AMADF - Polen International Growth Q3 2023 Commentary

2023-11-09 10:15:00 ET

Summary

• Polen Capital is a global independently-owned growth equity boutique, led by an experienced team of investment professionals who are committed to preserving and growing the assets of our clients through a prudent and disciplined long-term investment approach.
• Polen International Growth Composite Portfolio declined in Q3, underperforming the MSCI ACWI ex-USA Index.
• Non-U.S. equity valuations are historically cheap relative to the U.S., presenting an opportunity for international investing.
• Quality companies in the Portfolio are expected to outperform the broader universe in the long term.

Commentary

During the third quarter, the Polen International Growth Composite Portfolio declined by -7.52% and -7.80% gross and net of fees respectively, underperforming the MSCI ACWI ex-USA Index. On a year-to-date basis, the Portfolio returned 11.85% and 10.85% gross and net of fees versus the Index’s 5.35%. Third quarter results may reflect investor concerns about slowing growth prospects and the limitations that may impose business expansion across global markets. On a relative basis, the Portfolio’s returns were most impacted by exposures in the consumer discretionary, healthcare, and financial sectors. On an absolute basis, all sectors except for energy delivered negative returns during the quarter.

Stepping back, non-U.S. equity valuations have rarely been this cheap relative to the U.S. going back nearly two decades.

Suffice it to say that much pessimism is reflected in international equities. All else being equal, we feel lower valuations are a positive attribute to international investing.

Despite a weak macroeconomic backdrop, we continue to view the Portfolio’s earnings growth prospects over the coming five years as more compelling than the Index. Over time, we’ve observed that quality materially outperforms the broader universe, particularly in challenging environments. As an example, the MSCI ACWI ex-USA Quality sub-index has outperformed the MSCI ACWI ex-USA Index by +260bps annualized from 2000 to the just-ended third quarter. Equally notable has been the consistency with which quality has outperformed, delivering returns above the broader international universe in 18 of the past 24 years.

The past couple of years have stood in contrast with this historical experience. Quality underperformed the Index in 2022 and has continued to do so through the first nine months of 2023. Looking back historically, we see there was only one other period where quality underperformed for two consecutive years: 2003 and 2004. While we think it adds some context on how anomalous these past couple years have been, perhaps more important is what it may imply on a go-forward basis. Following 2004, quality went on to outperform the broader universe by +400bps annualized over 8 consecutive years. As the saying goes, “History doesn’t repeat, but it often rhymes.” Said differently, we’re optimistic that quality will, again, be rewarded by the market in the long term.

Bringing it all together, the combination of low starting valuations for international relative to the U.S. and the rare underperformance of quality vs. the Index makes for an opportune time to consider quality investing in international markets.

We construct and manage the Portfolio in alignment with Polen’s longstanding quality growth philosophy in mind.

Our view remains that the quality companies in the Portfolio are in a much better position to sustainably compound growth than the Index.

Portfolio Performance & Attribution

The top three contributors to relative and absolute performance during the third quarter were Sage Group ( SGGEF ), MercadoLibre ( MELI ), and Globant ( GLOB ).

Sage Group’s stock has delivered compelling returns the past few months due to favorable 1H23 results and higher full-year revenue guidance. The company’s cloud solutions should continue to drive robust growth on the top line, with the potential to reach a double-digit range this year.

According to our research, MercadoLibre continues to demonstrate all the signs of a strengthening e-commerce/fintech platform. In the most recent quarter, the company reported revenue growth of nearly 60% in local currency terms despite very difficult growth comparisons from the past two to three years. As we see it, nearly all key metrics for the company continue to trend very positively.

Lastly, despite a weaker IT services backdrop in recent quarters, Globant’s top-line growth has exceeded consensus expectations and that of its industry peers in our view. We attribute this outperformance to the company’s strong positioning with its clients and its expertise in digital transformation, which has become table stakes for large enterprises.

The top three relative and absolute detractors to performance during the third quarter were Evolution AB ( EVVTY ), Teleperformance ( TLPFF ), and Amadeus ( AMADF ).

Evolution AB is one of the world’s leading providers of online gaming solutions for the casino industry. The stock's underperformance this past quarter and year to date may be attributable to broad concerns around consumer spending growth and more specific concerns around the U.S. market—individual states have been slow to move legislation forward that would legalize online gaming. Still, Evolution’s fundamental performance has been quite robust, in our opinion, and we have yet to see signs of these concerns impacting the business. We will continue to assess these potential risks should they materialize. In the meantime, Evolution’s current NTM P/E of ~17x looks inexpensive for a business estimated to grow revenues by 20% this year.

Teleperformance, the world’s leading outsourced customer service provider, continues to see its stock price under pressure due to a weaker IT services backdrop and lingering concerns about generative AI disrupting Teleperformance’s business model. We retain our conviction that these AI-related concerns are overblown and that the weaker macro backdrop is the primary culprit for the company’s slower growth. We still view Teleperformance as a high-single-digit revenue growth business over the long term. In our opinion, the stock’s current NTM P/E of ~8x is very compellingly undervalued. Lastly, Amadeus, a global leader in IT solutions for the airline industry, has seen a weaker stock price over the past three months, likely owing to market concerns around weaker consumer spending that might pose headwinds to the travel industry.

Portfolio Activity

During the quarter, we initiated a new position in Novo Nordisk ( NVO ) and trimmed an existing position in CSL . We did not eliminate any positions during the quarter.

Novo Nordisk is a leading pharmaceutical company based in Denmark, focused on developing diabetes and obesity care products. The company began by developing human insulin for diabetes patients, eventually expanding into synthetic insulins and other diabetic pharmaceuticals. Most recently, it has been among the leading innovators of GLP-1 drugs, which help people with diabetes control blood sugar levels but have also shown to aid in weight loss. Novo Nordisk’s best known GLP-1 drugs—Ozempic (for diabetes) and Wegovy (for obesity)—are already blockbusters and have become well-known in popular culture for their dramatic results.

Today, GLP-1 drugs account for nearly 70% of Novo Nordisk’s sales and are the major engine of growth for the company, given the large populations affected by diabetes and obesity. In the U.S. alone, over 10% of the population has diabetes, and over 1/3 of the adult population is obese. We agree with analyst estimates that the size of the addressable GLP-1 market in the U.S. is nearly $100b and the global addressable market as large as $200b+

(including diabetes and obesity patient populations). While Novo Nordisk already faces competition from Eli Lilly in GLP-1s (and will gradually face even more competition in the coming years). We believe they are well-placed to retain high market share thanks to a first-mover advantage, its good track record of working with metabolic diseases, and its extensive body of already-conducted research showing the substantial efficacy and safety profiles of its drugs. Driven by GLP-1 drugs, we expect Novo Nordisk to be able to grow revenues at a mid-teens rate and earnings at a high teens rate for the next five years. At ~ 30x forward earnings, we believe the shares are appropriately valued.

We trimmed our position in CSL to help fund the addition of Novo Nordisk. Based in Australia, CSL is a global leader in plasma derived pharmaceutical products and vaccinations. Its recent acquisition of Vifor Pharma has also added products for iron deficiencies, nephrology, dialysis, and rare diseases. The growth opportunity for CSL in all these areas remains attractive, and we believe it is still highly competitively advantaged thanks to its scale and the breadth of its portfolio. We remain optimistic about CSL’s growth opportunity and believe it can grow revenues at a high-single-digit rate and earnings at a double-digit rate for the coming five years. But we also note that CSL’s valuation is comparable to Novo Nordisk’s, despite moderately slower growth expectations and similarly robust competitive advantages, thus making it a good candidate to help fund the purchase of Novo.

Outlook

Global equity markets continue to reflect slowing growth expectations after policymakers rapidly hiked rates in recent years and economies normalized from the pandemic and stimulus-related shocks in opposing directions. We believe the best way to navigate uncertain environments continues to be a quality-biased portfolio comprised of companies growing their aggregated earnings faster than the Index.

As we see it, the balanced composition of the Portfolio today leaves it well-positioned to handle any challenging conditions that may emerge while delivering the horsepower to drive well-above Index growth rates over time.

As we look for quality to exceed Index returns once again, we feel our portfolio is poised to win over time.

Thank you for your interest in Polen Capital and the International Growth strategy. Please feel free to contact us with any questions.

Sincerely,

Todd Morris and Daniel Fields

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