Saxo Morningstar Moat EUR portfolio Q1 2020 commentary

Market overview

Volatility in stock markets returned in Q1 2020, ending a decade of steady positive returns and the best period for investors in modern history. Stocks have declined sharply across most major markets. Companies with high debt or direct exposure to the economic downturn, such as travel, hospitality, energy, financials and leisure companies, have been hit particularly hard.

The catalyst of this downturn is COVID-19. Social distancing has led to a record-breaking rise in jobless claims, along with deep recessionary signals and even liquidity concerns. These are true risks to the financial system, sparking an offsetting response of boundless stimulus from both governments and central banks. The silver lining is that expected returns are rising in a forward-looking context. 

That said, business will struggle in the short term. Many are describing COVID-19 as a black swan; it meets the classical definition of an unforeseen event with a low probability of occurring. This has been exacerbated by the breakdown in oil negotiations between Saudi Arabia and Russia, causing the oil price to slide. It is little wonder that fear has gripped the public at large. So, while there is undoubted confidence of surpassing the prior heights in the long run, the uncomfortable reality is that the near-term future carries heightened uncertainty that we must all navigate. 

Portfolio performance

(Performance is net of all fees)

Best-performing positions

• RingCentral Inc is a provider of unified-communication-as-a-service software, or UCaaS, and provides users with a unified application for communication and collaboration that includes voice, video, messaging and conferencing capabilities. The transition from on-premises communication services to cloud solutions like UCaaS is in the early stages and offers RingCentral a long runway for growth. The Morningstar investment team believes that RingCentral’s offering plays a critical role (communicating with co-workers and outside entities) in the daily workflow of employees that will allow it to earn excess returns for the next decade. The share price increased by 28.5% in the last quarter but according to Morningstar proprietary analysis, the stock is still undervalued and trades at a 35% discount to fair value.
  
  
• Biogen Inc is Biogen and Idec merged in 2003, combining forces to market Biogen's multiple sclerosis drug Avonex and Idec's cancer drug Rituxan. Today, Rituxan and next-generation antibody Gazyva are marketed via a collaboration with Roche. Biogen has several drug candidates in phase 3 trials in neurology and neurodegenerative diseases and has launched Spinraza with partner Ionis. The Morningstar investment team thinks that Biogen's specialty-market-focused drug portfolio and novel, neurology-focused pipeline create a wide economic moat. The share price went up 9.08% in the last quarter and according to Morningstar proprietary analysis, the stock trades at a 27% discount to fair value.
  
  
• Tencent is a Chinese internet giant with businesses and investments in a wide variety of Internet services and contents. Major services include communication and social networking, online PC and mobile games, the cloud and financial technology. Tencent has an aggregate monthly active user base of over 1 billion for Weixin/WeChat. Tencent is transforming from consumer Internet to industrial Internet and is advancing into finance, government, smart retail and industrial verticals. This transformation will take time, particularly since Tencent has been more of a consumer-facing company in the past. The share price went up 4.58% in the last quarter and according to Morningstar proprietary analysis, the stock trades at a 16% discount to fair value.

Worst-performing positions

• Viacom CBS Inc is a media conglomerate operating around the world. Its assets include the CBS television network, a number of local TV stations, several leading cable network properties and several online properties, while Viacom's Paramount Pictures produces original motion pictures. The Morningstar investment team expects the company to increase the percentage of content on the broadcast network created in-house (currently above 70%) to fully capture the multiple cash flows that a hit show can produce. The investment team believes that the CBS broadcast network also provides ViacomCBS with an advantage, as the networks are the only outlets to reach almost all households in the United States. Even with viewers' shift toward cable over the years, network ratings still outpace cable ratings and provide advertisers with one of the only remaining methods for reaching a large number of consumers. This combination of highly rated original programming and exclusive sports rights will allow CBS to continue to increase its revenue from retransmission fees and reverse compensation while still receiving higher ad rates than a typical cable network. The share price went down 65.3% in the last quarter and according to Morningstar proprietary analysis, it is severely undervalued and trades at a 77.4% discount to fair value.
  
  
• Tenneco Inc's emissions-control products meet strict air-quality legislation, optimise engine performance, improve fuel economy and acoustically tune engine sound to fit a vehicle's profile. After closing on the Federal-Mogul acquisition in October 2018, management had originally intended to separate the new entity into two publicly traded companies in the second half of 2019. However, the separation is postponed because of the coronavirus-induced shutdown of much of the global automotive industry. Management now says that it is "reviewing and considering strategic alternatives... while pursuing the separation plan." This may include asset sales or potentially the sale of one or more business units. The share price went down 71.9% in the last quarter and trades at a deep discount of close to 90% of fair value.
  
  
• Macerich Co owns and operates premium regional malls. The company's portfolio should produce higher tenant sales productivity, occupancy levels and rent, and is therefore much better-positioned to face the economic headwinds of e-commerce. E-commerce continues to pressure brick-and-mortar retail as consumers increasingly move their shopping habits online, and in addition, Macerich must deal with the fallout of the current coronavirus pandemic. The Morningstar investment team believes that premium malls will rebound, but the short-term impact to Macerich's cash flow will be significant. The Morningstar investment team expects Macerich to continue improving its portfolio through redevelopment, opportunistic acquisitions and asset sales, which should deliver strong earnings growth for Macerich over time. The share price went down 75.7% in the last quarter and according to Morningstar proprietary analysis, the stock trades at a deep 77.7% discount to fair value.

Outlook

Whilst a negative sentiment is warranted, a more balanced view provides reasons to be more optimistic over a longer-term horizon. Periods of loss, while painful, are part of an investor’s journey, with the opportunity to buy quality assets at heavily discounted prices. Current analysis of investor activity suggests that the investor response has, in many cases, been emotive. As such, where only months ago, investors had to look very hard for value, there is now opportunity knocking across both stocks and fixed income. This is not to say that there won’t be further declines in the near-term, but seeing better value provides a compelling reason to buy discerningly for those focused on delivering longer-term outcomes.