Value Turns a Corner?

After a horrible start to the year, markets have begun to turn around and while some (mostly US) have finally found positive territory, international markets continue to lag. Most individual international markets including the major indexes remain negative. As such, we are happy to have turned the corner and ended the quarter with a slightly positive return. What did outperform for the quarter were value stocks, which was helpful to us. We believe our strategy remains undervalued and should benefit greatly if this pattern continues.

We have previously mentioned the unprecedented underperformance of value stocks, and along with our traditional value investing brethren, have been incredibly frustrated by this. A March 12th Barron’s article addressed this experience, citing that this has endured now for nine years (Pendo has the dubious distinction of being founded in 2007; exactly nine years ago). According to the article:

“But traditional value investing - often focused on stocks with low price/book or price/earnings ratios - is due for a comeback. ‘We’ve had nine years of systematic value underperformance,’ says Scott Black, president of Delphi Management in Boston and a member of the Barron’s Roundtable. ‘It has been the longest period of growth outperformance in my career.’ Black, a value investor, has been running money since 1979.” 

With international markets also underperforming for the same time frame, it has been doubly trying. We have maintained there would be a reversion to the mean and hopefully recent activity is indicative of such.

Portfolio Review

What Worked and What Didn’t

The largest contributors were Canadian Natural Resources (NYSE: CNQ), Jardine Matheson (SGI: J36; OTC: JMHLY), and Anglo American (LSE: AAL; OTC: NGLOY).

The largest detractors were Teva Pharmaceutical Industries (NYSE: TEVA), Phoenix New Media (NYSE: FENG), and ICICI Bank (NYSE: IBN).

There’s no obvious relationship between the industries or countries that did or didn’t work, but as a group, all commodity-related holdings seem to have outperformed.

Company Highlights

Canadian Natural Resources (NYSE: CNQ), a Canadian oil exploration and production company was the top performer and largest contributor to our overall performance. The company is well-financed with a very prudent management team that is using internal cash flow to bring new production on line. With oil prices down 60% from their 52-week highs, the financially sound industry participants are likeliest to be the last ones to take production off line. This should benefit them when oil prices inevitably start rising again. Since the $28/barrel low in January, oil prices have gained back 35%. Any gain in the price of oil will have a direct relationship with CNQ’s cash flow. It gained 24% for the quarter.

Anglo American (LSE: AAL; OTC: NGLOY) is a fully integrated mining company. It mines coal, copper, iron, nickel, zinc, platinum group metals and diamonds, with a world-dominance in the latter two. Due to the extended collapse in commodity prices, Anglo is cutting its workforce by over 60%, and appears to be spinning off its DeBeers diamond cartel. Anglo’s 85% interest in DeBeers in itself is worth more than Anglo American’s entire market cap. At some point commodity production will be taken offline and their prices should start to stabilize. Current market behavior suggests that this stabilization is in process. Anglo’s stock price was up 78% for the quarter.

Teva Pharmaceutical Industries (NYSE: TEVA) is one of the world’s largest generic pharmaceutical companies. We have long contended that Teva was undervalued, but it was not until last year that investors appeared to agree with us. Last year Teva embarked on an acquisition mission that ended with it acquiring Allergan Generics for $40.5 billion, shortly after acquiring Auspex Pharma for $3.5 billion. The company also announced that it will form a joint venture with Takeda Pharmaceuticals, where the two will merge some of their Japanese generics businesses into a separately listed company in which Teva will own 51%. Teva’s stock price was down 18% for the quarter and was the largest detractor from our performance.

ICICI Bank (NYSE: IBN) is India’s second largest bank and largest private insurance company. The company is a direct beneficiary to India’s economic growth. Last year, however, much of the GDP growth in what is now the fastest growing major economy was largely a function of increased government spending. The Indian Rupee is down 6% versus the US Dollar for the last 52 weeks, but appears to have stabilized and strengthened during the last month. ICICI Bank ended the quarter down 9%.