Equity markets began 2017 on a strong note as global indices gained steadily throughout the quarter. BBH Global Core Select Composite ("Global Core Select" or "the Strategy") appreciated 5.92% during the first quarter, while the MSCI World index gained 6.38%. Since inception, the Strategy has generated a positive compound annual return of 6.93% while the MSCI World index has compounded at 8.75%.
Share price performance was broadly positive across most of the Global Core Select portfolio during the quarter with all but six names generating positive returns. As our focus is primarily on the operating results and long-term shareholder value creation of our investments, we were pleased by the generally strong operating performances of our portfolio companies. We continue to view overall market valuations as high. Accordingly, we remain diligent in our efforts to invest in businesses that are both fundamentally resilient and trading at valuations that offer a margin of safety1 . We aim to generate attractive compound returns over time.
Our strongest contributors to the Strategy’s performance in the first quarter were Oracle, Davide Campari-Milano, and JCDecaux. Oracle is our largest position in the portfolio and its shares appreciated over 16% in the quarter as the company reported operating results that offered greater visibility into the underlying strength of its database and software franchises. Oracle’s cloud-based solutions again grew at a strong and accelerating rate and, while on-premise license sales continue to decline, growth in cloud subscription revenues is more than offsetting those declines. We originally invested in Oracle during the third quarter of 2014 and have added to the position when shares were sharply out of favor. We believe the company is a strong fit with our investment criteria given (i) its global leadership position in the enterprise software market, (ii) high levels of customer retention due to its entrenched position and the embedded nature of its products within its customers’ business processes, and (iii) the combination of strong profitability and low capital intensity leading to attractive returns on capital and cash flow generation. We continue to view Oracle’s valuation as attractive relative to our estimate of intrinsic value2 .
Our consumer staples investments appreciated strongly with four of our six companies generating double-digit returns in the quarter and reversing the sector rotation and currency-induced weakness that we had seen in the fourth quarter of 2016. Unilever led the way rising more than 21% in the quarter triggered by an unsolicited offer by Kraft Heinz to acquire the company. Unilever rejected the offer and has since accelerated productivity-enhancing initiatives and potential portfolio rationalization. Unilever’s senior leaders have always taken a long-term approach to managing the business, including investing consistently and appropriately behind brand equity, innovation, and channel development. We favor such an approach as we believe it is the best way for consumer goods companies to generate sustainable top- and bottom-line growth and create long-term shareholder value. We will watch carefully to make sure the new emphasis on greater near-term margin enhancement does not undermine the long-term health of the business. Unilever has an extremely attractive footprint in high-growth emerging markets such as India and Indonesia, where it is the leader in the personal care category.
Campari, the Italian producer of premium spirits, was a strong contributor as well, returning over 18% during the quarter. The company reported strong full-year operating results which indicated good progress against management’s strategy of focusing on high-margin international brands and on markets where it has its own distribution systems with the objective of driving solid and consistent top-line growth, higher mix-driven gross profits, and improved returns on capital. Aperol, a bittersweet orange-flavored aperitif, is doing particularly well having generated two consecutive years of double-digit revenue growth. The company is also in the early stages of leveraging its most recent acquisition, Grand Marnier, which was an under-managed brand and which we believe offers strong potential for value creation under Campari’s ownership.
JCDecaux, the French outdoor advertising company, was another positive contributor, appreciating nearly 20% during the quarter after declining in the fourth quarter of 2016. Operating performance is improving relative to last year’s results which were negatively impacted by a margin-dilutive acquisition, startup costs and delays associated with a large contract in London, and slowing market conditions in China. We take a long-term view of the business and recognize that reported results can be choppy quarter-to-quarter due to contract wins and related investments. Importantly the company has a leading market position with a strong global network of advertisers, a disciplined approach to bidding for contracts, opportunities to capitalize on digitalization of the outdoor media industry, and a strong balance sheet that it maintains as a strategic asset. We consider the business a strong fit with our investment criteria and, while the discount to intrinsic value has narrowed somewhat, we still view JCDecaux’s shares as attractively valued.
Our largest performance detractor in the first quarter was Perrigo, which declined by 20%. The company is making progress on its strategic review and recently announced the sale of its Tysabri royalty stream for an upfront payment of $2.2 billion plus potential milestone payments. We view the Tysabri sale price as a good outcome for Perrigo and expect that management will use most of the proceeds to pay down debt.
However, the company also delayed its 2016 10-K filing as its auditors are reviewing historical revenue recognition practices for Tysabri and the status of certain deferred tax assets. While we do not anticipate any adverse impact to reported cash flows, the accounting delay was an additional source of uncertainty during the first quarter. We continue to view the company’s core operating assets as attractive, particularly the store-brand over-the-counter (OTC) business, which continues to deliver solid results, enjoy leading market share in the U.S., and benefit from ongoing Rx-to-OTC switches. In our view, Perrigo’s current valuation reflects an overly negative scenario and is likely influenced by negative sector sentiment in addition to company-specific issues.
Qualcomm was the other significant detractor from performance in the first quarter declining by 11% due to legal challenges by both the U.S. Federal Trade Commission and Apple. Both complaints were linked by the common assertion that Qualcomm’s business model and market position are believed to be monopolistic and coercive. As a leader in the development and commercialization of wireless technologies, and with a cumulative research and development outlay of nearly $40 billion in the last 10 years, Qualcomm has a large intellectual property portfolio consisting of tens of thousands of patents that are essential in mobile networks. As such, device manufacturers have freely chosen to reach “portfolio license” agreements with Qualcomm for usage of the intellectual property. Qualcomm has faced similar legal challenges in the past, both from commercial counterparts and global regulators. While there have been occasional setbacks and meaningful fines, recognition of the company’s intellectual property and the validity of its licensing model have endured.
We exited our successful investment in Svenska Handelsbanken during the quarter as the shares reached our estimate of intrinsic value. Handelsbanken is a well-managed and differentiated bank that we would like to own again at the right price. We trimmed our investments in Wells Fargo and Zoetis as the gap between the share prices and our intrinsic value estimates narrowed, though both remain large positions in the Strategy. We also modestly trimmed our positions in Aggreko and Bed Bath & Beyond during the quarter. Our Aggreko trims were well-timed as later in the quarter the shares fell alongside oil prices. Bed Bath & Beyond has been an unsuccessful investment to date. While the company’s shares continue to trade at a low multiple of earnings and we view the management team as strong, it is clear that the challenges facing traditional retailers have intensified. Although Bed Bath & Beyond has made significant progress growing its multichannel business and remains very profitable and cash generative, it is unclear where profit margins will ultimately stabilize. Given our view that the range of potential outcomes has increased, we decided a smaller portfolio weight was appropriate.
We did not add any new companies to the portfolio in the first quarter. While our investment team has an active pipeline of investments, none of our “wish-list” companies traded down to our buy range. We did, though, add to several existing positions including Heineken Holding, Nielsen, and PayPal at attractive discounts to intrinsic value. We also continued to build our position in Wendel, and the French holding company is now a top-10 position for Global Core Select. Wendel’s shares declined in February following weaker-than-expected earnings from its publicly-traded subsidiary, test and inspection company Bureau Veritas. While Bureau Veritas is facing cyclical pressures in certain of its end-markets, we have been impressed by its resilience in a challenging environment and view it as an excellent business. In late March, Wendel’s shares rebounded after the company released its own earnings and its internal estimate of per-share Net Asset Value (NAV) advanced to €162 per share. Despite the rebound, Wendel’s shares ended the quarter at € 119 per share, or just 73% of the company’s estimated NAV.
Our investment team is committed to owning companies that offer essential products and services to loyal customers, are leaders in attractive industries, enjoy durable competitive advantages, earn attractive returns on invested capital, and are run by good managers who allocate capital wisely. We also look for businesses with limited external risks such that we can estimate intrinsic values within a reasonably limited range of potential outcomes. Our objective is to own shares of businesses that possess these characteristics trading at a discount to intrinsic value so that we can grow the capital you have entrusted to us.
On behalf of our entire investment team, we thank you for being an investor in Global Core Select alongside our team, and we welcome your questions and feedback.
Timothy E. Hartch
Regina Lombardi, CFA
1 A margin of safety exists when we believe there is a significant discount to intrinsic value at the time of purchase – we aim to purchase at 75% of our estimate to intrinsic value or less.
2 BBH’s estimate of the present value of the cash that a business can generate and distribute to shareholders over its remaining life.