Global equity markets rallied sharply during the first quarter of 2019, largely sparked by a pivot to a more dovish position by the U.S. Federal Reserve, significantly recouping the declines that occurred late in 2018. For the first quarter, BBH Global Core Select Composite (“Global Core Select” or “the Strategy”) appreciated by 13.39% while the MSCI World Index gained 12.48%.
Returns were broadly positive across the portfolio and nine of our 10 largest investments in the Strategy had strong double-digit gains during the quarter. The best performing investment for the first quarter was FleetCor Technologies, with a gain of 32.8%. FleetCor had been one of the biggest detractors from performance in the fourth quarter of 2018 driven largely by both market rotation and perceived sensitivity of the business’ economics to fuel prices. We had taken advantage of the share price decline at that time to add to our position at very attractive prices, making it one of the largest investments in the Strategy. We view the business as a very strong fit with our investment criteria given its strong network offering business-to-business payment solutions, high customer retention, and significant growth potential. During the first quarter of 2019, FleetCor reported very strong revenue and operating profit growth for 2018 and raised its guidance for 2019 organic growth. We view the company’s operating results as thesis-confirming, and we expect that continued digital payments penetration and the fixed cost leverage inherent in FleetCor’s business model to be supportive of the company continuing to drive incremental profitability at attractive rates.
Lloyds Banking Group was among the strongest contributors to performance in the first quarter as well. Lloyds’ share price responded favorably to diminishing expectations of a no-deal “hard” Brexit as well as difficulties faced by some other UK banks. More importantly, Lloyds has delivered solid operating results, reported in February, which underscored its differentiated position as the largest retail and commercial bank in the UK and its ability to increasingly leverage scale economies to drive an improving return profile. Lloyds announced that it is meeting its strategic 2020 targets ahead of schedule which supported dividend growth in line with our expectations and a larger-than-expected share repurchase in 2018.
Qualcomm and Qurate Retail were the most significant detractors from performance during the first quarter. Qualcomm’s share price fell early in the quarter as investor uncertainties accumulated during a key courtroom trial in which the U.S. Federal Trade Commission (FTC) is seeking to remediate alleged anti-competitive business practices by Qualcomm. The risks to Qualcomm associated with this case included threats to the company’s royalty stream which in turn would have a detrimental impact on the company’s profitability. Additional adverse developments, including (i) the escalating battle between the U.S. government and Huawei (China’s telecom/wireless giant) which posed knock-on effects that would be adverse to Qualcomm and (ii) a slowdown in the smartphone market which may be accelerating, led us to exit our position in Qualcomm during the quarter as the range of potential outcomes in respect to our estimate of intrinsic value1 had widened considerably.
Qurate shares declined in response to the company’s fourth quarter and full year 2018 earnings report. Qurate reported weaker-than-expected profitability due to mix shifts to lower-margin merchandise categories, higher fulfillment costs, and higher marketing expenses. While growth in new customers was strong and the company is gaining traction in respect to digital and mobile engagement, the cost of growth appears to be increasing. Management indicated it will be making incremental investments in marketing and fulfillment capabilities, which we view as appropriate initiatives given the increasingly competitive retail environment and the shifting landscape in terms of media content delivery. However, these investments are likely to continue to pressure profitability over the near to medium term.
We added three new investments to the Strategy during the first quarter: Bureau Veritas, Costco Wholesale, and Colgate-Palmolive. France-based Bureau Veritas (BVI) is a leading global provider of testing, inspection, and certification (TIC) services to over 4,000 clients across a wide range of industries. While the TIC industry is fragmented on a global basis, BVI specializes and has strong market positions in specific industries and niches such as: (i) Marine (assessment of ships and offshore facilities), (ii) Agriculture/Commodities including food, and oil and gas, (iii) Industrial assets (particular strength in the oil and gas market), (iv) Buildings and Infrastructure (leadership positions in France and China), (v) Certification (certifies compliance with quality, health, safety, and environment management [QHSE] standards), and (vi) Consumer Products (strong positions in U.S. and China). BVI offers a mission-critical service to its client base, has strong customer retention rates, and a global network of offices and labs that enable it to service key accounts that require international contracts and a global framework. Despite operating in a number of highly cyclical industries, BVI’s revenues and earnings have been very resilient through cycles, it has a healthy balance sheet, and it maintains very attractive returns on capital. We have had exposure to BVI in the Strategy via our investment in Wendel as Bureau Veritas has long been Wendel’s largest investment. However, as the discount to intrinsic value* of BVI and Wendel approached parity in both names, we decided to exit the investment in Wendel and redeployed the capital to BVI, offering us direct exposure in the Strategy to the highly attractive TIC space where BVI is the number two global player.
Costco, the leading warehouse club retailer, is a very strong fit with our investment criteria given its business model which centers on membership fee income, a growing and recurring income stream that is supported by high and consistent member renewal rates, and a management team obsessed with delivering value to its members. Costco is one of the largest retailers in the world with warehouse clubs in North America, Asia, Australia, and Europe serving 94 million paying members. Member retention has trended upward over the past 20 years and is currently in the high 80% range company-wide and in the low 90% range in its more mature markets of the U.S. and Canada. The company has raised membership rates consistently over its history and warehouse same-store sales have demonstrated strong resilience through economic cycles, highlighting the value the company delivers to its membership base. Costco continues to expand the warehouse base both in the U.S. and internationally, with 30% of expansion occurring outside of the U.S. The company earns attractive returns on invested capital, is highly cash generative, and has a very strong balance sheet. The shares sold off early in the quarter due to concerns around weakness in reported margins, giving us an opportunity to initiate a position at an attractive price. While margins can fluctuate over short periods of time, we view membership retention as the more relevant metric to gauge the health of the business.
Colgate-Palmolive’s leading consumer franchises in oral care, pet food and personal care/home care fit well with our investment criteria, and the company exhibits key attributes that we look for in respect to consumer products investments. Namely, Colgate has strong brand franchises that are scalable across developed and emerging markets, a competitively advantaged distribution infrastructure including specialty detailing teams that forge relationships with dental and veterinary professionals, and operates in a category in which branding investments translate into premium market positions and pricing power. While a U.S.-based company, Colgate has a global footprint, substantial operating profits generated from operations in Latin America, Asia Pacific, and Europe in addition to North America, and has a particularly strong position in key emerging markets. Colgate’s business is highly cash generative, though growth has been constrained recently by market specific challenges as well as some execution challenges. We view both as temporary (in respect to macro challenges in key emerging markets) and fixable (in terms of execution missteps), rather than structural. In our view, the Oral Care category offers substantial opportunity for growth given low penetration in much of the company’s footprint, an opportunity that we believe is underappreciated and not reflected in the current valuation of the business.
In addition to the exits of Qualcomm and Wendel during the quarter, we also sold our small position in Brenntag due to underperformance on key operating metrics relative to our initial investment thesis. While sales and gross profit growth were only modestly weaker than our expectations when we initially invested in the business, the flow through from gross profit to earnings before interest, tax, depreciation and amortization (EBITDA) has meaningfully trailed our expectations. This has raised concerns around operating execution and future operating leverage, and cash flow has been pressured further by rising working capital investments in both inventory levels and payment terms. Given our concerns, we decided to exit the position and reallocate the capital to more compelling investment opportunities.
With respect to additional portfolio changes, we added to our positions in Heineken Holding, Copart, and Alphabet during the quarter and trimmed our positions in Discovery Communications, Qurate, and Liberty Global.
Investment Team Update
We are pleased to announce that Maya Venkatraman and Jason Yum joined the Global Core Select team in January 2019. Maya is a Senior Analyst and will act as a generalist focusing on international equities across multiple sectors. Maya brings extensive international investment experience to the team. Prior to joining BBH, she was a Global Equity Portfolio Manager and Senior Research Analyst at Voya Investment Management. She received a Bachelor of Fine Arts from Pepperdine University and her MBA from Cornell University.
Jason Yum is an analyst and will also act as a generalist focusing on international equities across sectors. Jason joined BBH from Loomis Sayles where he most recently was a Research Analyst focused on convertible bonds, primarily in the tech and telecom industries. Jason received his Master of Finance from the MIT Sloan School of Management and his BS in Applied Mathematics and Economics from Brown University.
On behalf of our entire investment team, we would like to thank you for being an investor with us in Global Core Select. Please feel free to contact us with any questions or suggestions.
Regina Lombardi, CFA
Holdings are subject to change. Totals may not sum due to rounding. Price/Earnings (P/E) ratio is a company’s current share price divided by earnings per-share. Turnover ratio is the rate of trading in a portfolio; higher values imply more frequent trading.
Opinions, forecasts, and discussions about investment strategies represent the author’s views as of the date of this commentary and are subject to change without notice. References to specific securities, asset classes, and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations.
Purchase and sale information provided should not be considered as a recommendation to purchase or sell a particular security and that there is no assurance, as of the date of publication, that the securities purchased remain in a fund's portfolio or that securities sold have not been repurchased.
International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.
The strategy is 'non-diversified' and may assume large positions in a small number of issuers which can increase the potential for greater price fluctuation. Investors should be able to withstand short-term fluctuations in the equity markets in return for potentially higher returns over the long term. The value of portfolios changes every day and can be affected by changes in interest rates, general market conditions and other political, social and economic developments.
Data presented is that of a single representative account ("Representative Account") that invests in the strategy. It is the account whose investment guidelines allow the greatest flexibility to express active management positions. It is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the proposed investment strategy.
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Gross of fee performance results for this composite do not reflect the deduction of investment advisory fees. Actual returns will be reduced by such fees. "Net" of fees performance results reflect the deduction of the maximum investment advisory fees. Performance calculated in U.S. dollars.
The Composite includes all fully discretionary, fee-paying global equity accounts over $10 million that invest in a portfolio of approximately 30-40 companies primarily in developed markets, with a focus on companies with market capitalizations over $3 billion. Under normal conditions, at least 40% of investments will be in companies headquartered outside the United States. The strategy is benchmarked to the MSCI World Index (net of foreign withholding tax).
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IM-06328-2019-04-18 Exp. Date 07/31/2019
1 BBH’s estimate of the present value of the cash that a business can generate and distribute to shareholders over its remaining life.