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Commentary iMGP Oldfield International Value Fund Fourth Quarter 2023 Commentary

The iMGP Oldfield International Value Fund gained 9.14% during the fourth quarter of 2023, outperforming the MSCI EAFE Value Index (up 8.22%), but behind the MSCI EAFE Index return of 10.42%. The Morningstar Foreign Large Value Fund peer group gained 8.68% in the quarter.

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Quarterly Portfolio Manager Commentary

The largest positive contributors to the strategy’s performance in the fourth quarter were Svenska Handelsbanken, Embraer, Eni, Siemens, and Exor.

Embraer is an aircraft development and manufacturing firm, based in Brazil but largely selling into global markets—namely the United States. The firm had hit a severe valuation discount due to the failure of an expected deal with Boeing and downturn in demand due to COVID-19. In 2023, Embraer has demonstrated that these were transitionary setbacks. The valuation remains compelling, especially when compared to global peers. Beyond the core business on which our valuation is based, the firm also has a majority holding in Eve Air Mobility. EVE is a U.S.-listed entity developing electric powered aircraft for short passenger flights—the aircraft looks much like a large drone. While EVE is not profitable, and will likely not be for some time, it is a leading player in a market that is forecasted to be large in size. This is evidenced by the firm’s already substantive and growing international orderbook. As the technology and regulatory hurdles are met, the value of EVE will be added to the Embraer base valuation.

The largest detractors to the strategy’s performance in the fourth quarter were Ailbaba, Bayer, LG H&H, East Japan Railway, and C.K. Hutchison.

In the last week of October, LG H&H reported third-quarter results that fell short of the markets’, and our, expectations. While they reported continued resilience of sales and profits in their Refreshment division (soft drinks) and the Home and Daily Beauty (HDB) division (combined 60% of profits for the last twelve months), their Beauty division (luxury skin care and cosmetics) reported weak sales and profit.

The Beauty division has been challenged since 2021 and is dominated by its luxury skincare range sold largely in China and Korea (to Chinese tourists). Sales to China, largely luxury skincare, fell 29% on the same period last year. Given some restructuring, rebranding expense and negative operating leverage, profit in beauty for the quarter was down almost 90%.

The problem in China is not unique to LG H&H. Other global skin care companies such as Estee Lauder and Beiersdorf have seen similar declines in their Asian travel business. In response they, like LG H&H, are working hard to return the industry to its pre-COVID structure by reducing exposure to resellers and reducing inventory in the channel—both tough decisions to take.

The results raise concerns that the problem is more than skin deep and that brand equity for these international players has been impaired, ceding market share to domestic Chinese players. The fact that global industry leaders like Estee Lauder are also suffering similar issues offers us some comfort. That said, after adjusting for the net cash on the balance sheet, the shares are now valued at 12.6x the lowered consensus expectations for profit in 2024 (earnings which are based on Beauty operating profit which is just 20% of 2021 levels).

The extreme weakness in the share price and the slow recovery in Beauty are disappointing but we think the current valuation fails to recognize Beauty’s recovery potential, the strength and stability of HDB and Refreshment (60% of operating profit) and LG H&H’s strong cash generation and net cash balance sheet.

During the fourth quarter we bought two new holdings for the strategy—Michelin, the French automotive tire company, and Heineken Holdings, the Heineken family-controlled holding company that owns 50.4% of Heineken, the Dutch-based global brewing company. These purchases were funded from the sale of Mitsubishi Heavy Industries and a reduction in the holding of Sanofi (we later increased Sanofi after its profit warning funded by a reduction of Tesco).

Michelin is the largest global tire manufacturer. The company generates around half of its sales from the passenger car market, with the remainder split equally between trucks and specialty vehicles, including mining and aircraft tires. The low end of the tire market is commoditized, but Michelin is largely insulated as they focus on the premium end where customers care about performance and are willing to pay for it. Michelin tires have industry leading performance metrics and tend to be priced at a 10% premium. The initial purchase of a set of Michelin tires is often indirect, with customers choosing to buy a premium car which happens to come with a set of Michelin tires. When those tires are up for replacement after around four years, purchasers of premium cars tend to stick with the brand of tire the car was delivered with. The company spends a great deal of time and money to meet the strict performance requirements set by premium auto manufacturers. For this reason, the premium end of the market has significant barriers to entry.

Michelin is likely to benefit from industry tailwinds over the next few years. First, the move to electric vehicles means that tires gain in relative importance. This is because factors such as rolling resistance become more relevant. With cheap tires, an electric vehicle may not achieve the advertised energy efficiency and thus mileage. A second tailwind is more stringent regulation, including CO2 and microplastic emissions—Michelin performs well on both metrics and cheaper brands struggle to compete. These trends make it likely that Michelin can defend their market share and pricing premium.

Given its brand and pricing power, Michelin has a history of passing raw material costs on to customers, resulting in stable operating margins of 10-12% and return on invested capital of around 10%. With 75% of tire sales coming from the replacement market, this is also not a particularly cyclical business. We were able to buy Michelin at a historically high free cash flow yield of almost 10% which in our view does not reflect the quality and earnings profile of the business.

Heineken is a global beer company that was founded in 1864 by Gerard Heineken. Heineken owns 300 brands with the largest being Heineken (c.20% of volume). The Heineken brand competes with AB InBev’s Budweiser for the status of largest global brand outside of China. Other global brands the company owns include Amstel and Tiger.

Heineken owns 167 breweries with 14% share of the global beer market, second only to AB InBev
(27%).  A decade ago, Western Europe accounted for 44% of volumes, 50% of revenue, and 36% of profit. Following a series of acquisitions across several of the largest emerging-market countries, revenue from emerging-markets now accounts for 53% of revenue and Europe accounts for 30% of volume, 35% of revenue and 25% of profit. With the brewing costs for all beers being very similar, the key to profitability is the focus on cultivating premium branded beers. For Heineken, premium brands now account for 40% of sales. Among these is the world’s leading zero alcohol beer, Heineken 0.0%, a new growth area for the business.

The last three years have created the opportunity in Heineken today. Cost pressures and COVID-19 have seen gross margins fall from 50% to 44%. The competition has seen similar cost pressures that has meant that all operators have had to push through price increases not seen in a generation. Looking forward, we would expect pricing to hold but some of the costs to fall and this will help restore gross margins. 

Today the Heineken family remains the controlling shareholders of Heineken through their 53.7% holding of Heineken Holding which in turn owns 50.4% of the main Heineken listing. Heineken Holding shares fell to a valuation of 14x price to 2024 earnings, a 17% discount to the valuation of the main listing, and we see a multiple in the high teens as fair.

The strategy overall is valued at a price to expected earnings ratio of less than 10x and a price to book ratio of 1.1x. This compares with a price to expected earnings ratio of 13.2x and a price to book ratio of 1.8x for the MSCI EAFE benchmark and a price to expected earnings of 9.8x and a price to book ratio of 1.2x for the MSCI EAFE Value index. The weighted average upside for the portfolio ended the year at 54%, offering a prospective total return over the next couple of years of 60%, substantially ahead of its long-term average.

By SectorBy Region
Finance 16.3%Europe73.4%
Consumer Discretionary8.1%North America0.0%
Information Technology4.1%Asia ex-Japan19.0%
Communication Services5.1%Japan3.0%
Health Care & Pharmaceuticals13.6%Latin America4.6%
Consumer Staples20.1%Australia/New Zealand0.0%
Real Estate0.0%Middle East0.0%
Utilities4.9%Other Countries0.0%
Energy5.0%*Cash is excluded from calculation.
Cash -0.1%
By Region
US Equities0.0%
Developed International Equities84.4%
Emerging Market Equities15.6%
By Market Cap
Small Cap0.0%
Mid Cap10.6%
Large Cap89.4%

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