Fund appreciating 11.3% and Yacktman Focused Fund (Trades, Portfolio) Service Class appreciating 10.7%, compared to the S&P 500 which was up 13.7%. While the results lagged the S&P 500, we are happy to have achieved solid performance while keeping a strong focus on managing the level of risk in the Funds. Long-term results, which is how we judge our performance, continue to be strong in absolute terms compared to the S&P 500.
As our investors know, our goal is to achieve solid, risk-adjusted returns over a full market cycle. In the last few years, the U.S. stock market has rallied sharply, largely from multiple expansion; it seems some people are forgetting about cycles and becoming careless about risk. During these times, we continue to strongly focus on risk management.
Our largest positions continue to be in companies we think have enduring franchises in good times and bad, that sell at attractive valuations. We have also maintained excess cash because it is one of the best tools we have to manage risk when we are not finding enough attractive individual investment opportunities. Cash is not a market prediction. We deploy it when we find investments that meet our dual mandate of achieving sufficient return while managing risks regardless of the market level. In 2014, cash declined as a percentage of assets in both Funds.
Most of our time researching investments is focused on the micro, meaning the attributes of the individual businesses we own or look to invest in. However, we also consider macro issues because they can impact what happens to businesses, sometimes in a dramatic way. In 2014, several extreme macro events occurred. Commodity prices, especially oil, declined significantly and the U.S. Dollar was extremely strong versus most major currencies. Some currencies, like the Russian Ruble, collapsed.
Macro and micro issues have started to cause greater divergence in some of the stock sectors we look at, which is important for bottom-up investors like us. In the last few years, as the markets rallied and multiples expanded, stocks seemed to rise in tandem; however, in the last few months that has all changed. If this divergence continues, opportunities to build meaningful new positions might arise.
TOP CONTRIBUTORS INCLUDED PEPSICO, INC. PROCTOR & GAMBLE CO., MICROSOFT CORP. AND CISCO SYSTEMS, INC.
Both PepsiCo (PEP, Financial) and Procter & Gamble (PG, Financial) were large positions in both Funds that contributed solidly to results. We like both companies, in part, because they sell consumable products that are part of daily life which are less subject to pressures from more difficult economic periods. Both companies have significant product diversity with strong market share in a wide variety of categories, such as Frito Lay snacks and performance drinks (PepsiCo), to diapers, laundry detergent and razor blades (Procter & Gamble).
In 2014, Procter & Gamble announced that it would focus on its largest, most competitivelyadvantaged businesses. We like the increased management discipline and think Procter & Gamble will emerge stronger and experience faster growth after the restructuring. Microsoft and Cisco were also large contributors to results in 2014. Microsoft, whose shares were also up significantly in 2013, saw continued strength, especially after announcing the appointment of Satya Nadella as the new Chief Executive Officer early in the year. During the latter part of 2014, we reduced our position in Microsoft due to the strong multi-year run. Cisco’s shares rallied in 2014 on improved business execution.
TOP DETRACTORS IN THE FOURTH QUARTER INCLUDED AVON PRODUCTS, INC. EXXON MOBIL CORP., VIACOM, INC. AND AGGREKO PLC
All of the detractors above were smaller holdings that suffered from the macro issues mentioned earlier. Avon declined in part due to currency issues, Exxon Mobil from the steep drop in energy prices, and Aggreko, a combination of the two.
Avon (AVP, Financial) is a small position for our Funds but was the largest detractor in the fourth quarter. The company is in the middle of a multi-year restructuring, and its challenges recently increased due to significant currency declines around the world, especially in Russia and Latin America. We continue to think Avon has a valuable franchise and the stock is undervalued at current levels. It reminds us of the position we had in HP a few years back when that stock was out of favor, much like Avon is today. During the quarter, Avon resolved a long-running Foreign Corrupt Practices Act investigation for practices in China from 2004- 2008. This should reduce legal and administrative burdens going forward.
Exxon Mobil’s (XOM, Financial) shares declined about 6% as energy stocks fell due to the drop in the price of oil. Our direct exposure to energy stocks is modest because it is much more difficult to predict the price of oil than the prices of laundry detergent or media content.
Viacom’s (VIA, Financial) shares were weaker in 2014, due to concerns about the advertising markets and weak ratings at some of its cable networks. Management is working hard to address the ratings issues and the company continues to generate significant amounts of free cash flow. We think Viacom sells at an attractive valuation, and management has been an aggressive repurchaser of shares, buying back nearly one-third of the outstanding shares since the beginning of 2011.
Aggreko (LSE:AGK, Financial), a leader in temporary power solutions, faced challenges from both currency headwinds and the weakening energy sector. Aggreko’s customers in the oil and gas sector are clearly up against challenges in the near term. However, one benefit of lower oil prices is a reduction in the cost of fuel (the largest component of generator costs) which makes temporary power more attractive overall. We continue to like Aggreko’s strong market position and valuation.
OTHER
21st Century Fox’s (FOXA, Financial) return on shares were solid during the year. We think Fox is exceptionally wellpositioned with strong franchises in cable sports, news and entertainment, with significant exposure to overseas markets which should be much higher growth than the United States over the long-term. In the last few years, Fox has sacrificed near-term earnings growth by making significant investments in global business, sports and entertainment content. Over the next few years, as the investment level moderates and the new business ventures grow, we think Fox’s earnings should increase significantly. When coupled with attractive share repurchase, we think Fox could double its earnings per share in the next 3-4 years.
In 2014, we moved some of our Fox position from non-voting shares to the voting class. Historically, the voting shares traded at a premium, sometimes meaningful to the non-voting shares. We felt comfortable that it was not worth paying a premium to have the right to vote. Last year, due to a share de-listing in Australia and an active share repurchase that only buys non-voting shares, the voting shares began to sell at a discount, so we moved some of our position to the voting class.
Samsung Electronics Co. (XKRX:000830, Financial) is a remarkable company in which we built a position during 2014. We purchased shares in the company’s preferred shares, which are like non-voting common shares in the United States. We purchased the preferred shares because they trade at a substantial discount to the common.
Samsung has the top market share in DRAM, flash, mobile phones, televisions, display and many other markets. We think the shares are inexpensive, based on just the value of the DRAM and flash businesses, as well as the net cash and investments which total more than $60 billion at years end. Samsung has been successful by being willing to out-invest, out-wait and out-innovate its competitors. Over the next few years, the company will see if some large investments in the foundry market (making semiconductors for other companies), display and smart home pay off. We think that if any or all have success, the rewards could be huge. If they all fail, we still believe the core value of our investment is covered by other businesses plus the balance sheet. We like this kind of risk/reward, which is rare in the current investment environment.
CONCLUSION
We think the Funds are especially well-positioned in today’s environment, where volatility is increasing and stunning geopolitical events seem to dominate the news on a regular basis. We will continue to adhere to our discipline of evaluating businesses one-by-one with a focus on quality, consistency and, most of all, valuation. We will be diligent, patient and objective when managing your funds.
This commentary reflects the viewpoints of the Yacktman Asset Management LP as of 12/31/14 and is not intended as a forecast or guarantee of future results.
