Dear Investor:
2022 has been a difficult year for financial markets, with the main European indices down nearly -10%, and the main American index down -18%. Our funds have continued the positive performance started last year, with the international fund up +11% and the Iberian fund up +4%, both above their benchmark indices (MSCI Euro: -9.49%; IGBM + PSI20: 0.93%).
Although we have had two years of positive performance, confirming a clear improvement of our portfolios in difficult environments, we still have a long way to go in the coming years. We believe that our funds, based on our estimate of their target value, are still worth significantly more than their current share price.
The reason for our confidence is that we have a pool of good companies bought at very good prices, which greatly increases the likelihood of good returns. Despite the good performance of the last few years they are still trading at very attractive multiples, with the international portfolio trading at a P/E1 of 5.5x and the Iberian portfolio at 6.9x. Moreover, the outlook for most of our companies has improved during the year.
Economic Scenario
The last 12 months have presented a change of cycle due to rising inflation (we have commented on our view in previous quarterly letters). This has prompted central banks to respond, which have rapidly raised interest rates, bringing an end to the era of "easy money", as well as the end of a cycle, which has generated some bubbles in certain market segments: unprofitable technology, SPAC's, (companies that went to market with a special purpose acquisition) and cryptocurrencies, to name a few. The beginning of the new cycle shows a situation opposite to the previous one, with high inflation and interest rate hikes, which is causing an economic slowdown and perhaps a recession.
In this sense, after a difficult decade for value investing, it seems that the normalisation of monetary policies is causing the fundamental valuation of companies based on the cash they generate today to regain the interest it deserves as a critical element when it comes to investing. One of the conclusions discussed in our previous letters, and we insist in this one, is to own real assets, which we believe will reasonably maintain the purchasing power of our savings, and more specifically shares of companies that are trading at attractive prices.
What we can expect going forward
The new market focus now seems to be on when central banks will get inflation under control, at what level interest rates will be set and whether there will be a controlled landing of the economy or whether we will enter a recession.
We believe that trying to make economic predictions does not add much value. No one has been able to predict macroeconomic movements accurately and consistently. As history shows, it is difficult to predict a crisis because of the great complexity and uncertainty surrounding the global economy. This does not detract from trying to understand what is happening, where we are in the cycle and what it might imply in the future, i.e. to be well prepared. This is very different from trying to predict when it will happen, how deep it will be or even if such a recession will occur.
We do not know any more than others about what might happen in the next month or even the next year, and it is very difficult for anyone to know, but we believe that in order to invest well for the long term it is not necessary to know.
In the end, we should think that we are buying small parts of good businesses and always put the price (what you pay) in relation to the value of those businesses (what you receive). This is based on their ability to generate sustainable profits over the long term. To the extent that the price you pay is below the intrinsic value of the business, and this price is as low as possible, you are increasing the likelihood of a good long-term return, in turn generating a higher margin of safety.
We, in a complex geopolitical environment and in an uncertain economic situation, own good businesses and remain focused on where we can add the most value, which is the search for and in-depth analysis of highly undervalued companies with strong balance sheets, good management teams, and which are prepared to withstand different scenarios.
Our portfolios
During 2022 we have maintained a similar position in the main blocks of the portfolio (which we explain in detail in our Q1 and Q2 2022 quarterly letters), closing the year with: 34% in the energy sector which has protected us well in this high inflation scenario; 28% in the defensive segment; 19% in cyclical sectors; 6% in other commodities; the rest 9%; and in liquidity close to 4%.
Naturally, we have reduced exposure and sold some companies in the energy sector that had performed very well and increased our position in companies that we already had in our portfolio, and which had been left behind. We have also entered some new companies, which you can read about bellow in this letter.
Within the defensive segment, especially in the latter part of the year, we have been increasing our exposure to the pharmaceutical sector, reaching almost 9% of the portfolio, compared to 3% the previous year. Some are companies that we had a small position in the portfolio and have decided to increase their exposure (Viatris (VTRA), Teva (TEVA, Financial)), and others are new (such as the Fresenius group (FMS, Financial), Organon (OGN, Financial) and Taro (TARO, Financial)). This group of companies on a weighted basis to our holdings are companies whose share price has fallen by about 65% over the last 5 years, which tends to indicate that it may be a good place to go fishing.
We note in this group of companies that there are some reasonable concerns on the part of the market, although these are known and more than reflected in current prices. In some cases, these are temporary problems, and we see that they are improving given the execution that the companies are performing. They are trading on average at 5.5X times cash flow at the end of 2022, which we consider very attractive for companies that are not depenent on the economic cycle.
In short, we maintain our conviction in the investment process and our confidence in the companies in our funds. It is only a matter of time before the market recognises the important difference between price and value. For our part, we will continue to work with the aim of increasing this gap, i.e. to create value for our investor.
PORTFOLIO
At Cobas AM we manage three portfolios: the International Portfolio, which invests in companies worldwide excluding those listed in Spain and Portugal; the Iberian Portfolio, which invests in companies listed in Spain and Portugal or which have their core operations in Iberian territory; and, finally, the Large Cap Portfolio, which invests in companies globally and in which at least 70% are companies with a market capitalisation of more than 4,000 million euros.
Please note that the target value of our funds is based on internal estimates and Cobas AM does not guarantee that these estimates are correct or will be achieved. Investments are made in securities that the managers believe are undervalued. However, there is no guarantee that they are undervalued or, if so, that their prices will perform as the managers expect.
These three portfolios are used to construct the various equity funds we manage as of 31 December 2022:
International Portfolio
During the fourth quarter of 2022 our International Portfolio returned +10.2%, slightly outperforming its benchmark, the MSCI Europe Total Return Net, by +9.5%. If we extend the comparison period from inception to the end of December 2022, the International Portfolio returned -5.2%, while its benchmark returned +30.6% for the same period.
During the fourth quarter we made few changes to the International Portfolio in terms of inflows and outflows. We exited Energy Transfer (ET, Financial) and Petrofac (LSE:PFC, Financial) completely (in September these companies had a combined weighting of just over 2%). And we have entered Continental (XTER:CON, Financial), Fresenius Medical Care and Porsche (XTER:PAH3, Financial). At the end of December these companies had a combined weighting of just over 2%. In the rest of the portfolio we reduced our position in Subsea 7 (OSL:SUBC, Financial) and Affiliated Managers Group (AMG, Financial) due to their good performance during the quarter. On the buy side we increased our position in Atalaya Mining (LSE:ATYM, Financial) and Organon to take advantage of their falling share prices.
During the fourth quarter, thanks to market volatility and our rotation, the target value of the International Portfolio increased by just over 3% to €244/share, implying a potential1 upside of 158%.
As a result of this potential and the confidence in the portfolio, we are invested around 97%. The whole portfolio trades at an estimated 2023 P/E1 of 5.5x versus 11.8x its benchmark and has a ROCE1 of close to 27%. But if we look at the ROCE excluding shipping and commodity companies, we are close to 34%, which shows the quality of the businesses in the portfolio.
In short, we have done what we always do, taking advantage of volatility to buy what falls and sell what rises, resulting in a portfolio made up of very good businesses, which we have known for many years, trading at very low multiples.
Iberian Portfolio
The Iberian Portfolio's net asset value performance during the fourth quarter of 2022 was +14.5%, slightly better than its benchmark, +12.4%. If we extend the comparison period from inception to the end of December 2022, we returned1 -0.6%, while the benchmark returned +15.4% for the same period.
During the fourth quarter we made few changes in terms of portfolio inflows and outflows. We did not enter any company and only exited Logista, Sonaecom (XLIS:SNC, Financial), CIE Automotive (XMAD:CIE, Financial) and Mediaset España (XMAD:TL5), taking advantage of their good share price performance and the takeover bid launched by Sonae for Sonaecom. All these companies had a combined weighting of between 3 and 4% at the end of September.
In the rest of the portfolio the most important movements were: on the sell side Técnicas Reunidas (XMAD:TRE) and Sacyr (XMAD:SCYR) while on the buy side Atalaya Mining and LÃnea Directa (XMAD:LDA).
During the quarter we have slightly adjusted upwards the target value of the Iberian Portfolio by about 2% to €227/share. After this slight adjustment, the potential1 upside stands at 128%.
In the Iberian Portfolio we are slightly over 97% invested, and as a whole, the portfolio trades at an estimated 2023 P/E1 of 6.9x versus 11.0x for its benchmark and has a ROCE of close to 26%.
The summary is the same as in our International Portfolio, we have taken advantage of the volatility of the market to seed in good businesses at very good prices, prices that are difficult to see normally. But to this, we would add that the Iberian Portfolio is mainly made up of businesses that we have known practically all our lives.
Large Cap Portfolio
During the fourth quarter of 2022 our Large Cap Portfolio returned +11.6% versus +0.8% for the benchmark, the MSCI World Net. Since the Cobas Large-Cap Fund began, it has returned -8.2%. In that period the benchmark index appreciated +53.6%.
In the Large-Cap portfolio we made some changes in terms of inflows and outflows during the third quarter. We exited Dick's Sporting Goods (DKS), SKF (OSTO:SKF A), Inpex Corp. (IPXHY) and Energy Transfer (ET, Financial), which at the end of September had a weighting of just over 7%, and only entered Capri Holdings (CPRI) with a weighting of just over 1%.
In the rest of the portfolio the most important movements were: on the sell side Renault (XPAR:RNO) and Grifols (XMAD:GRF) due to their good performance during the quarter, while on the buy side Harbour Energy (LSE:HBR) and Porsche.
During the quarter we have slightly adjusted the Large Cap Portfolio's target value upwards by about 3% to €223/share. This represents upside potential1 of 143%.
We are approximately 98% invested in the Large Cap portfolio. Overall, the portfolio trades at an estimated P/E 2023 of 6.0x versus 15.0x for its benchmark and has a ROCE of 32%.
As with the other two portfolios, the summary is the same: during the quarter volatility has been our ally, allowing us to have a portfolio composed of very good businesses trading at very low multiples.
