Most of our positions performed admirably over the quarter – continuing their strong run over the preceding six months or so. More than half of the Fund’s positions posted double digit price gains and less than a handful went backwards.
The most significant news is our initiation of a position in Alibaba. Founded by the charismatic Jack Ma in 1999, Alibaba started life as a pure e-commerce business to business platform but it has since morphed into a sprawling services infrastructure for China, with its current activities also spanning financial services, cloud computing, media and entertainment among other things. We believe Alibaba provides us with a terrific opportunity to participate in the expanding Chinese economy and its growing middle class of consumers via its variety of businesses across emerging industries.
Alibaba’s sheer dominance and market reach provides it with an unparalleled data set from which it has options via artificial intelligence (AI) to further monetise. Its payments platform, Alipay, is the world’s largest with around a billion active users (and accounting for more than half of China’s non-bank electronic payments). Its retail marketplaces (including Taobao, TMall and Juhuasuan) have more than 770 million annual active users. Its cloud business is the largest in China, and it grew revenue by 50% last year. All up, Alibaba has grown its top-line by an incredible 48.4% per year, over the last 8 years! Yes, there are risks – regulatory mainly – of which we are aware. And like all investments, there are many risks in which we have no way of knowing, and we suspect these to be more prevalent with this particular opportunity. But we are prepared to accept these risks as trade-offs for the exciting return prospects.
Many of the Fund’s other investments also have their share of opportunities in the AI / data science sectors – to varying extents and in different ways. For instance, Micron, as we discussed here, and Samsung will both see continual increases in semiconductor demand. Dick’s Sporting is showing its data science work is fuelling sales. Lear benefits from designing products to meet the increased electrical requirements in automobiles. And we expect that Alphabet (the parent company of Google and Youtube), as holders of one of the largest data sets in the western world, has further avenues to capitalise on it. We increased our Alphabet position (from 1.8% to 2.8%) during the quarter. And although we had to pay more than what we paid for our first tranche (in August last year), with further signs as to its business strength we were happy to do so.
Western Forest (up 42.3%4 ), the Canadian lumber manufacturer, was one of the Fund’s strongest performers. We maintained our position whilst it suffered over the last couple of years as it battled labour strikes (which forced shutdowns / curtailments of its mills), tariff issues and then COVID-19. But now, its recent results are encouraging, as it took advantage of improved prices with initiatives such as product differentiation and redirection from weaker export markets to the improving North American market (both enabling higher margins). It also sold some non core assets to strengthen its balance sheet. It is not alone in being a beneficiary of rebounding commodity prices. LyondellBasell (up 14.6%), released its results and also provided an update consistent with our expectations that the business is ripe to capitalise on expected rising prices, largely as a result of its developments, acquisitions and joint venture deals over the last three years.
Other strong performers included three companies positioned to benefit from the “discretionary” and “back to nature” spending themes. They all continued their strong post pandemic price performance, with: Thor, the maker of recreational vehicles (up 45.3% in the quarter, to make it 227.9% for the year); Dicks Sporting, the retailer of outdoor equipment (up 36.1% in the quarter, 258.2% for the year); and Capri the luxury goods retailer (up 21.4% in the quarter, 372.7% for the year).
This prompts the question: Are these themes cyclical or structural? We believe the “back to nature” theme, which is directly applicable to Dick’s Sporting and Thor, to be largely structural (although the increased stimulus has likely led to an additional cyclical component). The “discretionary spend” theme, on the other hand, we consider to be more cyclical.
Thor, Dick’s Sporting and Capri all released solid operating results during the quarter – generally above expectations. We particularly note the strength of the Dick’s Sporting franchise. Its earnings per share were 84% higher than last year’s fourth quarter and 66% higher for the full year (and the base periods did not suffer any COVID-19 impact). Its e-commerce sales have doubled over the last year, to now account for one third of its business. It has particular strength in the buy online, pick-up in store / curbside, with its point of difference being its physical presence via 800 odd stores – clearly a valuable asset as it enables same day service. Around 70% of Dick’s online sales either ship directly from store or are in-store or curbside pickups. Dick’s also pointed to two other positives – its own brands were outperforming, and management believes its technology platform is effective in driving increased sales. We sold an immaterial amount (less than 0.2%) of Dick’s just to meet diversification requirements, so it still represented 5.3% of the Fund at quarter’s end.
We are a little more cautious on Capri which released its quarterly results in early February. All three fashion houses (Versace, Jimmy Choo and Michael Kors) showed tangible signs of positive momentum, such as an acceleration of e-commerce sales, improving gross margins and higher ticket prices. This is despite around 50% of its Europe, Middle East and Africa (EMEA) stores being closed – so the performance in the US and Asia was particularly strong. However, despite these positive signs, management does have concerns, citing “lack of visibility surrounding the progression of the pandemic, macro fundamentals and tourism flows”. We indeed share management’s concerns. As the discount to our valuation is nowhere near as compelling as it was a few months ago, we felt it prudent to trim our position, from 4.7% at the start of the quarter to 3.3% at the end.
We were pleased that two longer term laggards, Walgreens Boots and H&R Block, performed well (with their share prices up 37.7% and 37.5% respectively). Maintaining our conviction since their lows (as we discussed in our June 2020 report) has added meaningfully to the Fund’s performance since that time, most notably during the recent quarter. Both released pretty pleasing results, and Walgreens also announced the $6.5b sale of its interest in Alliance Healthcare, the pharmaceutical wholesaler, to fuel further investment in its core retail pharmacy and healthcare businesses.
Once again, the main detractors to performance over the quarter rests almost exclusively with the gold producers. These three companies together cost the Fund 2.5%. Despite reporting good results, the share prices suffered (Kirkland Lake -19.3%, Regis Resources -22.5%, Northern Star -25.3%). We hear there has been a wave of outflows from sector specific funds. Any such selling pressure would provide one possible explanation as to why these shares appear to be trading so out of line with their fundamentals. For on our numbers, employing conservative gold price and extraction cost assumptions, all three are well priced based on their identified reserves, and Regis and Kirkland Lake also look compelling value based on their expected cash flows over the next year or two alone. We topped up our positions in all three over the quarter.
The only other detractor was Vestas. Its full year results reported in early February revealed an increasing order backlog, a strongly growing services business (at impressive margins and across multiple brands), and a clear and succinct rationale behind its recent MHI joint venture deal with Mitsubishi.
Nevertheless, the Vesta share price declined 9.6%. We like the industry. Installed wind capacity has increased over the last twenty years from 12 GW to over 700 GW, while its costs have decreased by 63% over the last ten. And there’s no letting up, a new era of growth is supported by massive political commitment. With Vestas being one of the only few dominant players with 40% market share (and the one solely focused on wind generation), we are comfortable with our current 3.3% position.