Effective immediately, Regina Lombardi will become the sole Portfolio Manager for BBH Global Core Select Composite (“Global Core Select” or “the Strategy”). Regina has served as Co-Portfolio Manager of Global Core Select with Tim Hartch since inception of the strategy five years ago. Mr. Hartch will now shift his primary focus to a separate equity partnership managed by Brown Brothers Harriman & Co. that invests in small and mid-cap companies. The Global Core Select team is enormously grateful to Tim for his insights, diligence and prudent execution over the last five years.
The investment philosophy and approach we use for Global Core Select will remain the same. We employ a bottom-up, fundamentals-based process that seeks to invest in competitively advantaged, well-managed, cash generative businesses that provide essential products and services. Our portfolio construction decisions are driven by a ‘margin of safety’1 approach that considers the quality of the businesses as well as their valuations. We invest with a long-term ownership perspective and an expectation that our returns over time will be driven by the underlying performance of the businesses, their effectiveness at deploying capital, and their operational and financial resilience during periods of economic stress. Our key objective is to provide investors with long-term growth of capital. Our key objective is to achieve attractive absolute returns over full market cycles. As always, our team is committed to process quality, continuous improvement, team-wide collaboration and a disciplined, inclusive approach to decision making.
Global equity markets traded within a modestly narrow range during the second quarter with geopolitical dynamics and escalating threats of a trade war dominating the investment climate. While the overall market as defined by the MSCI World index has remained in a narrow trading range following the retrenchment from the market peak in January, there continues to be significant volatility on an underlying basis, and a narrow group of U.S. stocks accounts for virtually all the gains in the Index for both the second quarter and year-to-date periods. For the second quarter, BBH Global Core Select Composite (“Global Core Select” or “the Strategy”) gained 0.66% while the MSCI World Index appreciated by 1.73%. The appreciation in the U.S. Dollar during the quarter presented a headwind to Global Core Select’s returns, both on an absolute and relative basis given that our weight in non-U.S. investments is greater than the index weight. However, many of our European and U.K. investments have significant and highly profitable businesses in the U.S. market which provides a fundamental offset to currency movements. Overall, we have been pleased with the fundamental operating performance of most of our companies. We continue to look for opportunities to deploy cash when market volatility and sharp swings in sentiment offer us the ability to initiate or increase our investments in businesses that meet our demanding criteria at significant discounts to our appraisals of their intrinsic values2.
The largest positive contributor in the second quarter was Discovery Communications, whose shares rose sharply in June as consolidation activity in the media industry gained pace after AT&T obtained regulatory approval for its purchase of Time Warner, and Comcast bid against Disney in pursuit of 21st Century Fox. We have no reason to speculate that Discovery itself could attract interest from a buyer, but with its strong positioning in non-fiction and lifestyle content and its broad international presence, a logical view might be that the scarcity value awarded to the business has increased in the context of a consolidating industry environment.
Notwithstanding the recent rebound in the share price, Discovery shares continue to trade at what we view as a modest valuation, mainly due to investors’ fear of long-term revenue growth headwinds driven by pressure on traditional content distribution and platform fragmentation. While these trends are real, we believe Discovery’s strong brands, content quality and attractive audience characteristics (from the perspective of advertisers) position the Company well for continued growth in the U.S., both from the traditional ecosystem as well as by expanding into digital and direct-to-consumer platforms. In addition, we believe Discovery’s strong and diverse positioning in international markets should enable it to grow via higher multichannel household penetration and an ability to take pricing. The Company’s earnings power and cash flow conversion remain solid, with the added near-term benefit of earnings synergies following the recent acquisition of Scripps Networks. Discovery’s management team has made good capital allocation decisions over time in our view, and as the Company completes its targeted de-leveraging following the Scripps deal, we expect share repurchases to be an area of focus – especially if the public market valuation remains modest.
Alphabet, Diageo, and Davide Campari-Milano were among our strongest contributors to performance in the quarter. Shares of Alphabet (the parent company of Google) rose by 8% in the quarter, likely benefiting from an easing of investor concerns related to: i) the tumult earlier in 2018 over data usage at Facebook, and ii) the implementation of the European Union’s General Data Protection Regulation (GDPR). On the latter point, the GDPR launch at the end of May appears to have gone smoothly, and it may prove to confer certain benefits to Google given the Company’s higher level of preparedness and its overall greater importance to the industry value chain relative to smaller peers. In our view, Google’s scale and breadth create a particularly strong moat for the Company given that it has multiple leading Internet platforms that reinforce each other, and vast resources to invest in research and development, security and regulatory compliance. Google’s engineers focus not only on innovation and user experience improvements, but also on the continual expansion of computing throughput, data center capacity and network efficiency, thereby creating the flexibility to launch and administer new products on a global basis while still maintaining the service and security levels users and clients require. This ‘virtuous circle’ scaling process serves to reinforce Google’s data advantage, which in turn allows it to create more personalized outcomes and targeted products for both users and advertisers, strengthening its position as an effective and high-return media platform.
Diageo and Campari were strong performers in the quarter with double-digit gains in local currency terms and solid contributions in U.S. dollars. U.K.-based Diageo, the global leader in the attractive international spirits industry is well positioned to benefit from sustained healthy growth trends in the highly profitable U.S. market and improving trends in its key emerging markets. Over the past two years, Diageo’s management team has undertaken concrete actions geared towards delivering more consistent operating performance and generating ongoing cost savings that are being largely re-invested to drive top-line growth. Improving sales growth—particularly of premium and super-premium brands—combined with sustained focus on productivity is supportive of ongoing operating leverage and margin improvement. While share price appreciation has narrowed the discount to our estimate of intrinsic value, in our view Management is successfully transitioning the business to deliver and compound consistent and sustainable growth and returns. Campari, based in Italy, is a smaller and more focused spirits producer that has demonstrated its ability to acquire under-managed, “dusty” brands with strong heritage and to subsequently create significant value from those brands through methodical and disciplined investment. Most recently, Campari acquired Grand Marnier, and while it is early in the re-launch of that brand’s lineup, early indications are encouraging. Campari’s overall strategy is to segment its portfolio and drive growth of its relatively higher margin Global Priority brands, including Campari, Aperol, and Wild Turkey, which in turn drives strong organic sales growth and ongoing operating leverage. Campari’s brands are relatively underdeveloped in most of its key markets allowing for a multi-year opportunity for growth. The Company’s balance sheet is strong, and Management has ample capacity to execute additional acquisitions on an opportunistic basis.
Additionally, we note that shares of Wells Fargo traded higher at the end of the quarter after the U.S. Federal Reserve released the results of its two-part stress test. The first part (known as the Dodd-Frank Act Stress Test, or DFAST) puts the 35 largest U.S. banks through ‘Adverse’ and ‘Severely Adverse’ economic scenarios to test whether each has sufficient capital to absorb projected losses and continue extending credit. Wells Fargo was found to have sufficient capital under the parameters of the test, and it was one of only two banks that were modeled to remain profitable under the Severely Adverse scenario. The second part of the test (the Comprehensive Capital Analysis and Review, or CCAR) builds on the results of the DFAST scenarios but evaluates each bank quantitatively after giving effect to capital return plans (proposed dividend increases and buybacks) and qualitatively. Wells Fargo passed both the qualitative and the quantitative tests and, as a result, its capital return plans were approved. Wells Fargo will increase its quarterly dividend from $0.39 to $0.43 per share (equating to a 3.2% yield) and, over the next four quarters, will repurchase $24.5 billion of stock, or about 9.5% of the Company.
Our biggest negative contributor for the quarter was Perrigo. Perrigo’s shares fell largely in response to near-term challenges in the Company’s generic prescription segment, specifically the supply disruption of one new product and delayed approval of another which Management had expected to launch in the fourth quarter of 2018. Despite these issues, we are encouraged by Perrigo’s solid performance and execution across the Consumer Health businesses, including the core U.S. store-brand over-the-counter business, as well as steady operating improvements in its international consumer health business. Perrigo’s recently appointed CEO, Uwe Roehrhoff, is leading a comprehensive and methodical strategic review of the Company which is focused on improving its growth profile and economic value creation. The process is expected to be completed over the coming quarter and shared with investors in the Fall. Rather than radical changes to the Company’s strategy, we anticipate a set of enhancements that leverage Perrigo’s core strengths across its business lines and the substantial cash generation of the business.
Wendel, the publicly traded French holding company and investment firm, continued to face headwinds in the second quarter. IHS, the African telecommunications tower business in which Wendel is a major investor, remains pressured by currency movements and an ongoing regulatory inquiry in Nigeria. Additionally, wage inflation has become a more significant margin headwind for Allied Universal, Wendel's U.S.-based security services company, given the labor-intensive nature of the business. Additionally, the threat of escalating trade tensions and the prospect of tariff imposition on certain end markets such as autos and consumer goods could pose a challenge to sales growth at some of Wendel’s operating businesses. However, Wendel’s largest listed asset, the French testing, certification and inspection services company Bureau Veritas, is performing well and has seen improving organic growth across most of its businesses as end-market conditions are generally improving. Despite near-term challenges that we believe can be resolved, we continue to view Wendel as an attractive investment given i) the composition and quality of its listed and non-listed assets, ii) the Company's adherence to investment criteria that are well-aligned with our own, and iii) the significant discount to NAV at which the shares currently trade.
Qurate Retail and Liberty Global were negative contributors in the second quarter with share price declines of (16%) and (12%) respectively. Qurate, the parent company of QVC, HSN, Zulily and Cornerstone, has experienced share price weakness this year due primarily to: i) concerns that its U.S. business remains challenged following merchandising issues that first appeared in 2016, ii) margin headwinds related to product and category mix, iii) weakness in the recently acquired HSN business, iv) fear of competition from Amazon and other online retailers, and v) continued declines in cable-TV subscriber numbers in the U.S., which over time could reduce viewership and ultimately sales through Qurate’s traditional medium. We have carefully weighed these issues, and while each is significant and demands attention by the Company’s skilled and experienced management team, we remain optimistic that the differentiation and customer engagement inherent in Qurate’s business model will enable it to surmount temporary business challenges achieve both revenue growth and margin improvement. Importantly, we believe the Company remains advantaged over traditional retailers with its capital-light, analytics driven model and will be a beneficiary of the shift to ‘omni-channel’ commerce given its core competencies in the areas of entertainment and product discovery, both in the TV-based model and increasingly through digital distribution and partnerships. In our view, Qurate’s current market valuation implies very weak prospects for the business going forward. In contrast, we believe the tradeoff between risk and reward embedded in the shares is attractive.
Shares of Liberty Global fell as lower-than-expected subscriber growth numbers reported in May offset what was otherwise solid performance for revenue and operating cash flow. The drivers of the subscriber headwinds are not new (pockets of regional competition, lower promotional activity), and we believe the Company is responding properly. Also weighing on investor sentiment was uncertainty related to the eventual use of proceeds from Liberty Global’s recently-announced sale of certain operations in Germany and Eastern Europe to Vodafone in a deal valued at €19.0 billion. Despite the strategic merits of the divestiture and the attractive valuation (11.5x operating cash flow) being received by Liberty Global, Management’s lack of guidance regarding how the cash proceeds would be deployed prompted speculation that a large acquisition in the wireless industry might be pursued in the core U.K. or Swiss markets. Without speculating on the ultimate use of the cash, we feel confident that the Company’s strong capital allocation focus and track record will properly inform the decision; moreover, we take note of Management’s recent comments that share repurchases would be the top priority for the proceeds if the stock price continued to trade near current levels.
We added one new investment to the fund during the second quarter, Anheuser-Busch InBev (ABI). Following its acquisition of SABMiller in 2016, ABI is now the world’s largest brewer by a wide margin, owns seven of the top ten beer brands, and holds leading market share positions in many of the most attractive beer profit pools. ABI is a strong fit with our investment criteria given its leadership position in structurally attractive markets, strong brands supported by marketing and distribution scale advantages, attractive returns on invested capital, and strong free cash flow. While certain of ABI's markets are mature, such as the U.S., those markets are highly cash generative and produce resources that can be deployed in faster growing developing markets that have attractive long-term value creation potential. In recent years, the Company's revenue and cash flow growth has been constrained by severe economic weakness in Brazil, the continued rise of craft beers in the U.S., and adverse currency movements. However, in our view the SAB acquisition reshaped the portfolio, giving ABI a more diversified and attractive geographic profile. We believe Management’s shift in strategy towards broad category development when combined with the new footprint and portfolio of premium global brands is supportive of improved revenue, profit, and cash flow growth.
Additional transactions during the quarter included continued purchases of global convenience store operator Alimentation Couche-Tard, a new investment that we initiated in the Fund last quarter. We increased our positions in Nielsen Holdings, Qurate, and Lloyds Banking Group at prices that we believe represent significant discounts to our estimates of intrinsic value; Lloyds is now the sixth-largest investment in the Fund. We trimmed our position in PayPal based solely on valuation and completed our exit of Microsoft as the share price reached our estimate of intrinsic value. We ended the quarter with 31 portfolio companies and 45% of the portfolio in the top 10 positions, a cash position of 6.1%, and our weighted-average price to intrinsic value was 80% at quarter-end.
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.
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.
For purpose of complying with the GIPS® standards, the firm is defined as Brown Brothers Harriman Investment Management ("IM"). IM is a division of Brown Brothers Harriman & Co. ("BBH"). IM claims compliance with the Global Investment Performance Standards (GIPS®). To receive a list of composite descriptions of IM and/or a presentation that complies with the GIPS standards, contact Craig Schwalb at (212) 493-7217, or via email at firstname.lastname@example.org.
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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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.