Vermeer Monthly – May 2024
April was a more difficult month for global equities after a very good first quarter. The Vermeer Global Fund declined by 2.5% in April, slightly better than the decline in global markets. During April, we made the decision to increase the cash weighting in the portfolio from a virtually fully invested position to around 5% at the end of the month.
The global stock market has enjoyed an exceptional run since October 2023, and we feel that a period of consolidation is now due. To be clear, a move to the current level of cash puts us only in what we would regard as a more neutral position and we are still seeing plenty of new opportunities to add to the portfolio, which also has the scope to add a number of new holdings if the opportunity arises. We often talk about our sell discipline strategy to deal with problem stocks in our portfolio early and normally run our winners. However, we do feel that on this occasion, it is prudent to capitalise on some of the success that has driven our portfolio in recent months. We have trimmed positions in Cameco, Caterpillar, Linde, Novo Nordisk, Nvidia and Trane Technologies, all of which have performed well in recent months.
Persistently higher inflation has materially changed the outlook for US interest rates in 2024. In December, the dovish commentary from Fed Chairman Jerome Powell led to speculation that rates could be cut as many as 6 times this year. Over the last few months this has now faded to potentially only one or two cuts towards the end of the year and even the possibility of no cuts at all this year. Two year Treasury yields moved back above 5% at the end of the month while ten year yields are now at around 4.7%, up materially from a low of 3.8% at the end of last year. While this is clearly limiting the scope for rate cuts, solid economic data and low unemployment has meant that the Federal Reserve really can be patient and data dependent in assessing any shift in policy.
Life sciences company Danaher produced a solid set of results in April that hopefully move the company to an inflection point in sales following a very difficult period after the COVID related strength that saw the shares peak at $294 in September 2021. The company continues to execute well using its famous DBS (Danaher Business System) to improve margins and deliver impressive levels of cash flow, which were once again above 100% of net income this quarter. The company needs to see an improvement in its bioprocessing division, which has been significantly impacted by weakness in the biotech funding market and specific softness in China. Danaher is guiding to a material improvement in this area by the end of the year, so the set up for 2025 and beyond looks much better. This outlook could improve further should the company put to work some of its potential financial firepower for acquisitions that could see a deal, or series of deals, worth as much as $30-$40billion to complement a business with a market capitalisation of around $182billion.
Microsoft produced another excellent set of results with revenues up 17% and continued strength in the Azure cloud division the key feature. The company is seeing the early benefits of the lead they have established in artificial intelligence through its Copilot product that is gaining very strong traction, notably with developers as GitHub Copilot subscribers are already approaching 2 million. Despite the excellent results and an increasingly strong moat that Microsoft is building aided by its leadership in AI, the stock is only up 3.7% year to date, below the performance of major US indices. While the stock’s valuation is optically high at 29x fiscal 2025 earnings, we believe this is justified as we anticipate that the company will deliver at least the c.15% forecast earnings growth over the next two years.
Alphabet produced a superb set of results sending the shares 10% higher on the day. In the past, Alphabet shares have reacted negatively to earnings reports if one part of the business misfires, but on this occasion, Search, YouTube and its GCP cloud business all showed very strong growth. This performance enabled the company to announce a sizable addition to its share buyback programme and introduce its first ever quarterly dividend of $0.20 per share, which is very welcome. Alphabet shares have performed well this year, but we remain optimistic that it can continue to grow strongly. Although it has had one or two unfortunate missteps with its AI products, we believe it may well be one of the major winners from the growth of this groundbreaking technology.
Shares in Netflix have performed strongly this year, so it was no surprise that the stock back-pedalled on quarterly results which were very strong both in terms of continued subscriber growth and cash flow. Netflix is continuing to see the benefits of the introduction of its ad-supported tier and the major crackdown it has implemented on password sharing. Backed by a strong content slate, subscriptions in the quarter increased by 9 million, well above expectations. As the business matures, strong cash flow is powering the company ahead and this is reflected in very strong earnings growth which is dramatically reducing the rating the shares trade on, and we see any further weakens as an opportunity to add to our position.
Caterpillar fell sharply on its results that were in line with expectations but failed to meet the very high bar that investors had set for the company. These expectations were based on hopes that the company’s Energy & Transportation division would show an accelerated level of growth driven by data centre infrastructure along with continued positive infrastructure spending thanks to recent US legislation. The company’s back-up power generator business is seeing very strong demand from the artificial intelligence driven boom in data centre construction and the energy transition. However, this business is not big enough to currently move overall sales higher for the group, especially with very weak performance in China that has shown no sign of recovery. In construction equipment, the company still has a large backlog and dealer inventory remains stable, which is encouraging but after a great run in the stock since last September, we have pared back our position.
In the Japanese part of our portfolio, we added to our position in Shimano earlier in April following a long period of underperformance. We hope that we have reached an inflection point in the cycling industry, which was a beneficiary of the COVID boom in outdoor pursuits and has taken a long time to work through the very high levels of inventory. Results released in April were well ahead of previously issued guidance and should continue to see an improvement for the rest of the year. Shimano has a phenomenally strong balance sheet with a very high level of net cash that could be deployed via a higher dividend, or a share buyback to improve shareholder returns. We see Shimano as a world class company that is taking a very long time to recover from the slump that followed their COVID boom and could see a material boost to earnings in the next few years.
We added a new position in Spotify during the month, which we have been monitoring for over a year and we anticipate adding to the position further over time. The investment case for the stock is that Spotify, the world’s largest music subscription platform, has reached a critical number of premium paying subscribers. Currently the company has total subscribers of 615 million with a current target subs figure of 1 billion. Of these, 239 million are premium subscribers and the investment thesis is that the company will continue to be successful in converting these non-paying subscribers over to the premium offering. We believe that the market power of being the industry leader will allow for further price rises over time, the broadening of the product range to include audiobooks, education tools and the well-established podcast business will move into profit this year. We believe that this broadening of the product range will drive further growth and also crucially reduce churn. In 2023 management attacked its cost base and reduced global headcount by 25%. Cost discipline combined with growing revenue has produced a j-curve effect such that margins should improve rapidly as revenues rise against a largely fixed cost base.
Having moved to a more neutral cash position, we expect a period of consolidation in markets over the coming months. The results season so far has been broadly positive and we continue to be optimistic about the performance of our companies against an uncertain backdrop. We do anticipate that the upcoming US election may create increased market volatility as the year progresses but with company earnings still strong and if the US economy continues its robust performance, we will be able to maintain our cautiously optimistic stance.
Tim Gregory
Senior Fund Manager
Vermeer Investment Management