After a bruising first quarter for international value stocks, it would have been hard to predict a solid gain in the portfolio this year. The cheapest stocks were hit especially hard at the onset of the pandemic, and the first quarter of 2020 marked the only quarter our strategy has underperformed the EAFE index since our inception in June of 2019. Most of the underperformance came during the first three weeks of March, before a sharp recovery. In the first quarter, we underperformed the EAFE by nine percentage points, but since then we outperformed by 15 percentage points, ending the year 230bps behind the EAFE, but 810bps ahead of our style benchmark, the EAFE Value.

 

While we managed through the year with a mid-single-digit return, value in general did not fare as well. We believe this unusual decline in cheap stocks has created an incredibly attractive opportunity set. Value stocks are now trading with historically wide spreads versus the market, which has typically led to sustained periods of outperformance. We have performed well in a difficult period, and we are looking forward to our results when the value winds are at our back.

 

In 2019, deep value underperformance continued but with much more volatility. Deep value stocks had some very good months, but they were offset by worse months soon after. January was a great month but was offset by March. Then April was good, but May was terrible. June was good again, but August was the worst month of this entire period.

 

As bad as August looks on this chart, it was actually worse a few days before month end. But then, starting on August 28th, deep value stocks began to outperform significantly. The positive performance from the last days of August continued into September, which turned into a very strong month for deep value stocks. Since September, deep value stocks have continued to outperform, without any significant offsetting months.

 

We have reason to believe that August ended the 20-month downcycle for deep value. We saw a pattern emerge in 2019 that has been seen at the end of the last four value cycles going back 40 years. First, prior upcycles have started with a bang not a whimper, meaning a month of significant outperformance, as we saw in September. Second, prior cycles were darkest before the dawn, with the worst months of underperformance at the end of the downcycle, which we saw in August. Last, the timing was right for this to be the turn in the cycle. The average duration of prior downcycles is 20 months, and as of August this cycle had lasted 20 months.

 

In fairness, this is educated guesswork. We were hopeful that January 2019 was the start of the upcycle. It fit the same pattern that we saw in September except that the timing was short at 12 months, not 20. As it turned out, January was not the turn we hoped for. We cannot be sure September is the turn either, but we become more and more confident with each passing month.

 

 

 

• NXPI is a semiconductor company with the #1 position in radar technology for auto collision avoidance and autonomous driving. For 2020, EPS is expected to decline 22%, due in large part to global auto production shutdowns that occurred during the spring. Longer-term, little has changed, and the current 2022 consensus EPS estimate is near where it was prior to the pandemic and 67% higher than 2020. Through March 18th, NXPI was down 49%, which we believe was driven by the company’s exposure to the then-struggling auto sector. At that point, it was hard to know when auto supply chains would start up again. Regardless of how long the shutdown endured, it was easy to see that NXPI would grow secularly over the long-haul as more vehicles employ NXPI chips for collision avoidance, battery management, and more. We capitalized on the opportunity and purchased the stock on March 16.
  
  
• Ashtead, based in the U.K., is the #2 tool rental equipment company in North America and has been a position in our portfolio since inception. Early in the pandemic, there was a concern that demand would collapse, and the stock price dropped 53% in less than one month. We did not know exactly how far demand would fall, but we knew the business would benefit from countercyclical cashflows. Because of Ashtead’s scale as the #2 player, the company has negotiating leverage with suppliers. As a result, they can cut their new equipment orders with just 45-60 days notice. We saw the company cut capex by about 80% in the financial crisis, and we knew Ashtead could once again pull the same lever in an abrupt slowdown. This is exactly what happened. Even though EPS is expected to decline 11% in 2020, free cash flow is expected to increase 72%, to a record £1.1 billion. The stock initially sold off like other industrial cyclicals before the market realized Ashtead’s resiliency. From the bottom, the stock gained 210%, and it ended up 49% on the year. We were confident the company could survive a downturn, and now we once again should get the rewards from the company thriving in a rebound. Ashtead is a secular winner, benefitting from scale and technology advantages that allow it to consistently take share from the mom-and-pop businesses that still control most of the market.
  
  
• Element is a leading global commercial vehicle fleet management business. The company manages mission-critical cars, vans, and trucks for a diverse set of customers, including Amazon, whose businesses are heavily dependent on their fleets. While Element provides many services for its customers—purchasing, repair, and fuel to name a few—it does not bear any residual risk for the vehicles it leases to them. This means that even a sharp downturn is unlikely to impair the business. In the financial crisis, credit losses peaked at around 10bps. The company’s relationships are sticky and revenues are recurring. Suffice it to say, we were surprised to see the stock down 41% in the early part of the year, and we took advantage of the dislocation to make our investment on April 7. With fewer corporate vans on the road, service revenue fell 8% year-over-year in the second quarter, but by the third quarter service revenue was already rebounding and was +2% compared to the prior year. For all of 2020, EPS fell only 2%, a commendable result although far less than original expectations for 20% EPS growth. While the stock has more than doubled off the bottom, we are still in the middle innings of a shift to outsourced vehicle management that we think will drive double-digit earnings growth for years to come.

THE REPORTS OF VALUE'S DEMISE ARE GREATLY EXAGGERATED