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Holly LaFon
Holly LaFon
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Francisco Garcia Parames' Cobas Asset Management 4th Quarter Commentary

Discussion of markets and holdings

February 18, 2019 | About:

Year 2018 was a tough year, in which we saw negative results by our funds, mainly due to our investments in Aryzta and Teekay. These two companies undermined the return of the International Portfolio by 11.7% and 5.7%, respectively, while the overall return of this portfolio last year was around -31%. The Iberian Portfolio delivered negative result of 14.1%.

We would like to take this opportunity to perform a review, discuss our outlook and share our excitement and confidence over the future with our co-investors.

Many customers have asked us if we have sustained losses this big under similar circumstances. What happe-ned in 2018 appeared unprecedented and surprising. The answer is, we definitely have. Everything that happened in 2018 (e.g. losses, misvaluations) has happened to us at some stage of our 30 years of investment management experience, at different times and in different ways. For instance, when we started managing the International Portfolio in 1998, we experienced a 14.1% loss compared to market gains of 16.5%, i.e., 30% underperformance. Ano-ther example can be seen in the 2011 losses (-22% in six months), which were accompanied by a serious error in the valuation of CIR/Cofide, in which we had invested 7% of the International Portfolio.

Everything that happened in 2018 has happened to us at some stage of our 30 years of investment management experience

Despite the mistakes made (we have recognized 45 in more than 500 investments), the results have been satis-factory as our successes have easily outweighed the losses. Errors are part of the process. However, on the bright side, experience shows that the best times to invest are after the biggest falls.

As shown in the following table, significant losses have always been followed by strong recoveries:

As can be seen, recoveries have been relatively fast and the characteristics of the current portfolio instil faith in us that this may happen again, aware that past perfor-mance is not a guarantee of future returns.

The main tool at our disposal for funds to recover is an investment process that we have perfected over time. This process is precisely what allows us to identify good business with a broad margin of safety, which contribute to boost the target price of our portfolios. We spend almost all our time finding out how much the businesses in which we invest are worth, and therefore, we believe that this target price is accurate, although by no means does this mean we never make mistakes. The result of this process and daily work is that at 2018 year-end, we believe that our International Portfolio is worth more than double, i.e., we value it at 138% of its current price. For the Iberian Portfolio, the target price is 85% above net asset value. It is worth noting that after working with many of the companies for two years, the level of faith in our valuations has been enhanced. The passing of time is a strong ally in this sense.

The target price of our funds is real and our experience demonstrates that, with time, this is achievable. For example: in 2011, the five main positions of our interna-tional funds* (Exor, Thales, Schindler, Wolters Kluwers and BMW) were trading well beneath the target prices that we estimated at the time, after performing an in-depth analysis. Nearly eight years later, in line with the average investment period we recommend to our customers of 5-10 years, these companies have not only reached the target prices we assigned to them at the time, four of them are now well above these values.

It is important to us that our co-investors feel like the owners of the companies in which we invest, that they understand their business and the value of our portfolios, regardless of what the market says they are currently worth. Therefore, we believe it is worth discussing, yet again, the performance of each of the main positions in our International Portfolio, which represent around 60% of the total.

Teekay. The fourth quarter featured an improvement in Teekay LNG (NYSE:TK), earlier than expected in the company's plans, mostly thanks to improvement in the LNG (lique-fied natural gas) shipping market. A series of vessels with short-term contracts have arranged long-term contracts at attractive rates, while four new ships being built were delivered ahead of schedule. Thanks to the company's strong performance, it announced a plan to reduce debt and raise the dividend, now that the growth plan that required cutting back on the dividend a few years ago has ended. Interestingly, the company's share price has fallen, as it would seem the market expected an even greater increase in dividends. This has meant that the company has announced a buyback programme worth $100 million (10% of its market cap) to make the most of this opportunity. Needless to say, this appears the most sensible option for a company with a market capitaliza-tion of $1 billion and forecast net profit of approximately $200 million. In the case of Teekay Corp, its share price fell by 50% in the fourth quarter, reflecting a stress scena-rio in which the fall in crude oil prices, not to mention the impact of several of the company's assets, could compro-mise its ability to refinance its debt in January 2020. We believe that this risk is mitigated by the value of Teekay Corp shares in its various holdings; on our estimates, 80% of the company's value derives from its stake in Teekay LNG, where, as we have seen, investment rationale is solid.

Babcock. There were no major developments in the fourth quarter; Babcock (NYSE:BW) continues to generate profits, which are earmarked to reduce debt and pay dividends. In the meantime, its share price is still being affected mainly by Brexit and the market refuses to acknowledge the quality of its various businesses (defence, emergen-cy and nuclear services). As a result, Babcock is trading even further below its intrinsic value. One way of illustra-ting this would be as follows: the annual dividend yield was 6% at year-end. If Babcock were to distribute all the distributable normalised profit among its shareholders, the dividend yield would be double the current figure. These intrinsic yields would normally attract investors, pushing up the share price considerably. The main mem-bers of the management team must think the same, for they purchased shares following the release of earnings in November.

Tankers. Our investments in crude oil shipping fell by around 20% in the fourth quarter of 2018. This is interes-ting considering that the fundamentals of our invest-ments clearly demonstrated their soundness. For example, the main profit drivers in maritime transport, daily freight rates, have tripled since the end of September to above long-run averages, which would imply the return to healthy levels of cash generation. This improvement can primarily be attributed to the fact that vessel scrap-ping rates reached record highs in 2018. Elsewhere, the sulphur emission control regulation (IMO 2020) was approved in October 2018 and should speed up scrapping rates further between 2019 and 2021. Meanwhile, the industry continues to demonstrate great discipline and for the first time (in history, according to experts) almost all companies in the sector have decided to embark on share buyback programmes, as they have good levels of liquidity and valuations below net asset value provide for compelling investment opportunities. At the start of the year, we will see the final wave of delivery of ships orde-red in recent years; however, looking forward to 2019 and 2020, the outlook for our investments in crude oil ship-ping is positive and show progressively lower risk.

Automotive. Renault, Porsche (VW), Hyundai and BMW are trading near 5-year lows, having fallen by 35%, 43%, 28% and 28%, respectively, from April 2015 highs. During this period, the S&P 500 has risen by 25% and the Euro Stoxx 600 has fallen by 15%, both outperforming our com-panies for the most part. Part of this decrease can be attributed to the uncertainty generated by the threats posed to the industry (electric, autonomous, connected vehicles and emissions); however, it can also be attribu-ted to prices already reflecting some downturn in the cycle. We believe that in the event that this decrease were to take place, our companies would outperform the market. Excess pessimism has caused irrational situa-tions, as is the case with VW, where the current market price is lower than the value of the Porsche brand, the trucks division and the company's cash combined, with the rest of the Group's businesses "free" (Audi, the VW brand, SEAT, Skoda, Bentley and Buggatti, amongst others). In short, all the companies in which we have invested show a strong discrepancy between price and value, resulting in upside potential of over 100%.

Dixons (LSE:DC.). The company's share price fell by almost 30% in the fourth quarter. In addition to generalised market falls and Brexit fears, the share price was affected by more sector- and company-specific factors. The main reason for its poor performance has probably been the cut in dividend announced in December, coinciding with the presentation of the new management team's strategy. As part of this new phase, and given the macroeconomic uncertainty in the United Kingdom, the management team has preferred to take a more prudent approach with the company's financial position, hence the smaller divi-dend. The company is by no means experiencing finan-cial or solvency issues, and in fact, the new plan presen-ted, which underscores our upbeat stance on the com-pany, indicates a generation of more than £1 billion in cash over the next five years.

Asia. Asian companies account for around 15% of the International Portfolio. These are high quality busines-ses (ROCE > 40%), with families as majority shareholders (85% of our companies), sound balance sheets (65% have net cash) and trading at attractive prices (P/E ratio of 3.6x). Our two main holdings are Samsung and Hyundai. At Samsung, the share price reached lows for the year in the fourth quarter as the market is concerned about the peak in the business cycle for memory microchips, which represents 70% of Samsung's EBIT. However, only 3-4 competitors remain in this segment and we are seeing how the cycle is bottoming out. Samsung enjoys a technological leadership position in an oligopolistic industry that boasts opportunities for structural growth. Furthermore, Samsung has committed to returning 50% of its free cash flow to shareholders through dividends and share buybacks. Hyundai has been affected by the volatility of the automotive sector and a series of company-specific factors. The main cause was the need to set aside extraordinary provisions for the potential with-drawal of vehicles in the US, which has resulted in losses in its car division. On the positive side, there has been a clear improvement in corporate governance, through the buyback and cancellation of shares, not to mention a change in leadership, boding well for a change for the better.

To conclude, it is essential that our co-investors unders-tand that it is precisely when the value of funds drop that we must show patience and self-control, avoiding the impulse to sell at the worst possible time. A good exam-ple of this can be seen in the case of the Fidelity Magellan fund, managed by distinguished US investor Peter Lynch between 1977 and 1990. Over the 13-year period in which Lynch headed the fund, it enjoyed an average annual return of +29%, easily outperforming its benchmark index. Unfortunately, a study by Fidelity, showed that the average investor in this fund was obtai-ning much smaller returns, precisely because they had bought and sold at the wrong times.

At Cobas, we believe our clients have embraced this mes-sage, as shown by the €264 million in net subscriptions seen in 2018 despite the poor performance of the funds. We would once again like to thank the trust shown in our management model and, in particular, the 517 new co-in-vestors who have seized the negative returns in the fourth quarter as an opportunity for investing with us, in addition to the 2,578 existing unit holders who have deci-ded to increase their investments during this period. We obviously think this is the right path towards good long-term returns and this is how the management team has proceeded with our own savings.

  1. Francisco Garcà­a Paramés stepped down as Head of Investments at Bestinver Gestión, SGIIC, S.A. (fund manager) on 23 September 2014, having been involved in the management of the fund since its inception.
  2. Past performance is not a guarantee of future returns.

Source: Bloomberg. Fondo Bestinver Internacional. ES0114638036.

About the author:

Holly LaFon
I'm a financial journalist with a Master of Science in journalism from Medill at Northwestern University.

Visit Holly LaFon's Website

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