
Never a dull moment.
Just as people were beginning to expect a return to normalcy after COVID, unexpected events, such as inflation and war in Ukraine, left investors wondering how to adjust. Then, on March 17, Silicon Valley Bank (SVB) became the second-largest bank in U.S. history to go bankrupt, quickly followed by Signature Bank. This caused panic selling across financial companies worldwide, ultimately leading to the demise of Credit Suisse and its forced merger with UBS. Many quality articles already exist that explain these events in detail so we will instead focus on their impact on Global Alpha portfolios.
Our Investment team had already decided to be cautious on banks and take profits on some of the names we owned at our year-end review in December 2022. Our rationale was that net interest margins would be compressed by rapid rate hikes and the need to remain competitive on lending rates to retain customers. We certainly did not expect the impact to be this immediate.
Our portfolios performed well during this period, offering downside protection due to our underweighting of banks and financials as well as our quality bias. None of our holdings were materially impacted by SVB’s or Signature Bank’s collapse. We have made no material weight adjustments to our financial names and have reached out to their management teams for more information on their situation. We remain confident in the business models and growth prospects of all our financial sector holdings.
On the macro front, the European Central Bank raised rates by 50 basis points (bps) on March 16 and reassured investors that it has ample tools to manage price and financial stability separately without needing a trade-off. The US Federal Reserve Board appeared to follow the same line of thought with its 25 bps increase a week later.
In Japan, a new Bank of Japan governor, Kazuo Ueda, was chosen to replace Haruhiko Kuroda. Ueda is expected to slowly pave the way to a normalization of the Bank’s ultra-accommodative policy over his tenure. We see this as a net positive in the medium to long term given the unsustainability of the current policy in this global inflationary environment.
On a positive note, China’s reopening seems well underway, with retail sales for January and February up 3.5% year over year, providing a net tailwind to the global economy in the short term.
BACK TO INTERNATIONAL SMALL CAP
During the first quarter, the MSCI EAFE Small Cap Index underperformed the MSCI EAFE Large Cap Index, but outperformed the MSCI Emerging Markets Index.
Within the MSCI EAFE Small Cap Index, information technology, which represents 9.9% of the Index, was the strongest-performing sector, delivering a 11.1% return. Real estate was the worst-performing sector, returning -2.4% for the quarter, with an Index weight of 10.3%.
PERFORMANCE HIGHLIGHTS
Over the same timeframe, our International Small Cap composite delivered a 9.1% gross return, outperforming the MSCI EAFE Small Cap Index by 4.3% (gross).
Our top performer for the quarter was Sopra Steria (SOP FP), a France-based IT services company providing digital consulting services and software development to help clients with digital transformation, ranging from changes to business models to revamping information systems and internal processes.
Since Sopra acquired of Steria in 2014 to accelerate growth outside of France, the company has seen significant success and is now the second-largest IT provider in the country, with over 6% share in a highly fragmented market.
So, what drove the stock up?
Sopra has some defensive characteristics that made it an attractive investment in the volatility seen in the early part of the quarter. Indeed, a large percentage of Sopra’s revenues are recurring in nature, while also deriving 30% of its revenue from the public or semi-public sector.
Amidst this environment, Sopra announced strong 2022 results in February with revenue topping the revised guidance due to a strong end of year, citing an upbeat market for digital services. Sopra then closed the quarter with a meaningful acquisition, announcing a €517 million offer for Ordina, one of its peers in the Netherlands that possesses a similar profile to Sopra with its exposure to the public sector above 40%. The deal offers clear synergies and is immediately accretive to Sopra, reinforcing our confidence in Sopra’s management.
Another top contributor last quarter was Meliá Hotels International (MEL SP), a leading European hotel group that owns and manages more than 326 luxury and mid-scale hotels and resorts in 33 countries, mainly in the Americas and Europe. Meliá’s brand recognition and strong positioning in less competitive regions, such as Latin America, remain key differentiators compared to its peers.
Despite being penalized at the start of COVID due to global travel restrictions, Meliá saw a resurgence of interest from investors as a reopening play thanks to its strong operational resilience and undervalued assets, outperforming its competitors since the pickup in international travel.
What drove the stock up?
Meliá rallied in early January along with the overall stock market, as fears about the extent of a recession eased. Optimism was high for the hotel sector to outperform in 2023. Indeed, given the strong end to 2022, momentum was expected to continue, especially with China easing travel restrictions and Meliá’s revenue per available room (RevPAR) being above its 2019 levels in many regions.
Meliá supported this positive outlook with solid Q4 results, with revenue and EBITDA coming in better than expected. The company noted that travel demand remained resilient despite fears of inflation and economic downturn. Booking numbers showed 25% growth compared to 2019, and there was also a positive outlook for corporate travel and conferences. Melia remains one of the highest-conviction picks in our portfolio.
Our top detractor for the quarter was L’Occitane (0973 HK). A French company listed in Hong Kong, L’Occitane manufactures, markets and retails natural and organic skincare and beauty products. The company has over 3,400 retail locations in 90 countries. Its main brand, L’Occitane en Provence, represents the majority of its sales and is well-known for its quality at an affordable price.
The global beauty market is estimated at US$240 billion and growing between 3% and 5% per year, driven by demand in Asia. L’Occitane benefits disproportionately from this trend as its brand recognition in China outshines many of its Western competitors.
What drove the stock down?
The company saw its same-store sales growth decline in the quarter ending December 2022 due to weaker than expected sales in China and the strategic decision to reduce sales to promotional web partners in the U.K. As a result, the company lowered its full-year guidance for both sales growth and margin.
However, L’Occitane benefitted from China’s reopening in January and we remain confident in the company’s medium-term outlook. Growth in the next fiscal year will be supported by the recovery in travel retail, Elemis product launches and entry into new markets, and channel expansion for its emerging brands.
NEW POSITION
We finished the quarter with a new position in Concordia Financial Group (7186 JP). It is Japan’s third-largest regional bank in terms of loans and deposits, with large exposures to the Tokyo and Kanagawa regions, which account for 60% of listed companies and 18% of the population. The group consists of 205 branches, including Bank of Yokohama and Higashi-Nippon Bank.
We have been monitoring Japan-based banks for some time, but were waiting for a catalyst given the ultra-low-rate environment in Japan. With the Bank of Japan now expecting to shift away from its extremely accommodative monetary policy following the nomination of Kazuo Ueda, we anticipate improved profitability for the banking industry. Concordia Financial Group has a higher ratio of variable rate loans than other regional banks and should therefore benefit disproportionately. Additionally, even without the expectation of rate hikes, Concordia provides best-in-class management with one of the lowest overhead ratios and a history of efficient operations.
Despite the negative press from their U.S. counterparts in March, Japan’s regional banks’ fundamentals remain solid. As their stock prices corrected during the SVB saga, we saw an opportunity to initiate a position in a quality name at a discount.
OTHER NEW BUYS AND SELLS
During the quarter we also initiated a new position in Allkem Ltd. (OROCF) while we sold our holdings in Biffa, M&A Capital Partners, LINTEC Corp., Dometic Group and Schweiter Technologies.
WHAT IS OUR EAR-TO-THE-GROUND APPROACH TELLING US?
Global Alpha has been back on the road with company meetings and conferences. Across the multiple regions we cover, we found mixed signals from management teams in various industries in the first quarter. Despite the alleviation of supply chain pressures and the resurgence of the Chinese consumer, concerns around persistent inflation, the impact of rate hikes on liquidity and continued geopolitical tensions persist.
Even amidst the speculative and risk-on sentiment earlier in the year, our quality bias benefitted us during the quarter as March saw a flight to safety and quality throughout the SVB and Credit Suisse saga.
In this macro-driven environment, we are focusing on companies with little debt and strong cash flow generation, as well as well-defined secular trends that will drive growth for years to come. We believe this new volatile environment will provide active asset managers with opportunities to add value.
We are not making significant sector or country adjustments to the portfolio based on these expectations. Instead, we are maintaining a diversified list of holdings with defensible business models that are trading at a discount to their intrinsic value. Our portfolio remains well-diversified across the many countries, currencies and industries that comprise our benchmarks.
The Global Alpha team