• Russia’s invasion of Ukraine has exacerbated a risk off environment. The FTSE All- World Index declined 2.5% and the Global Equity Growth Portfolio fell 3.0%.
• Inflation expectations are now expected to decline less fast due to sanctions that will be imposed on Russia. All else equal, this likely means that central banks continue with their plans to reduce global money supply by raising interest rates and reversing quantitative easing.
• A new position was added to Reliance Industries and Meta (formally Facebook) was exited. Reliance industry is India’s largest listed company. The company is a conglomerate with interests in the energy value chain including clean energy, as well as Retail, telecommunications and digital services in India.
Markets reacted negatively to the invasion of Ukraine by Russia. Ukraine, formally part of the Soviet Union, gained independence in 1991. Russia annexed the Crimean Peninsula from the country in 2014. Russia has made clear their displeasure at what they regard as NATO’s creep towards their borders. With troop build ups on the border and western governments pulling citizens out of the country in January and early February, we had envisaged that Russia looked likely to annex some further modestly sized, and ethnically Russian, regions of Ukraine’s Eastern front. As a reminder it was for this reason that the Global Equity Growth strategy sold out of the position in Russian bank Tinkoff during January, given the threat of economic sanctions on a small Russian annexation.
The full invasion of Ukraine was however unexpected. With Ukraine not being part of NATO, and Russia being a nuclear power, direct escalation seems unlikely. We do not expect the war in Ukraine to extend westwards, nor for the USA or NATO to become directly involved in the conflict. The world has reacted to condemn the actions of Russia and is in the process of implementing a swathe of sanctions targeted against the country to severely hamper their economy.
During the month, the portfolio’s best performing holdings were Vermilion Energy (+20.2%), Enphase (+18.7%) and the Global Metals and Mining position (+12.2%). Vermilion’s shares performed strongly given the increase in hydrocarbon prices following the geopolitical turbulence in Europe. With over 30% of cash flow anticipated from European gas, the company looks well positioned to benefit from the current turmoil. Despite the strong performance in the share price since purchase, the shares continue to look undervalued, offering a prospective free cash flow yield estimated at 40% for the coming year. Enphase reported impressive results ahead of expectations, with earnings growing 41% and encouraging guidance.
On the negative side Meta (-24.1%), formally known as Facebook, reported extremely disappointing results during the month. Management highlighted three major headwinds to growth. Changes to Apple’s iOS and European privacy regulation have depressed advertising targeting abilities and hence pricing. Market share loss to TikTok and ByteDance threatens the longevity of Facebook’s user base in particular highlighting the reduced attractiveness of the platform to the younger demographic. Generally macro headwinds including supply chain snags from advertisers are expected to continue this year. The position was sold on the day of results, and we note that shares have subsequently fallen a further 15%.
Alibaba shares were also weak (-16.4%). The company reported customer growth of 13%, ecommerce growth of 6.8% and cloud growth of 20% which in aggregate meant that revenue growth was 0.5% below market expectations. With a trailing free cash flow yield of 10%, a prospective one of around 6% and over 30% of the market cap in net cash we continue to believe that the company to be materially undervalued.
Home Depot (-13.9%) reported in line results but provided lacklustre guidance. Our expectation is that the US housing market, and by extension home improvement market, will remain robust but there is no doubt that the company will enjoy more modest growth in the coming year than during the boom period of home improvement, during the lockdown year of 2021.
During the month, a new position was established in India’s largest company, Reliance Industries. The company was predominantly a petrochemical refinery until 2002 when the company entered telecommunications and in 2006 it entered retailing. The company has a digital services platform that is so attractive that Facebook and Google have taken minority stakes. We anticipate higher refining margins and continued impressive retail growth.
War in Europe has had immediate impacts for markets within those directly impacted sectors. Russia and Ukraine supply a substantial proportion of the world’s hydrocarbons, as well as precious metals and food. Sanctions will result in further increasing inflation expectations. With both inflation and employment levels both high, central banks would seem obliged to follow through on their plans to reduce global liquidity. Reducing money supply by raising interest rates and actively quantitative tightening ought to reduce asset prices. We remain cautious on equities trading on high multiples. The team continues to track a number of quality high growth companies that have seen substantial multiple contraction in the recent sell off.
Written as at 4 March 2022. Commentary covering 01 February to 28 February 2022.