Volatility returned to global equity markets in the first quarter as stocks were buffeted by the first signs of wage pressure in the U.S., an uptick in interest rates (the yield on the 10-year U.S. Treasury note rose by approximately 50 basis points (.50%) in a matter of weeks), and by a host of additional macroeconomic worries including the prospects for continued global monetary tightening and increasing trade tensions between the U.S. and its trading partners. It is not surprising that, during a time of enhanced volatility in our markets, all but one of our Funds led their respective benchmark indices as of March 31 (through April, all four Funds were leading their respective benchmarks).
While most stocks finished modestly in the red in local currency during the quarter, there were a few bright spots, including several of the Funds’ insurance holdings (CNP, Munich Re, Zurich Insurance), two Singapore based banks (DBS, United Overseas Bank), one oil & gas company (Conoco), a couple of media holdings (Daily Mail, Axel Springer), and two information technology businesses (Cisco, MasterCard). Leading decliners were the Funds’ auto related holdings (Kia, Hyundai Motor, Inchcape, AutoZone), pharmaceutical holdings (Johnson & Johnson, Roche, Novartis), a few bank holdings (HSBC, Standard Chartered, Wells Fargo), an oil & gas holding (Devon), a couple of media related businesses (Comcast, WPP), and the Funds’ lone mining company, Antofagasta. It’s fair to say that a good bit of the quarter’s price action was due to headline induced volatility as opposed to significant changes in underlying fundamentals.
Overall, portfolio activity was modest during the quarter; however, in terms of more material changes, the Funds did establish one new portfolio position (Inchcape), sold our remaining shares in four holdings (ABB, Baxter International, Philip Morris Int’l, and Signet), and added to and trimmed a number of others including Roche(+), WPP(+), DBS Group(-), Shire(-) and Axel Springer(-). ABB, Baxter, and Philip Morris were sold, having met our intrinsic value targets, and we also decided to sell our remaining shares in Signet Jewelers at a loss, as the company continued to struggle and lose market share despite a strengthening economic environment.
Inchcape (INCH, Financial), our newest acquisition, is a small- to mid-cap ($4B) UK-based automotive distributor and retailer that functions like a franchisee or outsourced country manager allowing major automobile manufacturers to efficiently gain access to smaller markets (like Peru, Greece, Singapore, or even Hong Kong) that do not generate enough sales volume for the original equipment manufacturers (OEMs) to want to focus on them directly. In this role, Inchcape has the exclusive rights to sell a particular brand and its related parts in a particular country, controlling distribution and selecting and managing the dealer network in the country. It is an asset light business and as such has generated high returns on invested capital. At purchase, it was trading at less than 10 times earnings, 7-8 times enterprise value1 (EV) to earnings before interest, taxes, depreciation, and amortization (EBITA), carried very little debt, and had a dividend yield of approximately 3.6%.
WPP (WPP, Financial), one of our newer holdings, was in the news late in the quarter as the company announced that it had hired a law firm to investigate allegations of personal misconduct by Martin Sorrell, the company’s CEO and one of Britain’s best known and highly acclaimed business leaders. The company stressed that any financial liabilities associated with the allegations are not material, and over the weekend of April 14, Sorrell announced his retirement. We continue to monitor the situation closely, but it is possible that this Board intrigue could result in changes at the company that might be beneficial to shareholders, such as streamlining the business and exiting noncore assets. The situation remains fluid. In our view, the company remains fundamentally a good business given its asset light nature and variable cost structure. It is significantly undervalued in our view, and currently has a dividend yield of nearly 5% while we wait for value recognition in its shares.
Also, the Hyundai Motor Group (HKSE:005389, Financial) announced late in the quarter a major restructuring plan in an effort to streamline its complex ownership structure in response to pressure from the Korean government to reform powerful chaebols (family run conglomerates). The plan consists of a series of complex transactions that reorder the controlling family’s ownership interests. We are currently actively discussing with the Hyundai group the proposed transactions and evaluating the associated impact on the underlying intrinsic values of our holdings.
With valuations full to high in most equity markets around the world after the strong return environment of 2017, a nervousness crept into equity markets in the first quarter, as investor sentiment shifted back and forth with the ebb and flow of daily headlines. While we are no doubt in the midst of a global monetary tightening and prospects for rising interest rates, the global economy still appears strong and corporate profitability has been on the rise. This tension between rising interest rates and prospects for increasing corporate profitability will no doubt be a major determinant of equity returns over the next several years. Should negative surprises occur on either of these fronts, equity valuations could come under pressure rather quickly. All of that said, we are very comfortable with the positioning of our Funds’ portfolios. All four remain well diversified by issue, industry group, and country; are focused primarily in the developed markets although currently maintain as much as a 10% exposure to the more developed of the emerging markets (ranging from 0.9% in the case of Worldwide High Dividend Yield Value Fund to 10.3% in the case of Global Value Fund); consist of securities that we believe trade at reasonably attractive absolute and relative valuation levels; and carry a modest level of cash reserves that offer some optionality should the recent market turbulence continue.
Thank you for investing with us and for your continued confidence.
Tweedy, Browne Company LLC
William H. Browne
Thomas H. Shrager
John D. Spears
Robert Q. Wyckoff, Jr.
Managing Directors
Dated: May 2018
