CA - Longleaf Partners International Fund Q3 2023 Commentary

2023-10-15 10:00:00 ET

Summary

• Longleaf Partners Funds is a suite of mutual funds and UCITS funds that Southeastern Asset Management, the investment advisor to the Longleaf Partners Funds, created in 1987 as a way for Southeastern employees to invest alongside their clients.
• Longleaf Partners International Fund declined -3.94% in Q3, in line with the FTSE Developed ex-North America Index.
• Consumer Discretionary was the worst-performing sector due to risk-off sentiment, particularly in luxury holdings with exposure to China.
• The fund's management partners are taking action to address price-to-value discounts and create positive stock performance.

Longleaf Partners International Fund declined -3.94% in the third quarter, in line with the FTSE Developed ex-North America Index, which fell -3.98%. Equity markets were in risk-off mode during the third quarter, driven by high inflation and higher-for-longer interest rates in Western markets, coupled with a weak Chinese economy. With persistent geopolitical headwinds, sentiment broadly remained negative, and volatility was high.

We saw this risk-off sentiment particularly reflected in the portfolio’s luxury holdings, resulting in Consumer Discretionary being the Fund’s worst absolute and relative performing sector. It was a challenging quarter for most consumer-related industries, but especially those with exposure to China. The underlying structural themes that make the consumer and luxury businesses we own so attractive – namely the emerging middle class in China and the continued shift towards branded products – are still very much intact, and our luxury companies like Richemont and Kering remain well positioned to benefit over the long term. These companies are currently trading at long-term trough valuation multiples, and we believe the near-term negative sentiment is more than priced in. We took advantage of the extreme price dislocation in the quarter to add to Richemont.

By and large, our companies continue to deliver solid operational results. Our management partners are going on offense and taking action to address the price-tovalue discount, ranging from material share buybacks (as at Alibaba, Prosus, Kansai Paint, Man Wah, Glanbia, EXOR, Domino’s Pizza Group, Accor), to exiting non-core assets and splitting or spinning out business lines (Accor, Glanbia, Domino’s Pizza Group, Delivery Hero, Kansai Paint, Alibaba, Lanxess, Prosus) to selling the entire company (Applus). This translated into positive stock performance at some of our larger positions in a quarter when only Energy was a positive absolute sector for the FTSE Developed ex-North America Index. Our companies can create their own outcomes, even in a challenging environment.

We encourage you to watch our video with Portfolio Managers John Woodman and Manish Sharma for a more detailed review of the quarter.

Contribution To Return As Of September 30, 2023

• Domino’s Pizza Group – UK-listed Domino’s Pizza Group ( DPG ) was the top performer in the quarter. We were directly engaged with the company during its search for a new CEO and are highly confident in Andrew Rennie, who became permanent CEO in August. Rennie joins DPG from within Domino’s network with a strong track record, good credibility with the franchisees and a remuneration package that ensures he is well aligned with shareholders. The company announced strong top-line growth in the quarter, outperforming the broader market in the UK. DPG completed the sale of its shares in its German joint venture (JV) to the JV partner Domino’s Pizza Enterprises, and the company announced $70 million in proceeds would go to buying back discounted shares. We believe that the pieces are now in place for the management team and board under the leadership of Rennie to unlock the underlying value of this business and expect significant additional upside from here.
• Glanbia – Irish-listed global nutrition company Glanbia was another positive performer in the quarter. We have similarly been engaged behind the scenes at Glanbia over the last several years and are seeing the company take steps to get the underlying value of its business recognized. In the first half of the year, Glanbia sold its cheese JVs in Europe and the UK, getting out of the legacy dairy business to focus on its much more valuable performance nutrition business. Optimal Nutrition reported mid-teens top-line growth in the quarter, and stripping away the accounting complexity of the historic JVs is allowing the market to better appreciate the value. We believe there is a lot more upside here, and the company is using its strong balance sheet to buy back discounted shares.
• Richemont and Kering – After being top contributors in 1Q2023 (and in the case of Richemont, a top contributor for 4Q2022), our two luxury goods companies, Richemont and Kering, were top detractors in the quarter. As discussed above, the luxury goods industry faced macro concerns over a weakening consumer in the US and Europe and a less linear than initially anticipated recovery in China, underscored by pre-emptive earnings downgrades for both businesses in anticipation of expected weak 2H23 results. Richemont owns some of the highest quality brands in any industry globally in Cartier and Van Cleef, both of which benefit from the structural trend towards branded jewelry, which is still underpenetrated compared to most consumer goods industries. We had trimmed our position in Richemont earlier in the year on the back of strong performance, and now the company is trading at a trough valuation multiple. Kering also has a stable of high-quality brands, but with more fashion exposure. We view Kering as an undervalued self-help story through the rejuvenation of Gucci and the ability to extract group synergies from its impressive stable of brands. We believe both are well positioned to benefit from long-term structural growth themes for investors that can look past near-term stock price volatility.
• Delivery Hero – German-listed food delivery business Delivery Hero, a new position initiated in 2Q23, was also a top detractor. We have followed the business closely through our investment in Prosus, which is a 30% owner of Delivery Hero. Delivery Hero is headquartered and listed in Germany, but the majority of its business is in Asia, the Middle East and North Africa, where it has number one market share in countries like Korea, Saudi Arabia and UAE. Delivery Hero was a large beneficiary of Covid lockdowns, when people were stuck at home and used the service to deliver food and groceries, leading to unsustainable demand growth that has plateaued this year, resulting in a sharp decline in the share price. This extreme swing gave us the opportunity to invest in this high-quality business with a management team that is clearly focused on balancing growth and profitability, with compensation aligned to these goals. We expect to see management exit markets where they do not have a leading position, which would reduce cash burn substantially and focus the business on core markets. We believe that Prosus’ presence will ensure capital allocation and operational discipline, and we added to the position in the quarter as the stock price pulled back.

Portfolio Activity

After a busy first half of the year, we further upgraded the portfolio by exiting two positions and initiating one new position in a business we also own in our Asia Pacific strategy. We exited CK Hutchison as a result of a lack of value growth and disappointing capital allocation, coupled with increasingly challenging macro-economic headwinds. Similarly, we sold Lazard on the back of a change in management and a more muted outlook for the business in the current environment.

We also sold half our position in Applus, which was the top performer in the first half after two private equity firms made bids for the entire business, as discussed in more detail in last quarter’s letter. We’ve been actively engaged with the company, pushing management to find a way to crystallize the value. We cut the position in half, recognizing we are likely at the end game, giving us more cash to redeploy in a volatile market that is producing a growing on-deck list of attractive opportunities.

Outlook

Despite disappointing short-term absolute returns in the quarter, we are pleased with the progress made across the businesses we own. We are partnered with management teams that are taking steps to crystallize value, regardless of the challenges of the current economic circumstances. Our portfolio holdings in aggregate have grown their values this year. The portfolio ended the quarter with a price-to-value ratio in the mid-60s%, offering meaningful upside potential. As more bottom-up opportunities have qualified this year, we have improved the quality of the portfolio over the last several quarters and have a strong and growing pipeline of new investments. We are confident in the portfolio’s position for future relative outperformance in multiple market environments.

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