As a bottom-up stock picker, Orbis loves buying companies that trade at steep discounts to their true value, for reasons specific to each company. Orbis also loves clustered opportunities, where a number of shares with a common trait all trade at low valuations. When clusters represent large parts of the market, this can lead to opportunities that offer the best of both worlds: an especially attractive stock within an especially attractive part of the market. One such example is the number of such ideas that Orbis has identified in the broader cluster of companies that appear to have been excessively punished for their perceived uncertainty.

Wells Fargo is an example of a stock in the Orbis Global Equity Fund that has been severely penalised for uncertainty. Once almost universally seen as America’s premier bank, Wells has gone from market darling to one of the most disliked stocks, thanks to a high profile ‘fake accounts’ scandal. Its shares have underperformed by roughly 15% over the past two years.
In similar situations in the past, it has been rewarding to look beyond nearterm uncertainty and take a longer-term perspective. Although the scandal has certainly been damaging for Wells, the core franchise is intact and the bank’s credit quality and capitalisation levels remain exceedingly strong. Even though current earnings are depressed due to high expense levels, low interest rates and muted marketing efforts in the wake of the scandal, the bank still manages to generate US$5 billion of earnings per quarter - amounting to US$20 billion per year relative to its market capitalisation of about US$270 billion.

To put this in perspective, Wells’ valuation on a normalised price-toearnings basis is roughly 10 times and near an all-time low relative to the US market average of approximately 20 times. Wells should be able to sustain a 14-18% return on tangible equity; is committed to returning cash to shareholders; and is generating a 7% annualised yield once dividends and share buybacks are considered. In addition, it is particularly encouraging that the scandal has prompted Wells to launch a massive US$4 billion costcutting initiative. Orbis expects half of the savings to be reinvested in the business, but the rest should go straight to improving profits. This additional operating leverage should help drive low-teens earnings per share growth in the coming years. Beyond this self-help, the company could also benefit from corporate tax reform and reduced regulatory friction in the US.

These factors give Wells many of the hallmarks of a classic Orbis or Allan Gray investment. It is a company with an excellent long-term track record that is undergoing what appears to be a temporary setback. It is trading at a valuation which seems to offer a meaningful margin of safety at a time when equity prices are generally high. And with dismal expectations and poor sentiment, the stock’s risk-reward proposition is skewed in favour of the upside. While none of this may satisfy investors who are craving short-term certainty, we believe the Orbis Global Equity Fund will be well rewarded for its patience if Wells can successfully repair its reputation in the years to come.

There have been no material changes to the Fund’s geographical exposures or currency exposures in the last quarter. With regard to individual holdings, Sberbank of Russia, the country’s banking leader, replaced KB Financial, Korea’s largest retail bank, in the top 10 holdings. That change is largely due to price movements, as Sberbank outperformed global shares, while KB Financial fared worse. Amazon, the global e-commerce giant, exited the top 10 holdings as Orbis trimmed the position after strong performance caused the discount to intrinsic value to narrow.

Adapted from Orbis commentaries contributed by Adam Karr.
For the full commentary please see www.orbisfunds.com

When I joined Orbis in 2000, the tech-heavy Nasdaq Composite Index was trading near an all-time high. Today it stands about 20% higher than that previous peak, leaving those of us with first-hand memories of the dotcom boom-and-bust era feeling slightly nervous. But there is a big difference between price and value. Just because a stock has gone up a lot doesn’t mean it’s expensive - and vice versa.

Today’s leading technology stocks are solidly profitable household names offering services that have become indispensable to many of us in our daily lives. It is also evident that today’s leaders are very different businesses. Whereas the tech bubble favourites were known for selling technology - mainly to corporate customers - the likes of Alphabet, Amazon and Facebook, amongst others, are deploying technology to reshape the nature of commerce itself. This is no different from the impact that companies like Ford, Walmart and Visa once had.

As Orbis has written in previous commentaries, periods of change can often create enormous opportunities for investors. Not all of today’s leading stocks will continue to thrive, but the few that manage to navigate the shifting landscape can produce extraordinary rewards for their shareholders. The retail sector provides a good illustration. Having analysed retailers for almost 17 years at Orbis, I’ve seen a continuous evolution in which the old is constantly being replaced by the new.

When I first started looking at the sector, Walmart was the dominant franchise and the retail innovation of its time. The range and location of its stores enabled the company to steal market share from weaker rivals, squeeze its suppliers and pass the savings along to its customers. A generation later and harnessing a new technology, Amazon’s growth trajectory to date has traced a remarkably similar path.

Amazon’s current US market share is roughly where Walmart’s was 20 years ago. Just as remarkable is the similarity in their share price performance. Investors have often had the opportunity to buy Amazon shares at a price of around one times the total annual value of its customers’ purchases. That is equivalent to the one times revenue that Walmart typically traded at - a price which proved extraordinarily attractive for investors with the benefit of hindsight. When adjusting for the value of Amazon’s cloud computing business, a multiple of one times its customer’s transaction value is exactly where Amazon’s shares trades today.
But is it contrarian? What do we see here that others don’t? Well, one common belief is that Amazon’s retail business doesn’t make money the way that Walmart’s always did. A closer examination of each company’s financial statements reveals this assumption is flawed.

Both businesses are actually rather similar apart from one key difference. To grow, Walmart needed to constantly build new stores, whereas Amazon’s growth depends on marketing. While both forms of spending represent investment in future customers, they are recorded very differently in company financial statements. Compared one way, Walmart had higher accounting profits than Amazon as a percentage of revenue. But when measured in free cash flow, Amazon’s profitability is actually greater than Walmart’s was at a similar stage of growth.

We are well aware of the dangers of extrapolating promising growth paths indefinitely and, while we won’t always get things right, we use an analytical approach that plays to the strengths of our ‘matrix’ of independent regional and sector research teams. Investors can be assured that we ignore the superficial noise, thinking independently and making a balanced assessment of each investment’s true long-term value.

There have been no material changes to the Fund’s geographical exposures or currency exposures in the last quarter. With regard to individual holdings, KB Financial, Korea’s largest retail bank, replaced Sberbank of Russia, the country’s banking leader, in the top-ten holdings. The Fund’s position in Sberbank has been trimmed following its strong outperformance in 2016. While Orbis continues to believe it trades at a discount to intrinsic value and have therefore retained exposure to this share, its performance has dipped this year. By contrast, KB Financial has outperformed in the year-to-date amid declining credit costs and improvements to its revenue structure.

Adapted from Orbis commentaries contributed by Ben Preston, leader of Orbis’ London-based Global Sector research team For the full commentary please see www.orbisfunds.com

Historically, Orbis has protected capital by avoiding the speculative, bubble-like areas of global equity markets. For example, the Fund had minimal exposure to both Japanese equities in the early 1990s and to the Technology, Media & Telecommunication (TMT) sector at the height of its bubble in 2000. Orbis’ relative performance lagged as a result of not owning some of the most rapidly rising shares followed by meaningful outperformance as the prices of those same shares fell sharply. During these periods the attraction of the most rapidly rising parts of the market sapped the interest out of other large sectors of the stock market. Valuations in those sectors became sufficiently low that they offered both high prospective returns and lower risk of medium-term price declines. That opportunity enabled Orbis to meet the Fund’s investment mandate in that era.

During the 2008 Global Financial Crisis (GFC), Orbis was less successful at avoiding losses. Prior to the crisis, the Fund had exposure to shares trading at low valuation measures, but when economies collapsed and credit markets ceased to function properly, those low valuations provided little protection, given the magnitude of the deterioration in earnings most companies experienced. Many financial sector and highly levered equities suffered permanent capital impairments as they either became insolvent or sought rescue financing on highly dilutive terms. Investors avoided participating in a valuation-driven bubble, but instead were caught by a less discernible credit bubble.

Today, as we enter the ninth year of the bull market that started with 2009 lows, Orbis is presented with a more challenging environment than the 1990 and TMT eras in that it does not appear that there are large sectors of the market which offer meaningfully lower risk of medium-term price declines. Governments and central banks have injected so much low-cost money into the global economy that investors do not face a trade-off to sell shares to buy others. Combined with economic activity being brought forward through borrowing and stimulus, the majority of share prices, valuations and earnings are elevated.

The shares that are traditionally most attractive after long bull markets, being those in stable, predictable but therefore less glamorous businesses, are not. Amid unprecedented low interest rates, investors have been attracted to the steady dividends these shares offer and have driven up their prices. On the other end of the spectrum, shares of companies with heightened economic sensitivity, secular challenges or dependency on credit markets also carry risk as the allure of economic growth has attracted investors’ attention - or enough to keep prices above bargain levels. With no large sectors of the equity markets unpopular, there is very little opportunity to invest where current prices present low risk of short- to medium-term losses.

The risk Orbis is most concerned about is permanent impairment of capital - the risk that in time a share ends up being worth less than was paid for it. Orbis believes that the Fund’s exposure to that risk is limited. Orbis is enthusiastic about the long-term business prospects of the companies its bottomup research process has identified. Many are led by outstanding management teams who appear capable of enduring troubled times and taking advantage of distressed market conditions. The Fund also includes a number of shares of businesses that are protected by wide economic moats. For example, Berkshire Hathaway and Air Products and Chemicals possess large cash balances that can be readily deployed towards attractive investment opportunities in the event of large price declines.

Investments such as Charter Communications, Rolls-Royce Holdings and CDK Global, which makes software for car dealers, are undergoing transformations which should enhance their intrinsic value. Others, such as Amazon.com, online travel agent Priceline Group, Latin American online marketplace MercadoLibre and Chinese ecommerce company JD.com, benefit from innovation and secular change. And lastly, some investments, such as the US health insurers and Sberbank of Russia, are available at attractive valuations due to concerns about uncertain conditions in their industries or countries. The Fund retains very little exposure to businesses that rely on ongoing access to capital and are therefore at greater risk of suffering permanent capital impairments. Overall, Orbis believes the Fund’s holdings possess strong economic characteristics and are well-positioned for a range of long-term outcomes.

There have been no material changes to the Fund’s geographical exposures or currency exposures in the last quarter. With regard to individual holdings, British American Tobacco, the leading international tobacco company, entered the top 10 holdings as Orbis took advantage of share price weakness to increase the Fund’s position in what they believe to be a high-quality, cash-generative business trading at a meaningful discount to intrinsic value. By contrast, NetEase, one of China’s largest online game operators, exited the top 10 as Orbis have trimmed the Fund’s position size following its strong outperformance which caused the gap between its share price and its intrinsic value to narrow. Share price movements largely accounted for the exposure to Amazon.com, the world’s largest e-commerce business, to increase, replacing Qualcomm, a US manufacturer of chipsets for use in mobile phones, in the top 10 holdings.

The Fund returned 4.6% this calendar year - a relative gain of 9.4% versus its benchmark. This was a particularly good year, but also serves to reinforce the message that highly selective investment management is unlikely to produce performance in a steady and linear fashion.

There are simply too many variables, both known and unknown, and too much inherent randomness in markets to allow for smooth, predictable returns. Even for the most skilled managers, striving for outperformance over the long term has proven to be the more reasonable objective.

In addition to the natural ebb and flow of good and bad fortune, another reason for the lumpy performance of the Fund over the last few years has been the market environment, in particular the high degree of 'trending' - the unusually high propensity for certain stocks to continually outperform or underperform over multiple years. Active stockpicking is inherently volatile under normal conditions - and trending markets only serve to amplify this effect. Correlations rise across the board and value becomes increasingly clustered into certain interconnected areas of the market.

A current example is the low exposure that the Fund has to stable growth businesses, such as those in the consumer staples sector. This was a headwind in previous years as these types of shares (which typically command large weights in the market indices) trended higher, but then became a tailwind in 2016 as the trending dynamic began to break down.
Despite this year's reversal, Orbis still finds very few compelling opportunities among stable growth shares and the portfolio remains skewed towards shares of cyclical companies such as industrials, banks and basic resources. Examples include Rolls Royce, Wells Fargo and Newcrest Mining.

A number of Orbis' preferred laggards rebounded to deliver strong returns this year. One example is Qualcomm, a US-based research and development company focused on wireless communications technology for 3G, 4G and soon 5G network standards. Orbis first invested in Qualcomm in 2014, when fears over possible market share erosion left its shares deeply depressed. Those concerns were prompted by Qualcomm losing business at one of its major clients, Samsung, on the production of the Galaxy S6 smartphone. Orbis believed them to be short-sighted and focused instead on the business's attractive fundamentals.
Qualcomm's licensing agreements are long-term, effectively insulating the company against shifts in market share between manufacturers. Its chipset business utilises an asset-light model whereby all manufacturing is outsourced, allowing Qualcomm to focus on developing new chips while avoiding the massive capital expenditure that is part and parcel of semiconductor manufacturing. Despite Qualcomm's meaningful outperformance in the last year, boosted by the announcement of a series of new licensing deals as well as its winning back 50% of the chipset business at Samsung's nextgeneration flagship Galaxy S7, Orbis retains conviction that its long-term prospects come at a reasonable price.

At all times, Orbis seeks to ensure that your capital is allocated to the most compelling pockets of value in the market. The outcome of this process is a portfolio that differs meaningfully from passive stock market indices and that will experience both strong and weak periods of performance. But, as examples like Qualcomm illustrate, volatility in relative performance is a natural and inevitable consequence of active investing. At Orbis and Allan Gray, we believe looking through these gyrations and focusing wholly on fundamental security selection provides the best chance of compounding value on your behalf over the long term.

There have been no material changes to the Fund's geographical or currency exposures over the last quarter. With regard to individual holdings, Berkshire Hathaway, the investment holding company led by Warren Buffet, and Anthem, one of the largest health benefits companies in the US, entered the top 10 holdings, replacing KB Financial Group, Korea's leading retail bank, and PayPal holdings, the global payments leader. Orbis incrementally increased the Fund's position sizes in Anthem and Berkshire as their conviction in each has strengthened, and trimmed the position in KB Financial Group following its recent outperformance.

Adapted from Orbis commentaries contributed by Adam Karr and Eric Marais
For the full commentary please see www.orbisfunds.com