The bull market that we have enjoyed over the last 10 plus years came to a sudden end in March, as the coronavirus wreaked havoc on world health and on our global economy. Coming on the heels of last year’s very strong equity market, this abrupt and sharp downturn is, understandably, unsettling for investors. We have mentioned in past commentaries that highly valued markets can sometimes fall victim to “black swan” events that are entirely unforeseeable. This time around, that dark bird has come in the form of a virus that has quickly developed into a pandemic.
Large portions of the global economy remain shut down, corporate earnings are in rapid retreat, unemployment is on the rise, and virtually all major market indexes have collapsed into bear market territory, declining by more than 20%. The Tweedy, Browne Funds have not been immune to the collateral damage imposed on our capital markets. All four of our Funds finished the quarter down more than 20%.
While seemingly no stock, industry group or country in our Fund portfolios escaped the impact of the pandemic during the quarter, it was the economically sensitive component of the global equity market that bore the brunt of the stock markets’ collapse. This also held true for our Funds as the financial, media, energy related, and industrial cyclical stocks faced the steepest declines. This included companies such as Bangkok Bank, Wells Fargo, SCOR, WPP, ConocoPhillips, Total, Royal Dutch, Safran, G4S, and CNH Industrial, among a host of others. In the energy sector, the damage was compounded by an oil price war that erupted between Saudi Arabia and Russia, which flooded the market with cheap oil as near-term demand was in rapid retreat. We cannot help but to believe that rationality will eventually prevail and the Saudis and Russians will resolve their differences, bringing some relief to oil markets. While all of these economically sensitive companies have faced undue near-term hardship, when the virus abates and demand returns, we would expect these companies and their respective stock prices to recover. As to when that happens, and by how much, we cannot know. We have full confidence, however, that our patience will eventually be rewarded.
In terms of good news during the quarter, there was very little. However, some of our portfolio holdings declined less than others. This included a number of the Funds’ food and beverage holdings such as Nestlé, Unilever, and Diageo; pharmaceutical holdings such as Johnson & Johnson, Novartis, and Roche; and technology holdings such as Alphabet (Google), Cisco, and Baidu.
Our initial analysis of any company always considers the real risks of investing. This is the risk of permanent capital loss. We look hard at balance sheets and stay far away from highly leveraged businesses. This is especially true during periods of deep economic uncertainty like the one we are in now. We continue to spend a good bit of our time reviewing the balance sheets of our current and prospective holdings, assuring ourselves as best we can that our portfolio companies can weather through a crisis like this. This involves an examination of bank covenants, debt repayment schedules, credit market access, and cash flows. While we cannot be certain, particularly in light of an economic shutdown, we believe that, as a group, our portfolio companies should be able to get through to the other side of this crisis in satisfactory, if not strong, financial condition.
Challenging markets invariably offer up pricing opportunities, and taking advantage of them when they appear is, in our view, the essence of successful long-term investing. As you can imagine, we have been very busy over the last few weeks, combing through the balance sheets and income statements of a plethora of new ideas. It may seem counterintuitive, but at times like this, we begin to feel better about our prospects for future returns. We have tried our best to be thoughtful, deliberate, and somewhat incremental during the market chaos that has prevailed over the last few weeks. That said, we have made considerable progress putting some of our cash reserves to work in new and compelling opportunities. Over the last several weeks, we’ve established new positions in companies such as Autoliv (ALV, Financial), a Swedish company that is an industry leader in passive safety products (airbags and seatbelts) for the automobile industry; Delta Air Lines (DAL, Financial), the strongest competitor in the consolidating US airline industry whose shares are also held by Berkshire Hathaway; and Shanghai Mechanical (SHSE:600835, Financial), an electrical and mechanical manufacturing business, which includes a valuable Chinese elevator company. For the first time in a long time we were able to uncover a number of new bargains in Japan, including Astellas Pharmaceutical (TSE:4503, Financial), Yamaha Motor Company (TSE:7272, Financial), Kuraray (TSE:3405, Financial), and ADEKA Corporation (TSE:4401). We also added to a number of positions, including Babcock International (LSE:BAB), BASF, CNH, Coca-Cola FEMSA, Krones, Safran, and Trelleborg. All of these new positions and additions to holdings were made at prices that reflect significant discounts to our conservative estimates of the companies’ underlying intrinsic values. In addition to the newly established positions mentioned above, we are currently studying several new ideas, some of which are approved for purchase, but have not yet met our price targets.
During times of great market volatility and pricing opportunity, we are constantly weighing new ideas against companies we already own. Sometimes we reduce or trim positions to make room for new ones. With the exception of a few names, including Carnival Corp (CCL) and Halliburton (HAL), we did very little outright selling during the quarter; however, we did trim our positions in Antofagasta, G4S, Standard Chartered, and HSBC, among others. In several instances these sales allowed us to realize losses, which could be used to offset distributable capital gains that in large part, for Global Value Fund and Value Fund, were the result of gains in our currency hedging contracts due to the strength of the U.S. dollar.
Many of the new businesses in which we are investing are facing significant challenges to their near-term earnings power that we believe are likely to be temporary. When analyzing these companies, we focus our attention on more “normalized” earnings power, asking ourselves what the company will likely be earning two to three years out when things recover. Can it get back to its normalized earnings power? Does it have a balance sheet that allows it to weather the current crisis, and are we being offered a price that affords us an acceptable margin of safety in light of enhanced levels of uncertainty?
When researching new ideas, we have also been spending a good amount of time studying the purchase and sale behavior of knowledgeable insiders, i.e. officers (CEOs/CFOs), directors, some well-informed large (5%-10%) position holders such as Warren Buffett (Trades, Portfolio)), and the company itself (buyback activity). Their actions using their own money will often tip us in terms of our decision-making, particularly when near-term uncertainty is high. Who could possibly know more about the company and its ability to weather the storm and its future prospects than the folks who live, eat, and breathe the business day in and day out. Empirically, insider purchasing, coupled with what appears to be an attractive valuation, have often proven to be clues to potential future outperformance. On March 26, Caitlin McCabe reported in the Wall Street Journal that corporate insiders had been buying back their own companies’ stock at a pace not seen in years. Apparently, more than 2,800 executives and directors had purchased nearly $1.2 billion since the beginning of March, which, according to the Washington Service, was the third highest level of monthly insider buying since 1988.
In closing, we recognize that, post this crisis, the world may not be quite the same. When a ten-year love affair between investors and risk assets comes to a shocking and sudden halt at the hands of a seemingly relentless and deadly virus, there can’t help but be lasting consequences. Attitudes about health, contagion, assemblage, debt and savings will no doubt be different for some period of time, resulting perhaps in a tamer form of capitalism, characterized by less tolerance for unpreparedness, leverage and complexity and greater emphasis on safety and transparency. On balance, such a shift will be beneficial for everybody. While there is no chapter in Security Analysis that deals with pandemics, Benjamin Graham’s investment philosophy provides a rational framework to insulate our thinking from the all too common relationship most investors have with equity markets. We believe brighter days are no doubt ahead, and we thank you for your continued confidence.
As of quarter end March 31, 2020, the current and retired managing directors and employees of Tweedy, Browne and their families had over $191 million invested in the four Tweedy, Browne Funds.
Thank you for investing with us. Stay well.
William H. Browne, Roger R. de Bree, Frank H. Hawrylak, Jay Hill, Thomas H. Shrager, John D. Spears, Robert Q. Wyckoff, Jr.
Investment Committee
Tweedy, Browne Company LLC
April 2020
