The following segment was excerpted from this fund letter.
Top Holdings
Our top five investments represented roughly 50% of the equity portfolio at quarter end. In alphabetical order, they were Avantor (AVTR), Baxter (BAX), Fiserv (FI), Nintendo (OTCPK:NTDOY), and Philip Morris (PM). Three of these five weighed on performance most heavily in the second quarter. And just the same, four of the top five were the fund’s largest contributors in July. As there was no major activity during the quarter, we provide a brief update on each of our top holdings below.
Avantor
Avantor is a leading provider of mission-critical products and services to the life sciences and advanced technologies industries. The company’s shares slid 17% during the quarter before rallying 26% in July, following a strong earnings report that alleviated investor concerns about the industry’s pace of recovery. While management remained hesitant to make an outright call on the recovery, both commentary and performance continue to trend in that direction. The company reaffirmed full-year guidance, noting increasing signs of improvement in Bioprocessing, which should exit the year at a mid-to-high- single-digit growth rate, and reconfirmed expectations for 20% EBITDA margins by year-end 2025. We continue to believe the guide is conservative as the mix shifts towards proprietary content, and accelerating cost initiatives should drive outperformance, with potential for significant upside revisions as the industry recovery takes hold. For a more comprehensive analysis, investors may access our recent write-up or our related conversation on Yet Another Value Podcast.
Baxter
Baxter is a global healthcare company specializing in critical-care products, medical devices, pharmaceuticals, and biotechnology solutions that enhance patient outcomes across hospitals and clinics worldwide. The company’s shares slid 12% during the quarter before rallying 7% in July and jumping 7% after reporting earnings in August. We thought the results demonstrated the durability of Baxter’s portfolio and confidence in the organic growth trajectory of its underlying business segments. Despite the broad-based outperformance, increased guidance across the board, easing supply chain constraints, accelerating sales of its recently approved infusion platform, and the recently announced sale of its kidney care segment, consensus remains unimpressed and comfortably in “show-me” mode until the separation is finalized. At less than 12x FY25 earnings estimates, we are happy to accumulate shares and significantly increased our position during the quarter. Once it becomes obvious that Baxter’s core business segments can generate 4% – 5% organic growth, we doubt the stock will continue to trade at half the market’s multiple as peers trade closer to 20x earnings.
Fiserv
Fiserv is the premier provider of financial technology services, supporting banks, credit unions, and financial institutions with innovative banking solutions, payment processing, and data analytics to streamline and secure financial transactions. The company’s shares slid 7% during the quarter before rallying 10% in July to fresh all-time highs. Clover remains the company’s crown jewel, generating over $300 billion in annualized GPV (Gross Payment Volume) with better monetization, driving 28% revenue growth in the recently reported quarter, and three new hardware products plus pilot programs in Mexico and Brazil going live in the coming months. Simply put, there are few businesses in this industry executing even close to the same level, and fewer still with Fiserv’s scale, distribution, and collection of assets. In our initial write-up, we highlighted the embedded distribution advantages often enjoyed by incumbents, noting that “Fiserv can cross-sell products through its large, engrained distribution channels, driving faster growth than even its most rapidly growing peers. And with Clover and Square accounting for less than 10% of a fragmented market, we think there is plenty of room for both to run.” Notably, Jack Dorsey, Chief Block Head, Square Head, Chairman, and Cofounder, recently came to the same conclusion, admitting as much on the company’s most recent earnings call: “I would state that our product quality is far above the majority of our competitors. Where we have been weaker in the past is how we mirror that with our go-to-market strategy and just updating our approach there, especially given what our competitors have done.“ We wonder which competitors come to mind.
Nintendo
Nintendo is a video game company with an iconic library of intellectual property. Shares lost 2% in the second quarter overall before recovering in July with a 3% gain. After its most recent earnings report, the guidance Nintendo set for console and software unit sales seemed more ambitious than reasonable. We are still waiting on the next console to be announced, but in the meantime, management is increasingly focused on monetizing its IP. In recent years, the company has partnered with Universal to open theme parks under the banner of Super Nintendo World and to develop movies based around its characters. These include last year’s Super Mario Bros. Movie and a forthcoming live-action movie based on Legend of Zelda. Meanwhile, we expect the anticipated Switch 2 console will bring a greater mix of software sales from new games. Aside from the improved financial profile that software typically carries, including higher profit margins and more recurring revenue, there is also room for the company to grow pricing in its subscription services which are currently priced well below competitors. We have admired Nintendo’s creative culture for years and are excited to take part in the financial evolution of the company.
Philip Morris
Philip Morris International is a multinational tobacco company focused on smoke-free products like heated tobacco and nicotine pouches to create a smoke-free future by transitioning away from traditional cigarettes. The company’s shares gained 12% during the quarter and tacked on another 14% in July. Well-publicized supply shortages, increasing competition from unauthorized products, grandstanding politicians, and a temporary halt to online sales did little to slow PM’s smoke-free momentum, as sales of reduced-risk products grew to nearly 40% of total company revenues. In fact, management expects an acceleration across its smoke-free business in the second half as supply constraints ease, driving substantial upward revisions to guidance and estimates. Notably, Zyn volume guidance (nicotine pouches) for FY24 has increased from 520 million units at the start of the year to 560–580 million units today, with capacity for 900 million cans next year. After three years of sideways trading, investors are finally waking up to the strength and resilience of PM’s earnings power and transition from a manufacturer of traditional tobacco to a faster-growing and significantly more profitable business. The stock’s rally over the last quarter was enough to put it ahead of both the S&P and the Nasdaq for the past three years. But at a now “inflated” 14.5x FY25 consensus estimates (which are likely too low), we think today’s valuation is a long way from discounting the transformation to a smoke-free Philip Morris.
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