How We Think

Thoughts at the Onset of the Pandemic

It has been decades since the entire world simultaneously altered its behavior in such an extreme and sudden way.  It has been even longer since a global health crisis was the cause.  We are saddened by the toll that it is having on so many people.  The human race is resilient and will endure this crisis, just as it has endured past crises and will endure future ones.

We have great confidence in human ingenuity to create significant economic progress over the next century.  Of course, the COVID-19 pandemic, the political response, and the madness of crowds make it difficult to predict revenues and earnings for the next month, quarter, and year.  In times like these and in times like three months ago when no one imagined we could be where we are today, we assume the following:

  1. In the short-run, economic activity is difficult to predict. An economic decline at least as large as any that have occurred in the last 125 years[1] could begin any day.
  2. In the short-run, markets can trade anywhere. On any particular day, markets can act at least as erratically as any markets have in the last 125 years.
  3. In twenty-five years, the world will be more productive and prosperous than it is now.

We have always sought businesses that will benefit from long-term prosperity and are also built to be successful in any economic or market environment.  Such businesses allow us to focus less on harder-to-predict short-term results and more on long-term prospects.  For each business, we forecast a base case of expected operational results, and then we contemplate what conditions could severely impair the equity value of shareholders.  For example, can the company survive a disruption to its supply chain?  How does an economic downturn affect the demand for its products and services?  Is its balance sheet capitalized in a way that the company can survive a sudden drop in cash flow with a simultaneous lack of access to capital markets?  Many events can lead to these outcomes individually or collectively.  Of course, we did not presume a pandemic as a precipitating cause, but that is partly the point.  We want our businesses to be robust against conditions that are difficult to presuppose.

As partners, your investment in our funds is a fractional ownership interest in the earnings and cash flow generated by our businesses.  While the stock prices of these companies are down alongside the broader equity markets, we expect operating results have not been impacted as severely.  Our businesses satisfy thirst, entertain, and connect friends, families, and workers.  Our channel checks suggest that the demand for these offerings has increased in response to the pandemic.  Consumers in many of our markets are not just stocking up on toilet paper, they are also buying lots of water, cokes, and beer.  Some evidence suggests that consumption of our products has also increased with people spending more time at home.  Broadband, mobile services, and premium television have never been in more demand with millions of people working from home, seeking indoor entertainment, and connecting with family and friends digitally.  Importantly, if the economy does slow for a prolonged period, our businesses have historically been less cyclical than the economy at large.  They will generate profits in 2020 and 2021 regardless of the economic cycle, and they will generate substantially more profits in 2030.

We have spoken with the management teams of our businesses over the past few weeks.  We have asked how the pandemic has impacted their people and operations, how they are responding to these issues both personally and professionally, and how they are managing any financial impact to maintain and promote the overall health of the organization.  We also have been encouraging them to have the same mindset we describe above.  Our message to them is:

  1. Do not assume that the market is necessarily providing any useful information about your business when it lowers the stock price.
  2. Have confidence in what you know about the prospects for your business.
  3. Plan for the full range of outcomes possible in the coming months and years.
  4. Take advantage of the opportunities that the market is giving you, whatever they may be.

A few days after one such conversation with a CEO, the company announced its first ever share buyback program.  In “normal” times, this company has so many attractive ways to deploy capital organically at high rates of return that it never made financial sense to buy its own stock.  The sudden drop in its stock price this month, however, made share buybacks a more attractive place to deploy capital.  We applaud share repurchases that are compared carefully against the expected return on investment of other uses of cash.  For most public companies, the experience has been the opposite.  Managements were delighted to repurchase shares when prices were much higher, but now many of those companies are raising cash to try to ensure they remain solvent.  A great deal of shareholder value for remaining owners has been destroyed in this process.  We are pleased that this management team had the fortitude to pursue an opportunistic share buyback in a moment of broader fear.

If a company’s prospects are not determined by the rise and fall of its stock price, then investors should appreciate the opportunities that market volatility creates.  We are benefitting from the cumulative work of our research team over the last two decades.  This institutional knowledge allows us to better recognize and allocate finite time to the most promising ideas, especially in fast-moving markets.  These market environments are much more likely than a low volatility environment to offer the types of opportunities that we seek.  In fact, we are deploying available cash in high quality businesses, and we are actively considering selling existing stakes to buy more attractively priced businesses.

We expect to enjoy very satisfactory returns from current stock price levels for the businesses in our portfolio.  Through a long-term lens, the intrinsic values of our businesses have not changed much in the past month, meaning their discounts to these intrinsic values have grown as prices have fallen.  Encouragingly, the gap between the valuations for the S&P 500 and our opportunity set has widened in our favor in the last few weeks.  We have been adding to our personal investments in our funds to capitalize on these opportunities.  We are grateful for the trust you place in us.  Please do not hesitate to let us know how we can be of service – we encourage you to reach out if we can be a resource.

Earlier from May 2020…

First and foremost, we hope this letter finds you and all of your loved ones safe and well.  People around the world are suffering from this pandemic in ways big and small.  We are thankful that our companies are making significant contributions to help their communities.  The Coca-Cola system is giving more than $100 million to support COVID-19 relief efforts, including more than $39 million in cash donations to organizations such as the Red Cross/Red Crescent Societies, Boys & Girls Clubs, and regional food banks.  Coke bottlers are transporting needed medical supplies; producing hand sanitizer for local hospitals, clinics, and nursing homes; and donating plastic to produce protective face shields for healthcare workers.  In addition, our bottlers are giving mom & pop store owners plastic shields to keep them and their customers safe.  Anheuser-Busch InBev’s (ABI) efforts are also global in scope.  ABI is donating millions of liters of potable water to regions with poor sanitation, and the company is producing and donating millions of bottles of hand sanitizer and disinfectant to hospitals and front-line workers.  ABI and its Latin American subsidiaries are building and donating new hospitals and medical facilities in Sao Paolo, Brazil; Barranquilla, Colombia; and Lima, Peru.  The hospital in Lima is a project led by ABI’s Peruvian subsidiary Backus y Johnston (which is also one of our direct holdings) and is being built for the benefit of Peru’s national police.   In Africa, ABI is responding to a spike in gender-based violence from the lockdown by expanding its #NOEXCUSE initiative, including a help line and support services.  ABI is directly supporting restaurant and bar owners across the world via programs like “Café Courage” in Belgium, through which consumers can pre-order and pay for their favorite beer at a participating bar to enjoy whenever it reopens.  Because connectivity is an essential service for the safety of its customers, Liberty Latin America has created lifeline plans that maintain essential connectivity services for customers who cannot afford to pay their bills because of the economic disruption caused by the pandemic.  Additionally, it has funded an organization called One on One Educational Services Limited to provide virtual learning access to over 130,000 students across the Caribbean at no cost while schools are closed.  These initiatives reflect our companies’ dedication to being good citizens.  While these efforts will help their communities bounce back faster, our companies are ultimately playing the long game.  They expect to serve these communities for decades to come.

 

[1] 125 years includes the Panic of 1907 and the full history of the Dow Jones Industrial Average.