The Island Investing Blog

  • IIM International Portfolios: Investor Letter for Q4 ’18

    Skyfall

    Chicken Little had a point in 2018 – for equity investors, whether in the U.S. or abroad, the sky fell!

    Political turmoil, rising interest rates and a slowing global economy were credited for pushing the S&P 500 Index and the Dow Jones Industrial Index down  6.2% and 5.6%, respectively.  Digesting U.S. turmoil along with other woes such as Brexit, international markets fared even worse – the Morgan Stanley All Country World Ex-U.S. Index fell 14.2%.

    Our International ADR Portfolio Frigate, focused on capital appreciation, returned a negative 9.05% in 2018, better than the gross return of the S&P ADR index of a negative 15.82%. Since inception on 7/1/2013, Frigate has returned a cumulative positive 13.23% versus 11.42% for its benchmark. Key detractors included Bayer, which, as discussed in previous letters, is having trouble digesting the its Monsanto acquisition along with the glyphosate litigation, which I am hopeful will be less onerous than previously expected. Perhaps due to uncertainly in its major American and Asian markets, Japan-based, Komatsu the second largest construction equipment manufacturer by revenue, also had a bad year, despite rising consensus estimates. French bank BNP worked against performance as expected provisioning increased in some marginal markets and unexpectedly in a specific area of its home market. I am expecting this pressure to abate and earnings return to a growth trajectory.

    On the bright side,  Frigate captured a very nice profit in British telecommunications company SKY PLC, which we sold into the bidding war successfully won by Comcast.  Investors also approved of the turn-around progress made by Swedish telecommunications and equipment provider Ericsson, who also should benefit from the roll out of 5G. Indian software developer Infosys enjoyed good revenue growth and an improving share price.  Taking advantage of volatility, we sold luxury good maker LVMH when it became expensive in June and bought it back in Treasure Harbor after the price fell and the yield became attractive.

    Treasure Harbor, our ADR portfolio focused on dividend yield, fell 8.99% in 2018 versus its blended benchmark’s return of a negative 10.21%. Since inception on 10/1/2013, Treasure Harbor has returned a cumulative negative 4.98% versus the return of its benchmark (15% SPDR S&P Emerging Market ETF, 85% SPDR S&P International Dividend ETF) of a negative 3.78%.  Brazilian brewer AMBEV and Spanish Bank Santander were negatively impacted by their exposure to Brazil, which struggled to come out of its two-year recession.  As of the third quarter, there was a moderate return to economic growth, which has underpinned improvement in their share prices. UK communication provide Vodafone  is transitioning from a wireless  provider to a converged player while simultaneously restructuring and trying to buy  assets from Liberty Global – a transaction that has been delayed by the European Commission.

    Combining the uncertainty of shape of Vodafone’s future with that of the UK,  it’s not surprising that Vodafone’s share price was a big detractor to performance last year. Slightly offsetting our beer exposure,  Coca-Cola European Partners PLC continues to execute its expansion well and its share price appreciated accordingly.  Other good performers included: telecom company Spark New Zealand, which also will benefit from a roll-out of 5G and its economies of scale in a relatively small market , and Spanish-based utility Iberdrola, which has a global footprint and good investments in renewables.

    Not surprising, Yellowtail, our international small/mid cap strategy was the most vulnerable to negative investor sentiment, falling 20.46% in 2018 versus a negative 18.61% percent for the benchmark (Vanguard FTSE All-World ex-US Small-Cap ETF).  Since inception on 12/1/2014, Yellowtail has returned a cumulative + 14.31% versus +8.59% for its benchmark. German-based Wacker Chemie was recovering from a September, 2017 explosion in its Charleston, Tennessee plant, but due to changes in Chinese solar policies suffered  from lower pricing and profits in its polysilicon division and the stock price continued to suffer.  The position in Wacker is currently under review as the company lowered 2018 earnings expectations this January due to questions over insurance coverage.

    Sulzer, a provider of pumping solutions, rotating equipment maintenance and mixing technology to oil and gas, power and water markets,   lifted the cloud of sanctions by reducing the majority ownership of  Renova, chaired by Russian “specially designated national” Victor Vekselberg, below 50%. Still Sulzer’s share price languished as the year and volatility in the energy markets progressed.  With the terms of Brexit unresolved, the share price British- based staffer and recruiter Hays PLC suffered. Although the company reported a strong second-quarter ending in December, currency and Brexit uncertainty could be working against Hays in the future; I believe these scenarios have been discounted in the share price. Yellowtail also owns Spark, which was a bright spot in performance. Reporting good nine month growth in assets, fee income and premiums, Swiss Life’s share price also did well in 2018. London-based Bunzl, a global leader in supplying nonfood consumables, benefitted from outsourcing trends and smart acquisitions, and its share price was a positive contributor to 2018 performance.

    Maybe the sky didn’t actually fall in 2018, but it sure got dark. Perhaps due to the abatement of tax-loss selling, there has been a rebound in some areas of the market, but there is still plenty of volatility and the sky is still dark. I expect the current shut down of the US government and the overhang of new tariff regimes will have a real economic impact on individuals, the economy and company earnings in both the US and abroad. In the meantime, the Brexit situation is reaching a dangerous impasse. The EU, Theresa May and the UK parliament cannot agree on the terms of Britain’s exit from the European Union and the deadline at the end of  March is fast approaching.   There are several possible outcomes: the UK could hold another referendum and stay in the EU or not,  the UK and EU could hammer out a gentle exit,  the EU could grant an  extension while details are worked out or the UK could “hard exit” which, among other things, could create a hard border between Northern Ireland and the Republic of Ireland.  I will keep you updated on our client message board. Please let us know if you need access to login.

    We don’t know when any or all of these issue will be resolved and the sky will start to clear, but after their performance last year, I believe the markets have discounted the uncertainty and risks, somewhat.  In the meantime, “markets” are made of individual stocks managed by people and boards that incorporate risks into their plans. I will continue to test our holdings for their adaptability and prospects while looking for new quality companies whose share prices have been unfairly penalized by these clouds.

    Thank you for investing with IIM along side with Cale and myself, and please reach out with questions and comments.

    -Lauretta “Retz” Ann Reeves, CFA AWMA

    Posted by: Retz Reeves , For Investors
  • IIM International Portfolios: Investor Letter for Q3 ’18

    As discussed in my recent blog post, international investing this year has been like walking through a mine field, as stock prices discounted the implications of tariffs, Brexit and volatile emerging markets. Adding insult to injury, the strengthening U.S. dollar further eroded domestic returns for foreign stocks. Unless otherwise noted, the performance in this letter is either for the first nine months of 2018 or since inception to September 30, 2018. Returns for the portfolios are net of fees.

    During the former period, Frigate eked a small net gain of 1.29% while its benchmark, the S&P 500 ADR Index, returned a negative 4.02%. Since inception on July 1, 2013, Frigate was up 26.12% versus the benchmark gain of 27.04%. Working against performance this year was Swiss employment agency Adecco, where revenue growth has slowed but margins have been resilient. I added to this position following my visit with them in September as I believe 1) they will benefit from increased digitalization and integration of acquisitions and 2) the valuation was very compelling. German health/agriculture company Bayer’s share price reflected the company’s difficulty digesting its Monsanto acquisition which gives its increased scale but also increased exposure to litigation around glyphosate herbicides. As of now, due to its strong human healthcare portfolio, Bayer remains a core holding – especially in-light of new trials which may mitigate or reverse glyphosate punitive damage charges. French Bank BNP Paribas has been enjoying good business development in-line with economic growth in Europe, but its share price has suffered from the less favorable financial markets for Corporate Investment Banking and Foreign Exchange. BNP’s share price versus future earnings and current book value is very attractive in my opinion, and I believe in a more normal environment shareholders will benefit from improved earnings, more beneficial exchange rates and an expansion in valuations.

    The Frigate Folio benefitted from its holding in UK communications company, Sky, which continued to be the subject of a bidding war. China Petroleum and Chemical’s share price, also known as Sinopec and as half a government-protected oil and gas duopoly, enjoyed higher oil prices. Swedish- based telecommunication equipment provider Ericsson showed a very nice performance probably from the anticipation of ramp-up in 5G network spending and the improvement in profitability from the company’s turnaround efforts.

    Not surprising, Treasure Harbor’s focus on higher dividend paying stocks did not fare as well during this period of rising interest rates. It was down 4.93% versus a negative return of the blended benchmark (15% SPDR® S&P Emerging Markets Dividend ETF/ 85% SPDR® S&P International Dividend ETF) of a negative 4.7%. Since inception, October 1st 2013, Treasure Harbor has returned a negative .74% versus a positive return of 2.12% for the benchmark. Despite a strong second quarter, the share price of Ambev, the Latin American arm of Anheuser-Busch InBev, suffered along with the Brazilian Market. Banco Santander, with extensive exposure to Latin America, also underperformed. UK Telecom company Vodafone slumped as investors worried that as its reach is expanding, so is its debt, and its 8% yield is therefore threatened. Even if the dividend is cut, the yield will still be compelling and the excess cash could be used to deleverage and assist the company’s growth. Although I am monitoring these positions, I believe that they are extremely undervalued, as does Morningstar – which has them rated at 4 stars – and for now they remain holdings. Coca Cola Enterprises, a distributor of non-alcoholic beverages in Europe, reported better than expected earnings, enjoyed broker upgrades and performed very well this year. French-based, integrated oil producer Total benefitted in part from the higher oil prices but also from a confident analyst’s day that showed their continued ability to improve costs and improve cash flows. UK pharmaceutical company, Glaxo, also did well as investors showed appreciation for its current product-line and early stage pipeline.

    After displaying great performance for years prior, Yellowtail retrenched a bit returning a negative 6.9% for the first nine months of this year versus a negative 5.18% for its benchmark VSS (Vanguard FTSE All-World ex-US Small-Cap ETF). Since inception on December 1st 2014, Yellowtail has generated a positive return of 33.78% versus 26.5% for its benchmark. Profits at Spanish Supermarket chain Dia continued to deteriorate, along with its share price, and it was liquidated after the quarter’s end. Wacker Chemie, A German manufacturer of chemicals and plastic products, also performed poorly. Japanese Minebea Mitsumi also detracted from performance as management fine-tuned estimates at its 1st quarter earnings review due to the continued shrinkage of the cell phone market and uncertainty in the macro environment. With a 60% market share in the growing miniature ball-bearing market and a penchant for innovation, I still find this stock attractive. On the positive side, Japanese generic pharmaceutical manufacturer Sawai reported good 1st quarter core profits and confirmed expectations for full year results after acquiring Minnesota based Upsher-Smith Laboratories last year. Swiss-based Lonza, which supplies pharmaceutical, biopharmaceutical and services also had a great nine months as it continued to reinforce it mid-term targets. The price of Jordan-based, London-listed generic and pharmaceutical manufacturer Hikma staged a huge rebound as the company reported good interim results and upgraded its 2018 outlook.

    Following the third quarter, investors struggles with the aforementioned challenges and volatility returned with a vengeance – mainly to the downside – and all of our international products are in negative territory. I am expecting this volatility to continue, but I also believe that this is an opportunity, which I have used to add to positions or initiate new ones that appear to be of good quality and under-valued. In confusion, there is opportunity.

    Please don’t hesitate to reach out if you have more questions on any of our portfolios or our financial planning services.

    – Lauretta “Retz” Ann Reeves, CFA AWMA

    Disclaimer: This post nor any of the material linked to herein in any way constitutes investment advice. Historical performance data above represents performance results as reported by the portfolio identified. Performance results are for illustration purposes only. Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and timing of initial investment. Investing may cause capital loss. The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.

    Posted by: Retz Reeves , Commentary, For Investors
  • Brexit or Not to Brexit

    Deal or No Deal

    On September 10th, I headed to Europe with my two-country Eurail Pass and a notebook full of questions for some of IIM’s Swiss and German current and prospective investments. I was especially interested in their perspectives on raw material prices, tariffs and Brexit – unpredictable, but interrelated, issues.

    Tariffs can be an effective method for discouraging predatory dumping and protecting domestic industries, but in the process, they can increase input costs for manufacturers and retail prices for consumers as well as lead to retaliating tariffs. Most of the companies with whom I met are able to match prices with changes in input costs, albeit with a lag, and smooth gross margins over time. Due to elasticity of demand, however, some feared that higher prices would lead to lower volume growth and dampen economic activity. While discussions on metals, dairy and autos are threatening Canada’s participation in NAFTA, Chinese tariffs placed on agricultural commodities are already having a negative impact on US farmers, and new ones have gone into effect on about $60 billion worth of US goods, including more food products, chemical products and aircraft.

    Tariffs on US products could benefit European exporters, but a no-deal Brexit could create billions of dollars of tariffs on items such as food, beverages, cars and clothes on both UK and EU exports. Investors and companies all hope that UK PM Theresa May can put together an acceptable Brexit plan; but wanting to minimize the risk of other country exits, the EU has taken a hard line and rejected the most recent proposal. Exacerbating the process is the prospect of a hard border between Ireland (member of the EU) and Northern Ireland (Part of the UK) and the economic relationship with the EU SHOULD the UK actually Brexit.

    In the personal opinion of some company IRs and UK fellow travelers, the current UK government would like to stall and kick the Brexit can down the road to future parliaments, but there are fears that this wouldn’t be acceptable to the EU.

    We discussed many other macro challenges such as refugees, elections, climate change, emerging markets and currency in our meetings, but we also reviewed lots of positive company specific influences, such as: digitalization, productivity, innovation and opportunity.

    In that context, despite all the macro uncertainties faced by many companies, I still am optimistic regarding the opportunities in careful international investing.

    In my next client letter, I will explore in detail the performance, holdings and outlook for our international Folios, but please feel free to reach out with any questions you may have.

    In the meantime, our hearts and prayers are with our friends and clients who are still recovering from Irma and those who are putting their lives together after Florence.

    – Retz Reeves, CFA

    Posted by: Retz Reeves , For Investors