lacik came to the company to implement a strategic vision based on three axes, which he built in parallel with a management team of extraordinary professionals. The first of these was to strengthen its business model through the management of the distribution channel. Traditionally, Pandora's sales had been channelled through its own stores and a network of franchises and multi-brand points of sale. However, Lacik realised that the high percentage of revenues from franchised and multi-brand shops was a weakness in the business model. In his view, if he could bring this share down, he would gain more control over inventories and improve the customer experience. This would result in higher revenues as the company's own stores absorbed the sales of the franchises and generated better margins by retaining the profits that previously went to franchisees. His plan was to acquire the franchises as their contractual relations expired, because that way he would only have to pay little more for them than the value of his inventory. He thereby reduced the number of non-owned retail outlets —from 1,373 in 2019 to 779 in 2023— and the percentage contribution to group revenues from 35% to the current figure of 20%.
The second axis was the recovery of respect for the brand. Lacik decided to drastically reduce the use of promotions and discounts, which were very common under the previous management, as they were seen as eroding the business's brand attributes. In addition, he initiated an ambitious digital marketing plan to reposition Pandora on social media: he recruited high-impact influencers, launched the new Essence product line and the Brillance lab diamond brand, and activated an attractive loyalty programme. For this purpose, Lacik increased the advertising spend from DKK 2,142 million in 2018 to DKK 3,840 million in 2023, increasing from 9.4% of revenue to 13.7% in just five years.
The third strategic focus was the increase in the number of the company's own shops and the development of the online channel. From his arrival, Lacik realised that the profitability of the business meant that opening new stores would have a positive effect on margins as it only needed one year to recoup its initial investment. The question, therefore, was not whether to open new stores, but where to open them. A geographical analysis of Pandora's revenues gave him the answer: while in countries such as Italy, Mexico, Spain or Austria it had a market share of around 10%, in others such as Germany and the United States market share was only 5% and 2%, respectively. Therefore, it was decided that store openings should focus on these countries, particularly the US. Since 2019, the number of own outlets has grown from 1,397 to 1,869.
In addition, boosting the online channel has been a major milestone for Pandora: at 21% of group revenues, its contribution has exceeded that of third-party stores for the first time in the company's history. In total, by end-2023 these measures had resulted in own stores and the online channel accounting for 80% of the group's revenues.
The impact of these three strategic axes on the company's profitability has been spectacular. Total sales have increased from DKK 21,868 million to DKK 28,136 million, income per point of sale has increased by 48.5%, gross margin has grown by almost 600 basis points —already outperforming luxury companies such as LVMH or Hèrmes— and the 2023 operating margin was 750 basis points higher than in 2019. All this, despite drastically increasing advertising spending and closing more than 600 points of sale.
Pandora has a great business model thanks to its high margins and scale. Also because of the efficiency provided by its vertical integration and the fact that it concentrates all production in its two factories in Thailand. As announced at its last investor day, the good performance of the business is expected to continue over the next three years, with estimated average growth of 7% to 9% per year. These rates have already been exceeded in the last two quarters, after generating sales increases of 12%. In fact, according to our estimates, the company could achieve double-digit annual growth until at least 2027. Therefore, the strategy initiated in 2019 has not only improved the company's profitability but has also established a strong growth platform for the coming years.
But what makes Alexander Lacik the kind of manager we want for our companies is that his strategic vision is complemented by his great skill as a capital allocator(I, II and III). Proof of this is the fact that, since he became the company's CEO, he has dedicated the free cash generated by the business to remunerating its shareholders through dividend payments and share buybacks. In particular, he has paid out DKK 6,986 million in dividends, has bought back DKK 14,888 million worth of own shares and has reduced the number of outstanding shares by 20%. All this, with only a slight increase in the group's net leverage. Shareholder remuneration since 2019 has totalled DKK 21,874 million, equivalent to just over 60% of the company's market capitalisation when Lacik took over. These are spectacular numbers.
The Pandora case is highly educational because it brings together many aspects of the reality of value investing. Today it is easy to admire what Lacik has achieved, but when he arrived only a few investors believed in his project. At the beginning of 2019, the Danish company had been one of the worst stocks in the European market for the previous two years, and market consensus was extraordinarily negative on the outlook for its business.
Without any doubt, this pessimism allowed us to buy the shares at a price well below the company's true value. But that pessimism, until it was dispelled by the overwhelming numbers reported, caused the market to test us several times. The most difficult occasion was in 2022 when the Danish company's shares plummeted, dropping almost 60% at one point during the year.
For this reason, it is important not to fall into the trap of hindsight and explain value investing as if it were as simple as analysing a business, buying cheap, waiting and reaping strong capital gains in three to five years. Quite the opposite: even when a company evolves in the way Pandora has, the path is always extraordinarily complex. This is something we must always remember. Value investing is never easy. It requires hard work, patience, humility, a cool head and conviction. Precisely the same attributes that Alexander Lacik has demonstrated.
Portfolio movements
We continue to rotate our capital from names that have performed very well, where the spread between price and value has narrowed significantly, to other types of companies where just the opposite has occurred.
The first group of companies includes names like Meta (META, Financial), Inpost (XAMS:INPST, Financial), Siltronic (XTER:WAF, Financial), Informa, Stellantis (STLA, Financial) and Pandora itself. Among the latter, we have continued to increase our holdings in Heineken (XAMS:HEIO, Financial) and BP (BP, Financial), among others. The objective is the same as always: to continue to find the right balance between equilibrium and performance, knowing that it is not always possible to achieve this in the short term.
We have acquired shares in Elevance Health (ELV, Financial) (formerly Anthem), an investment with an attractive combination of stable growth and profitability, as well as a valuation that has room to expand.
Elevance is the second largest health insurer in the United States, with 48 million customers. Thanks to its scale and brand recognition, the company has historically generated returns on equity that we consider very attractive (15-20%), particularly in view of the low cyclicality of its business.
In 2017, a new CEO from UnitedHealth (UNH, Financial) joined the company. Since then, Elevance has implemented a diversification process in order to become a broader healthcare provider, not just an insurance company. It has created a new segment called Carelon, based on four pillars: lab testing, behavioural health, medical care and prescriptions. Elevance has stated that it wants Carelon to account for 30% of its profits in the next four to five years.
We believe this is the right strategy, as the margins and returns this division could generate are higher than those of the traditional insurance business, which could raise its valuation multiples in the market.
By way of reference, UnitedHealth's Optum division accounts for half of the company's earnings and the American company trades at 18 times earnings, compared to Elevance's 14 times (11 times if we look two years ahead). As the management team continues to implement its plan and the improvement in profitability becomes more evident, we believe this valuation gap should narrow.
We should now turn our attention to the total divestments we have made in TechnipFMC (FTI, Financial), BNP (XPAR:BNP, Financial), Bayer (XTER:BAYN, Financial) and Booking (BKNG, Financial). In the case of the former, we continue to believe that the current cycle favours oil equipment and service companies. The lack of investment over the last five years, together with the stability in oil prices that results from having OPEP as a marginal producer in the market (compared to shale producers in the previous cycle), provides the sector with levels of visibility and profitability unseen in the last ten years. After TechnipFMC's plus-90% rally over the last 12 months, this new reality is clearly reflected in its valuation.
In the case of BNP, we are still in the process of recycling our exposure from eurozone banks to banks that have experienced a narrowing of their net interest income. This is the case for names such as Barclays or Natwest (an old acquaintance of Bestinfond (Trades, Portfolio)). Unlike their continental cousins, which have benefited enormously from the rates hikes of the last two years, UK banks have been under enormous pressure to remunerate their depositors. We expect an imminent stabilisation of margins, even if the Bank of England changes its monetary policy in the coming quarters. In our opinion, this reality is not discounted by the low valuations at which we have bought their shares in recent months.
In the case of Booking, after three years of blood, sweat and … smiles (having more than doubled our capital since the pandemic) we have exchanged our shares for those of its competitor Expedia, the owner of brands such as Expedia itself, Hotels.com and Trivago. We know the sector well and believe that the US company is trading under a stigma that does not do justice to the improved profitability of the business that we expect in the coming years, after having integrated its brands and technology platform. Expedia is a much better company than it was before the pandemic, when it was earning USD 8 per share. It returned to this profit level in 2022, when its shares were trading for USD 180. According to analyst consensus, earnings this year and next year are expected to reach USD 12 and USD 15 per share, respectively (our three-year forecast figures are higher than the consensus) and its price is almost 40% below the level at which it was trading three years ago.
Finally, the sale of Bayer should be seen as an investment mistake on our part. The German company's multiples had been depressed for a long time, but we believed there were compelling reasons to reverse the well-deserved discount it has traded at in recent years. What we did not expect is that one of the pillars of our investment case, the replacement of two drugs (Xarelto and Eylea), which represent a significant part of the value of its pharmaceutical division and whose patents will expire in the next two years, would suffer a setback like the one the company announced at the end of last year.
Bayer announced the suspension of the OCEANIC-AF study, a phase III clinical trial of its new oral anticoagulant (Asundexian), after acknowledging that the results did not evidence a higher efficacy and safety profile than the existing drug on the market (Apixaban). The business opportunity for this medicinal product was very important for many reasons, but one of the most important is that it relieved the balance sheet pressures that the German company had suffered since the purchase of Monsanto in 2018, a deal that included huge contingent liabilities that have led to the payment of millions of dollars in compensation.
The new management team (another pillar of our thesis) can do little about this situation. It has announced a painful cost restructuring programme, including a 95% cut in its dividend, and has delayed sine die the possible segregation of the businesses that could have unlocked so much value.
The suspension of the OCEANIC-AF study is a reminder that new drug development is a complex and risky process. Even those that appear promising in the early stages of development may fail in phase III clinical trials. The other lesson from Bayer is that, once again, when you buy debt-ridden companies, you have much less room for manoeuvre in the face of misfortune than you might initially think
Bayer still “looks” very cheap. It probably is. However, any investor can buy a mix of Corteva, Glaxo and Haleon, for example, replicating Bayer's business and doing so at a valuation very similar to Bayer's. But without the burden of debt, a burden that in the investment world does not allow any mistakes to be made.
Thank you again for placing your trust in us.
Yours sincerely,
The Investment Team.
Bestinfond (Trades, Portfolio) is an equity investment fund and as such mainly involves the following risks: market risk, currency risk, country risk, concentration risk and inflation risk.
Detailed information on the risks associated with the investments can be found at the end of this document.
Past performance is no guarantee of future performance.
The fund's full prospectus, regular reports and KIID can be found on the following websites www.bestinver.es and www.cnmv.es
(1) In his book “The Theory of the Idle Class” published in 1899, Thorstein Veblen explained how certain goods have a positively sloping demand curve, i.e. as their price increases so does their demand. These are goods whose value derives not only from the intrinsic utility of their consumption, but primarily from the reputational value that an individual derives from owning them, as in the case of luxury goods.
(2) Momentum-based investment strategies are built on the idea that stocks that have performed well in the past are more likely to continue to perform well in the future.
