Dear Unitholder:
The third quarter continued the positive development that we discussed in the previous two quarters and that we have been observing in our funds since the discovery of the COVID-19 vaccines almost a year ago. September was a particularly good month for our international portfolio with gains of around 6%. The value sector in Europe has performed very similarly to the European market as a whole, especially during the last quarter, but our funds have been observing an increasing de-correlation, which has resulted in a significant outperformance of the market and of European value companies as a whole, as shown in the chart below.
Although it is impossible to know with certainty what will happen in the future, we expect this positive development to continue, as the investment assumptions of the companies in which we are invested continue to be realised. Regardless of what the market does in the short term, we continue to insist that cash generation is the only factor that counts in the long-term evolution of the share price. In this respect, we have great confidence in the quality of our companies, which is reflected in the good performance of their business and their ability to continue to increase in value over time.
This has allowed us to continue to increase the target value of the funds, with the Iberian Portfolio once again reaching all-time highs in target value and the International Portfolio close to those highs. We believe that sooner or later this will have to be reflected in the net asset value of the funds. In short, our portfolios are still worth more than twice as much.
This quarter we comment on the performance of the gas sector and take the opportunity to briefly review what is happening in the oil sector and our theory on the matter, which we discussed in detail in our previous letter (see here). Our direct exposure to the gas sector represents about 9% of the International Portfolio, while our indirect exposure through gas transmission and processing infrastructure companies represents about 16% of the International Portfolio. We also use this letter to comment on oil services companies, which we believe will benefit from the expansionary investment cycle that should occur in the sector, and which account for about 10% of the International Portfolio and 10% of the Iberian Portfolio.
OIL
In our previous quarterly letter we commented on our view of the oil sector, which has been supported by the sector’s performance in recent months, where the rise in the price of a barrel of oil, as well as the lack of investment in necessary supply capacity, have led to supply shortages, creating a favourable situation for the oil sector companies in our portfolios. The major international energy agencies have recently confirmed our assumption that oil demand will return to pre-COVID-19 levels of 100Mn barrels/day by 2022.
Thereafter, the most likely medium-term scenario is that demand in the sector will continue to increase at least until the end of the decade, supported by population growth and economic growth, due to the development of emerging economies.
Part of the market believes that the high oil prices we have been seeing, above $80/barrel recently, are due to OPEC’s artificial restriction of supply and lower production from US shale, which will sooner or later return to the strong growth path seen in the past. Conversely, we believe that as the necessary prior investment has not been made during the last five years, when the reactivation of demand is consolidated, the price will have to reflect it, as is already happening. Therefore, although OPEC plays an important role in balancing the market, we believe that the problem is structural in nature and that it is essential to undertake the necessary investments to ensure that oil supply can cope with expected future demand.
For this reason, we believe that oil service companies should benefit strongly from increased investment in the future. These are companies whose business is to undertake engineering and construction projects for the development of oil fields and associated oil and gas treatment infrastructure. Subsea (OSL:SUBC, Financial) pipelines (Subsea 7), gas processing (Maire Tecnimont (MIL:MT, Financial), Petrofac (LSE:PFC, Financial), TĂ©cnicas Reunidas (XMAD:TRE, Financial)), seismic exploration (CGG), refineries and petrochemical plants, among others. In addition, all of them have exposure to the energy transition, due to their energy engineering capabilities.
GAS
Demand
In contrast to what has happened in the oil sector in the wake of the pandemic, with demand falling by 9% in 2020, demand in the natural gas sector has remained reasonably stable, with a slight fall of 2% in 2020. In fact, some countries such as China have increased their consumption significantly, with increases in natural gas demand of close to 7% and 12% in LNG imports.
So far this year we continue to see double-digit increases. Gas accounts for 25% of global energy consumption worldwide and this share has been growing steadily over the last 25 years, gaining market share from oil, but above all from coal.
While in oil there is a divergence of opinion on what demand will be in 20-30 years, in gas there seems to be a broad consensus on a long-term increase in demand.
This is mainly because it is an abundant source of energy, relatively easy to extract and transport, and emits around 50% less CO2 than coal and 25% less than oil. All of the above suggests that gas has a key role to play in the ener-gy transition to cleaner energy over the coming decades.
Supply
Global natural gas production has increased by more than 20% over the last 10 years, very much in line with the increase in demand over the same period. As in the oil sector, the increase in production comes largely from US shale gas (about 50%).
So far this year, several cyclical factors have contributed to the imbalance we are seeing between gas supply and demand, mainly in Europe and Asia. This imbalance has led to price increases like we have never seen before, reaching $30/mmbtu in Europe and over $35/mmbtu in Asia.
The high price of gas has been the main cause of soaring electricity prices in most European countries, reaching levels close to €200/MWh in Spain.
Some of these factors are of a temporary nature, such as the delay of the Nordstream 2 pipeline from Russia, or a too low level of gas inventories due to last winter being unusually cold. However, we believe that the current imbalance has a structural cause, namely the lack of necessary investment in the sector. Similar to what is happening in oil, financing for new investments has also been reduced in the gas sector, especially in the American shale, but also in other geographies such as Russia and the Middle East. Proof of this is that after a growth in proven gas reserves of 40% over the last 20 years, there has been a slight fall of 1% in 2020.
In a market where increased production is quickly absorbed by new demand and where future growth prospects are very positive, as we have seen, any small imbalance can generate strong price swings, as is being demonstrated.
In addition, there is an imbalance between the regions where gas is produced and the regions where it is consumed. Much of the production comes from North America, the Middle East and Russia, while Europe and Asia are net importing regions with gas deficits.
For this reason, we believe that investment in gas transport, liquefaction and regasification infrastructure must continue, and we have positioned part of our portfolio to benefit from this trend.
Surprisingly, the market is also showing a strong rejection of gas companies on sustainability grounds, even though they look set to play a key role in the decarbonisation of economies and the transition to renewables. As in the oil sector, and despite the strong recovery of gas prices and the structural growth trend, companies have lagged in their share prices.
For the reasons explained above, at Cobas AM we are detecting good investment opportunities in the sector, such as Kosmos (KOS, Financial), IPCO (TSX:IPCO, Financial), Inpex (TSE:1605, Financial) and Cairn (LSE:CNE, Financial) in the production sector, and Golar (GLNG, Financial), Exmar (XBRU:EXM, Financial), Dynagas (DLNG, Financial), Gaslog (GLOG, Financial) and Energy Transfer (ET, Financial) in infrastructures. All of them at very attractive multiples.
Portfolio
In Cobas AM we manage three portfolios: the International Portfolio, which invests in companies worldwide, excluding those listed in Spain and Portugal; the Iberian Portfolio, which invests in companies listed in Spain and Portugal, or that have their operational hub on the Iberian Peninsula; and, last but not least, the Large Company Portfolio that invests in global companies, 70% of which at least have over 4 billion euros in stock market capitalisation.
With these three portfolios, we built and have managed the various equity funds as of 30 September 2021:
We remind you that the target value of our funds is based on internal estimates and Cobas AM does not guarantee that its calculation is correct or that they will be reached. We invest in assets that the managers deem to be undervalued. However, there is no guarantee that these assets are actually undervalued or that, even if they are, their price will move in the direction expected by the managers.
International Portfolio
Over the third quarter of 2021, our International Portfolio posted a positive return of +4.2% versus the +0.7% profitability posted by its benchmark index, the MSCI Europe Net Total Return index. Since the Cobas Internacional FI fund began investing in equities in mid-March 2017, it has obtained a return of -13.1%, while its benchmark index has obtained a return of +34.2% for the same period.
During the third quarter we made few changes in the International Portfolio in terms of purchases and sales. We have completely exited G-III (GIII, Financial), Porsche (XTER:PAH3, Financial), and Diamond S Shipping (DSSI, Financial), which in June had a combined weighting of less than 3%, and have entered Gaslog Partners (GLOP, Financial), BW Offshore (OSL:BWO) and Enquest (LSE:ENQ) with a combined weighting of slightly more than 3%. Elsewhere, the main movements have been: on the buy side, we increased our weighting in International Seaways (INSW), and in Babcock International (LSE:BAB); however, in the latter case we increased the weighting mainly due to the revaluation of its share price during the quarter (+28%), while, on the sell side, we decreased our weighting in AMG (AMG), and Sol Spa (MIL:SOL).
During the third quarter we increased the target value of the International Portfolio by 3% to €192/share, which implies that the potential for appreciation stands at 121%.
Obviously, as a result of all this potential and our confidence in the portfolio, we are invested at 98%, close to the legal maximum. The whole portfolio trades at an estimated 2022 P/E of 8.0x versus 15.1x its benchmark and has a ROCE of 30%, but if we look at the ROCE excluding shipping and commodity companies, we are close to 43%, which demonstrates the quality of the portfolio.
Iberian Portfolio
The net asset value of our Iberian Portfolio in the third quarter of 2021 was +0.2%, compared with +1.5% for its benchmark index. If we extend the comparison period since we started investing in equities until the end of September 2021, it has obtained a return of -4.9%, while its benchmark index has obtained a return of +13.1% for the same period.
During the third quarter we have made few changes in terms of portfolio purchases and sales. We have exited Merlin Properties (XMAD:MRL) completely and have entered ACS (XMAS:ACS) in both cases with a weighting of close to 1%. In the rest of the portfolio, we have slightly increased our weighting in Atalaya (LSE:ATYM) and Galp (MEX:GALP) ; and we have lowered it in CTT (XLIS:CTT) and Elecnor (XMAD:ENO), although, in the latter case, due to their worse relative performance versus the rest of the portfolio.
During the quarter we increased the target value of the Iberian Portfolio by about 6%, to €210/unit, as a result of which the upside potential stands at 121%.
In the Iberian Portfolio, we have invested 98% and, as a whole, the portfolio trades with an estimated 2022 P/E ratio of 7.6x, compared to the 14.5x of its benchmark index, and with a ROCE of 30%.
Large Company Portfolio
During the third quarter of 2021, our Large Company Portfolio had a return of -1.2% versus +2.3% in the benchmark index, MSCI World Net. Since the Cobas Grandes CompañĂas FI fund began investing in equities in early April 2017, the return has been -16.0%. In that period, the benchmark index rose by 60.9%.
Over the third quarter, we have hardly rotated the Large Company Portfolio. We have not exited any stocks and have entered ACS and New Fortress Energy with a combined weight of less than 2%.
In the rest of the portfolio, on the buy side, we mainly increased our position in Galp and Babcock International, although in the latter case this was largely helped by the share price appreciation during the quarter (+28%); while, on the sell side, we have lowered our position in KT Corporation (XKRX:030200) and Dassault Aviation (XPAR:AM).
During the quarter, the target value of the Large Companies Portfolio remained stable at €181/share, representing a potential upside of 115%.
In the Large Companies Portfolio we are 98% invested. Overall, the portfolio trades at an estimated 2022 P/E ratio of 7.1x, versus 18.7x for its benchmark index, and with a ROCE of 32%.
