It’s not rocket science… The US 10-year bond yield rose from 3.8% to 4.6% during the quarter. It was last around this level in the period leading up to the global financial crisis (in 2007). And for the 25 years prior it averaged about 7.5%. Heck, many of us still harbour memories of the double digit rates of the mid 1980’s (yes, we are showing our age). The point is, if history is any guide, we are far from being in uncharted territory. Whilst we make no predictions, there’s still plenty of room for them to keep rising.
“War, huh, yeah, What is it good for? Absolutely nothing, uhh – Norman Whitfield, Barrett Strong, 1970.”
The Fund was not immune, with its net returns turning negative (but to a lesser extent than the broader market) for the March quarter. They were -1.3% for the EUR class and -3.5% for the USD class2. The Australian Fund posted a return of -6.5%.
Central banks are finally acting on inflation. The sell-off during the quarter may be a sign that the market is beginning to listen. But we do wonder how many of today’s investor’s (particularly the Crypto and Web3 proponents) have lived through an environment of rising rates – after all, US 10-year bond yields have, until recently, generally been on a one way 40 year descent.
McKesson3 (the health logistics company), up 23.4%, is now the largest contributor to returns over the last three, six and twelve months. We provide some details of this robust business in a following section of this report.
Conversely, Capri (which houses the Michael Kors, Jimmy Choo and Versace luxury brands) largely reversed its strong December quarter’s performance with its share price falling 20.8%. Notwithstanding some recent management team hiccups, we believe the current strategy will create further shareholder value in the longer term.
With the outbreak of war and the potentially catastrophic ramifications, the gold price rallied, as did the share prices of our gold producers – up an average 12.7% and contributing 1.6% to the Fund’s returns.
Alibaba’s flattish return masks significant volatility – likely stemming from the unsettling nature of China’s implicit backing of Russia’s actions (by not supporting sanctions), renewed delisting concerns and surging Covid-19 cases.
Other strong performers, such as LyondellBasell (the plastics business, which was up 12.8%) and H&R Block (the accountants, up 11.8%), were not enough to offset Capri and the other detractors.
The most notable poor performers were the auto parts producers, which continue to face operational difficulties. These three businesses (which comprised 10.5% of the Fund at the start of the quarter), experienced negative returns ranging from -25.8% to -12.0%, and cost the Fund 1.9%. We bought a little more Linamar amongst the sell-off.
Thor, the recreational vehicle producer, is also experiencing operational challenges, but as consumers keep looking to nature orientated offerings it shows solid momentum in its sales. With a share price fall of 24.1% we were buyers.
Despite the solid results reported by both our semiconductor businesses (Micron and Samsung) their share prices fell by 16.4% and 11.1% respectively. With our long term focus on their solid fundamentals, we are not perturbed.
And Dick’s Sporting, which has been a standout since we first bought the business at the Fund’s inception (January 2019), posted a poor return of -12.6%. We’ll accept that in light of the strong longer term performance.
The short term impact of the dramatic rise in oil prices was mitigated by the conservative hedging policies of Southwest and Ryanair – although the latter will suffer from poorer patronage due to the ongoing regional conflict.
We only executed five trades over the quarter, and none were material. We ended the quarter with the same 25 positions that we started with (albeit Kirkland Lake was enlarged and renamed) and 15.0% cash.
With a 34.1% return, the strongest performer was Capri Holdings. Its second quarter earnings were greater than analysts’ (and our) expectations, mainly by delivering better than expected margins and successfully mitigating the inflationary and supply chain pressures. Management raised its earnings guidance and the Board authorised a new share repurchase program.
Micron Technology, the memory maker, was up 31.4% after management reported strong results and expressed their confidence in the near term. We noted in our September report that we viewed its sell-off (from April) as a buying opportunity (and we bought), so we are pleased the Fund participated significantly from this subsequent rebound. Our analysis continues to indicate that Micron remains attractively priced. It has now grown to be the Fund’s largest position at 6.7%.
McKesson, the health logistics company, was up 24.9%. It once again reported quarterly results above expectations, and management again raised earnings guidance as well as announced a few divestments and a USD 4b increase to its buyback. McKesson offers a 7.6% sustainable earnings yield (higher if one were to adopt management’s latest guidance) and double digit free cash flow yield – and in our view it remains good value. It now accounts for 5.9% of the Fund, having been a core portfolio position basically since the Fund’s inception.
Rounding out the top performers are the auto component suppliers, which we have noted had been laggards due to the semiconductor supply issues affecting motor vehicle production levels. However they rebounded during the December quarter. Lear Corporation returned 17.4%, Methode Electronics 17.3% and Linamar 14.2%. Given the industry’s challenges, there were no real surprises from their quarterly results with the exception of Linamar’s strongly positive cash flow which led to an increase in the dividend and share buyback. Together these three companies represent 10.5% of the Fund.
To the other side of the ledger – Vestas, the wind turbine business, continues to suffer (down 22.3%). There’s no letting up from the demand side, but cost blow outs have hit margins. We are disappointed, but then again it must be difficult when the prices of your raw materials (like steel and resin) have unforeseeably more than doubled! As the number one player in an industry where scale matters, our view is that these margins will normalise at an acceptable level, and together with a profitable and growing service business, Vestas is well positioned to serve the renewable energy sector over the long term.
The Omicron fears hit the airline sector – and both Southwest and Ryanair (albeit it to a lesser extent) suffered, being down 16.7% and 6.6%. They are the strongest airlines in their markets, and as we look past the pandemic and toward a normalised environment, we see these businesses as operating profitability and generating large amounts of free cash flow.
The news on Alibaba continues to be pretty much all negative – and the share price suffered for yet another quarter, being down 16.4%. To compound the listing concerns and general increased hesitancy toward investing in Chinese companies, the operating environment is becoming more challenging with additional competition fighting for what may be a reducing wallet. However, Alibaba is a quality company that is cheap, and we bought more on price weakness. We also bought more Thor Industries and Dick’s Sporting, which despite both reporting excellent results that again displayed the strength of their businesses, posted negative returns of 15.5% and 3.6% respectively. Interestingly, we were not the only ones buying. Insiders of the companies bought shares on market during the quarter, and they also have buyback authorisation in place.
Finally, T-Gaia Corporation performed poorly (down 18.8% until we sold it in December). This position was a relic of our prior, substantially quantitative approach – which we have progressively reviewed. There was some delay with T-Gaia due to a lack of updated information, which only became available (in English) in December. This revealed a continued deterioration in T-Gaia’s primary business (selling mobile phones and plans) and a lack of traction with other business lines. Given these developments, we no longer considered it appropriate to maintain our small position (less than 2% of the Fund).
We ended the quarter with 25 positions and 7.8% cash.
Roche – Solid!
Founded in 1886 in Switzerland, F. Hoffmann-La Roche AG (Roche) is the largest biotech company in the world – and incidentally the oldest investee company in the Fund. Roche has two businesses: Pharmaceuticals and Diagnostics. Three quarters of its sales are derived through the former, which provides medicines mostly for oncology but also for immunology and other applications. The quality of Roche’s business franchise, and the critical nature of some of its medications and tests, is highlighted by the World Health Organisation (WHO) lists of essential medicines and diagnostics, which include numerous products developed by Roche.
Roche ticks a number of boxes. Firstly, the business model, for unlike many of the 100,000 or so members of Roche’s Research and Development (R&D) team, one does not have to be a rocket scientist to understand it – invest massively into R&D activities (20% of sales give or take) to transform ground breaking discoveries into commercial blockbusters that generate high returns. It’s a numbers game – and the payoffs, although rare, can be very lucrative. And across a broad research endeavours this can lead to a diversified range of successful products. Next, the strong balance sheet (just USD 3b in net debt and ample liquidity) which facilitates the R&D investment to continually grow earnings. Third, the business franchise. By all accounts (as measured by its historic returns on invested capital and cash flow conversion), it is of high quality. And finally, the long term outlook shared by management and the founding family. For example, the current CEO (who joined the company as a trainee in 1993) has driven an increased focus on the diagnostics division (despite its lower margins), with the vision that better and smarter testing lead to more valuable medicines and ultimately more personalised healthcare. We believe that this long term oriented approach has been fostered by the management incentive structures that Roche has in place, and the business still being largely owned (about 45%) by the founding family (who are proponents of those structures).
But now, let’s consider some short term factors at play. It is interesting that, due to the pandemic, sales in 2020 declined across both divisions. This was because lockdowns and travel restrictions discouraged patients to visit hospitals and/or perform their routine diagnostic tests. But there were some positives, such as USD 4b in sales of COVID-19 treatments and USD 2.8b of revenue from tests. Of course, these “pandemic” effects are more likely than not to be temporary in nature. This is unlike another major detractor coming to prominence in 2020, which was increased competition from cheaper biosimilars for Roche’s established cancer medicines. Biosimilars are approved substitutes for the original medicines available upon patent expiry. They cost Roche a whopping USD 5b of sales over the course of 2020 – and there’s more to come. This of course exemplifies the need for Roche to continue to rejuvenate its portfolio. Its commitment to do so is unwavering. The Roche team worked around the clock to enhance its PCR tests to enable them to identify the latest Omicron variant in just days. If COVID-19 continues to mutate (and testing solutions need to continually evolve), then perhaps at least some of the pandemic’s effects (the ones that boosted sales) will be more enduring than we initially thought.
With a market capitalisation of over USD 350b, Roche is the third largest company in the Fund. At current prices, it trades at a 4.0% earnings yield, and despite its heavy reinvestment into its business it provides a 2.3% dividend yield – all with negligible debt. These metrics will only be enhanced by Roche’s recent purchase of over 6% of its outstanding shares (some USD 21b worth) from its competitor Novartis. The deal was struck at a pretty reasonable price – such that it will increase Roche’s earnings per share while maintaining a perfectly manageable level of debt. And aside from the immediate financial upside, Roche’s management team regains “full strategic flexibility”. What’s not to like? To us, it illustrates prudent capital allocation.
Roche’s strengths across both divisions places it in an ideal position to lead the future of healthcare: more integrated and more digital, thus allowing more personalised solutions. Medical needs continue to grow, and thus so do the long term prospects of the business (including such promising areas like gene sequencing). With the firepower to pursue its in-house research endeavours, and inorganic opportunities such as acquisitions, licencing and alliance arrangements (of which Roche has had a successful track record), there is reason to see a lot of value upside in this investment.
What crazy times we live in, when:
despite inflation running rampant at 7.0%, the yield on US government 10 year bonds remains at low levels (around 1.7%). The last time inflation was on an upward trajectory from the 6.0% level was in 1978. At that time US government 10 year bonds were yielding 8.0% and they went on to peak in October 1981 at 14.7%!
there are no apparent efforts to address the unsustainable level of US debt which is now approaching USD 30 trillion, or 1.5 times GDP (compared to USD 3.2 trillion, or 0.6 times GDP 30 years ago). The credit card is well and truly “maxed out”. How long can we kick the can down the road? And is anyone thinking of those forced to pick up the tab?
a currency which was conceived in 2013 as a joke, and named after a dog with bad spelling habits (Dogecoin), reaches a market cap of USD 39.6b.
a piece of digital art (or perhaps better termed “5,000 pieces of art” as it changes every day for 13.5 years) in the form of a non-fungible token (NFT) sells for USD 69.3m5.
For a satirical illustration of the current levels of exuberance in certain parts of the market:
“What? Revenue? No, no, no, no, no. No revenue…If you show revenue, people will ask “How much?”. And it will never be enough. The company that was the 100xer, the 1,000xer, becomes the 2x dog. But if you have no revenue, you can say you’re pre-revenue. You’re a potential pure play. It’s not about how much you earn it’s about what you’re worth. And who’s worth the most? Companies that lose money.” – Fictional character Russ Hanneman in show “Silicon Valley”, Season 2 Episode 3.
Meanwhile, with share prices at all time highs, we are not surprised to see insiders (like Elon Musk, Mark Zuckerberg, Satya Nadella and Jeff Bezos) selling record numbers of shares (that were issued to them at little cost) for billions (in cash). And we are pleased to see that insiders of companies the Fund owns (like Northern Star, Thor Industries and Dick’s Sporting) are buying shares (with their own hard earned cash) at prices similar to (or in some cases higher) than the Fund has recently paid.
And finally, changing tack a bit, we cannot help but highlight from a different perspective what strange times we live in. Picture yourself contemplating life a couple of years back, with no comprehension of what’s to come. Would you have thought the world’s number one tennis player would be held captive (twice) as part of his efforts to retain the Australian Open, and ultimately precluded from competing? Or that the French president would quite openly pronounce that he wants to make life hard and “piss off” around 10 million of his country’s residents?
Yes, crazy times indeed. We thank you again for your interest, and hope you are keeping well.
Stuart Pearce Principal
17 January 2022
Alexis Delloye Principal
Figure 3: Diversification by Sector
Source: Alluvium, Factset
Figure 4: Diversification by Region
Source: Alluvium, Factset
Table 4: Fund Overview
Top 15 Holdings
Number of Holdings
Weight Average Mkt Cap. (USD m)
Source: Alluvium, Factset
Table 5: Quality Metrics (weighted average)
Fixed Charges Coverage (3y median)
Sales Growth (3y average)
Return on Invested Capital (3y average)
Return on Invested Capital (8y average)
Source: Alluvium, Factset
Table 6: Pricing Metrics (weighted average)
Enterprise Level Yield (EBIT/EV)
Earnings Yield (NPAT/Mkt Cap)
Free Cash Flow Yield (FCF/Mkt Cap)
Source: Alluvium, Factset
Table 7: Top 15 Holdings
Source: Alluvium, Factset
Alluvium: Alluvium Asset Management Pty Ltd, ABN 69 143 914 390, AFSL 476067
Australian Fund: Alluvium Global Fund
Factset: Factset Research Systems, Inc.
Fund: Conventum – Alluvium Global Fund
Enterprise Value (EV): The market value of equity plus the book value of debt
EBIT: Earnings before interest and tax
Earnings Yield: The most conservative result from four different calculations at the equity level
Free Cash Flow (FCF): Cash flow from operations less capital expenditure
Mkt Cap: Market capitalisation
NPAT: Net profit after tax
Operating Assets: Total assets less total liabilities plus total debt (Alluvium adjusted)
Owner’s Earnings: Operating cash flow, plus cash interest paid less assumed maintenance capital expenditure
Return on Invested Capital: Owner’s Earnings as a percentage of Operating Assets
1 Source: European Fund Administration S.A.
2 Company names have been abbreviated throughout this document in the interest of readability.
3 Source: Factset
4 Returns are time weighted, include dividends, and are expressed in local currency.
Alluvium is solely responsible for the preparation of this document.
The Fund is a sub fund of Conventum. Conventum is an open-ended investment company (société d’investissement à capital variable, “SICAV”) with multiple sub-funds incorporated under Luxembourg law, subject to Part 1 of the Luxembourg Law of 17 December 2010 on undertakings for collective investment, as amended. The SICAV has appointed Conventum Asset Management S.A. as the Management Company in charge of the portfolio management, the central administration and the distribution of the SICAV. Conventum Asset Management S.A. has appointed Alluvium as the Asset Manager of the Fund. Relevant documents for the Fund are available via the following links: Prospectus (FR/EN), Key Investor Information Document (“KIID”), (FR/EN).
Alluvium is the issuer of units in the Australian Fund, which is an unregistered managed investment trust available to Wholesale Clients as defined under Section 761G of the Corporations Act 2001 (Cth). The Australian Fund feeds into the Fund. An Information Memorandum (“IM”) is available here.
A person should obtain a copy of the Prospectus, the KIID, and/or the IM and should consider the documents carefully before deciding whether to acquire, or to continue to hold, or in making any other decision in respect of shares in the Fund or units in the Australian Fund.
This document was prepared by Alluvium and does not contain any investment recommendation or investment advice. This document has been prepared without taking account of any person’s objectives, financial situation or needs. Therefore, before acting on any information contained within this document a person should consider the appropriateness of the information, having regard to their objectives, financial situation and needs. Neither Alluvium, nor its related entities, directors or officers guarantees the performance of, or the repayment of capital or income invested in, the Fund nor the Australian Fund.
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