International High Dividend Equity Strategy Q Commentary. Market and Economic Review

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1 S C H A F E R C U L L E N C A P I T A L M A N A G E M E N T International High Dividend Equity Strategy Q Commentary Market and Economic Review Major international equity indices ended a volatile quarter modestly higher, against the backdrop of rising global macroeconomic and geopolitical risks and a weather-induced slowdown in the US. This more muted backdrop found its way into softer reported earnings from companies though we remain optimistic in this regard, given the early and intermediate stage economic recoveries unfolding in Europe and the United States, respectively. Equities underperformed bonds for the first time in seven quarters, as long-term interest rates fell. By region, Europe performed best, led by equity markets in Scandinavia and in the periphery region. Japanese equities, which are up sharply since November 2012, underperformed, as did other major markets in Developed Asia including Hong Kong and Singapore. Emerging markets, which recorded large fund outflows, remained volatile, with equity markets in countries such as Indonesia and India benefiting from the positive sentiment surrounding potential positive electoral outcomes later in the year. The combination of low long-term interest rates and rising confidence among corporations led to the best quarter for global mergers and acquisitions activity in over five years. With confidence high and markets melting up in the absence of meaningful corrections, the price disciplines of low price earnings and high dividend yield have become all the more important in providing satisfactory absolute and risk-adjusted returns. We believe that our strategy of buying shares in strong companies, at attractive valuations and holding them for the long-term (i.e. 5 years) remains attractive in this environment. In the quarter, we slightly underperformed the modest 0.7% increase in MSCI EAFE which witnessed more narrow performance participation by sector versus previous quarters with only Utilities and Healthcare strongly outperforming. By style class, value outperformed growth and small caps outperformed large caps. Portfolio Performance The SCCM International High Dividend Composite was -0.4% (net) in the 1st Quarter versus +0.7% for MSCI EAFE. Since Q1 YTD 1 Year 3 Year 5 Year Incept* SCCM Intl High Div (net) MSCI EAFE S&P *August 31, Performance for periods greater than 1 year is annualized. 645 Fifth Avenue New York, NY Tel Fax

2 Sector Attribution The largest contributor to relative performance was our superior stock selection across both cyclical and non-cyclical sectors, including Consumer Staples, Utilities and Energy. Outperformance here was led by a diverse set of world-leading companies, which continue to pay large and sustainable dividends, including Imperial Tobacco, British American Tobacco, GDF Suez, Total and Statoil. Our overweight allocation to Healthcare and our underweight allocation to Consumer Discretionary and Financials, aided performance. The largest detractor from relative performance was our inferior stock selection in Industrials and Healthcare. In Industrials, some of our companies were impacted by near-term headwinds to end demand which we believe will moderate over time. Our more conservative large capitalization pharmaceutical companies in Healthcare lagged behind high valuation, high momentum biotechnology companies which outperformed. Cash was a drag on performance during the quarter. Source: Bloomberg Page 2 of 9

3 Country Attribution The largest contributor to relative performance was our overweight allocation to companies producing strong dividend growth in Switzerland, Indonesia and Norway, and our underweight allocation to companies producing lackluster dividend growth in Japan. Our superior stock selection aided performance in Japan, United Kingdom and Norway, driven by our leading companies which continue to generate strong free cash flow and dividends. The largest detractor from relative performance was our overweight allocation to Russia and our underweight allocation to Australia, Italy and Spain. In Russia, our only holding is energy company Lukoil whose shares have de-rated down to a P/E of 4.0, even though we believe that there has been no material operational impact from recent political events in the region. In Australia, Italy and Spain, we continue to look for suitable investment opportunities which have a combination of both high and sustainable dividend yields. Stock selection hurt performance in France and Germany though we continue to retain conviction in our holdings here. Cash was a drag on performance during the quarter. Source: Bloomberg Page 3 of 9

4 Portfolio Strategy and Changes Purchases BCE Inc. Canada Telecommunication Services BCE Inc. is the leading integrated telecommunications company in Canada, providing wireless and wireline services to consumers and businesses. The Canadian wireless market is attractive given its relatively low wireless penetration and prospects for higher smartphone penetration, giving BCE significant opportunities to grow its high margin data services. The company is well positioned to benefit from robust postpaid subscriber growth, higher data usage from LTE adoption, and the integration of tablets and other internet devices into shared data plans. Concerns about a new potential entrant are mitigated by the substantial capital required to acquire spectrum and build a competitive network, as evidenced by the absence of foreign players in this year s recently completed spectrum auction. BCE s wireline business remains strong, driven by the company s deployment of fiber across the country, and its IPTV and high speed internet offerings. The company also owns substantial media assets, allowing for significant earnings upside as the advertising market recovers and also offering a unique means to unlock significant shareholder value via a potential spinoff. BCE is attractively valued relative to its North American peers while offering a higher dividend yield, a conservative payout ratio, and an excellent long-term track record of dividend growth. BCE trades at 15.0 times forward earnings and offers a 5.2% dividend yield. BNP Paribas S.A. France Financials BNP Paribas S.A. is a leading universal bank centered in Europe, with strong positions in retail banking, commercial and investment banking, and asset management. BNP Paribas is among Europe s best run and managed banks, backed by a traditional banking model and a conservative management philosophy that is underpinned by a strong track record. BNP s strong and conservative management practices were demonstrated by its far superior performance versus peers during the recent global financial crisis given the bank s strong underwriting standards, solid capital levels, and lower-than-average exposure to peripheral Europe. Of late, the bank has successfully avoided the regulatory fines and penalties which have plagued so many other large global banking peers. This position of strength has allowed BNP to buy attractive banking assets in Europe which have been available at fire-sale prices due to the protracted sovereign and banking crisis in the region. In addition to benefitting from the recovery in value of these acquired assets, BNP Paribas stands to benefit from other catalysts. The company s earnings should benefit from the unfolding economic recovery in Europe which should lead to higher revenues given rising net interest income and fee income and to lower expenses, given improving trends for credit quality and reserving. While difficult to predict, regulatory catalysts may also buoy operational performance if anticipated capital requirements are less draconian than anticipated or if the European Union seeks to incentivize lending in more distressed markets. These catalysts may further augment the company s already strong capital ratios and dividend attributes which remain attractive relative to European peers. Management has shown a good commitment to the dividend historically and dividend growth could exceed 10% annually in coming years. BNP trades at 10.5 times forward earnings, 0.9 times book value, and offers a 2.7% dividend yield. Orkla ASA Norway Consumer Staples Orkla ASA is a leading seller of packaged foods, snacks, confectionery, home and personal care products and food ingredient additives, across the Nordic countries of Norway, Sweden, Denmark and Finland. The company s well-known, localized brands dominate 80% of the product categories Page 4 of 9

5 that they serve. This core business which has organically grown top-line historically at 3% annually, is facing near-term difficulties, promoting management to introduce a strategic plan to improve profitability which could lead to earnings growth of 40% or more over the next five years. This plan appears achievable and a comparison may be drawn to a similar successful plan introduced by Cadbury in Orkla s core Nordic consumer staples business is complemented by an attractive portfolio of non-core investments, which the company is looking to sell down over the next three years, in a bid to simplify its structure. Major assets here include stakes in Jotun - the world s 9th largest paints company, downstream aluminum businesses, consumer staples businesses in countries in which Orkla is sub-scale including India, Russia, Austria, Poland and Czech Republic, Nordic hydroelectric generation assets and other miscellaneous equity and real estate assets. Even when applying fairly modest valuations to these non-core stakes, the core Nordic consumer business, which should see profitability improve, is valued at an unjustifiably low valuation. The complexity of structure at Orkla has turned many investors off, but we believe that in three years, Orkla will have a far more profitable and simplified structure. A pure Nordic consumer staples business could then also attract a bid at a much higher price than currently from a global multinational company looking to enter these attractive markets. Orkla has excellent dividend attributes, having returned over 100% of its original cost basis over the last 10 years in re-invested dividend alone, with no cuts in the regular dividend in over 20 years and multiple special dividend payments. The Chairman, Stein Erik Hagen owns 24% of the company and this also bodes well for the stability of the dividend payment. Orkla trades at 13.5 times forward earnings and offers a 4.9% dividend yield. SSE PLC United Kingdom Utilities SSE PLC is one of the largest diversified utilities in the United Kingdom (UK). The company s operations are vertically integrated across power generation, transmission and distribution, and retail energy supply. In transmission and distribution, SSE is a top four operator in the UK, supplying close to 10 million customers with electricity and natural gas. This core business, which now accounts for half of operating profits, has seen consistent profit growth as a result of the company s investment program and the UK s secure regulatory return regime. In generation, SSE produces roughly 20% of the UK s electricity and the company has the most diversified generation portfolio by fuel type; and importantly, is the largest generator from renewable sources. Over the past two years, the electricity generation industry has been volatile in the UK, albeit to a lesser degree than in continental Europe. However, SSE has managed this volatility well, posting relatively stable earnings thanks to its highly diversified generation portfolio. SSE is also the second largest retail supplier of electricity and natural gas in the UK with over 9 million household and business customers. Profit growth has been stagnant here as this area has been under the most pressure from a competitive standpoint and has received the most negative scrutiny from politicians in the UK. The outlook for this business remains unclear as a result of political and regulatory uncertainty though on a long-term basis, SSE is well positioned to be solidly profitable in this business given the company s competitive advantages, which include its level of vertical integration through, for instance, the ownership of natural gas storage assets. The expansion of regulated assets along with a steady commitment to growing the generation and retail businesses has resulted in a strong earnings track record and has allowed SSE to raise the dividend in each of the last 15 years. SSE trades at 12.3 times forward earnings and offers a 6.3% dividend yield. Sales Verizon Communication Inc. United States Telecommunication Services We sold the Verizon Communications shares that we received in the quarter as part of the special cash and shares payment from Vodafone, given our mandate to invest in companies outside the US. Page 5 of 9

6 Outlook Since Mario Draghi s pledge in July of 2012 that he would do whatever it takes to preserve the Euro, equity price multiples globally have recovered to pre-crisis levels, while earnings in regions such as the European Union remain depressed and have room to recover. In this regard, we believe that we are most likely in the early innings of a multi-year recovery in economic activity in the Eurozone, which should provide a supportive backdrop for growth in corporate earnings and dividends. As a recent study done by JP Morgan shows, we are in the second quarter of the latest Eurozone recovery, whereas the average economic recovery in the region lasts 24 quarters. Earnings thus may continue to rise for several years, providing support to Europe s equity markets. As always, we do not expect a smooth ride upward and as mentioned over the last few quarters, we continue to see pockets of froth and excess, most notably in new-age, high valuation, high momentum, concept stocks. In many cases, these companies have questionable valuations and/or questionable business models. A large correction in the value of these companies may dent nearterm sentiment towards equities, though we believe that the long-term outlook remains constructive and that a disciplined value approach to investing will continue to produce satisfactory long-term results. The slowdown in fixed asset investment and bank lending in China is another area of concern, though we believe that the authorities in China will do all that they can to achieve a more gradual readjustment in their economy. We continue to find value in leading companies internationally and three out of our four new purchases this quarter had sustainable and growing dividend yields in excess of 5.0% at the time of purchase, which compares very favorably to a 10 year US Treasury bond which yields under 2.8%. Dividend growth continues to be robust with several of our companies having increased their most recent YoY dividend payment, indicating confidence in the long-term outlook. With equity price multiples having recovered to historical norms, going forward we believe that the bulk of returns will be generated via the components of dividend yield and earnings/dividend growth, which is inline with the long-term norm of equity markets globally. On both these measures we are well positioned with a higher dividend yield and a faster and more sustainable dividend growth profile relative to the benchmark MSCI EAFE. In our International High Dividend portfolio, 89% of our companies have paid dividends thus far in % of these companies have raised their dividends with an average increase of 7.8%. This calculation does not include the sizable special dividends that have been announced this year from Page 6 of 9

7 holdings including Vodafone, RTL Group, United Overseas Bank and Telekom Indonesia. With strong balance sheets and continued earnings growth, we anticipate that this trend will continue in 2014 and beyond. Best Regards, Schafer Cullen Capital Management, Inc. Page 7 of 9

8 Appendix: Portfolio Exposure And Characteristics As Of 3/31/2014 Portfolio Exposure Sectors % Asset Regions % Asset Consumer Discretionary 2.5 Developed Asia Pacific 14.7 Consumer Staples 15.2 Continental Europe 46.0 Energy 9.3 United Kingdom 22.1 Financials/ REITs 16.3 North America 6.0 Health Care 16.1 Asia Pacific Emerging 1.7 Industrials 11.5 Latin America 0.0 Information Technology 1.9 EMEA 5.4 Materials 1.6 Telecommunications 16.4 Developed Markets 88.8 Utilities 4.9 Emerging Markets 7.1 Cash 4.2 Cash 4.2 Total Total Top 10 Countries United Kingdom Switzerland Germany France Japan Canada Norway Australia Singapore Luxembourg Top 10 Holdings Nippon Telegraph & Tel. Deutsche Telekom AG Total S.A. Novartis AG GlaxoSmithKline PLC Nestle S.A. Manulife Financial Corp. Munich Re AG Zurich Insurance Group Imperial Tobacco Group Portfolio Characteristics Forward Forward Q1 14 Est. Est. Q1 14 Price / Dividend LT Debt / LT DPS LT EPS Market Earnings Yield Capital Growth Growth Cap SCCM Intl High Div $78,559 MSCI EAFE ETF $67,183 Source: SCCM Research, BCA Research, Bloomberg Page 8 of 9

9 Disclosure: Schafer Cullen Capital Management (SCCM or the Adviser ) is an independent investment advisor registered under the Investment Advisers Act of This information should not be used as the primary basis for any investment decision nor should it be considered as advice to meet your particular investment needs. The portfolio securities and sector weights may change at any time at the discretion of the Adviser. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that future recommendations or decisions will be profitable or equal the investment performance discussed herein. Investing in equity securities is speculative and involves substantial risk. Past performance is no guarantee of future results. Market conditions can vary widely over time and can result in a loss of portfolio value. Individual account performance results will vary and will not match that of the composite or model. This variance depends on factors such as market conditions at the time of investment, and / or investment restrictions imposed by a client which may cause an account to either outperform or underperform the composite or model s performance. A list of all recommendations made by SCCM within the immediately preceding period of not less than one year is available upon request. The strategy depicted in this report has been managed in accordance with the investment objectives of the strategy as determined by the Adviser. The Adviser has selected benchmarks, which in their opinion closely resemble the style of the securities held in the composite or model portfolio of the strategy (e.g. large cap value, small cap value, international, etc.). The securities held in the composite or model are actively managed while the benchmark index is not. Investors should be aware that the Adviser makes no attempt to match the portfolio securities, or the security weightings of the benchmark. The composite or model s performance will be affected greater by the price movements of individual securities as the composite or model is more concentrated, generally less than 100 securities, while a comparative benchmark will generally have between 500 and 2,500 securities where individual security price movements have a lesser affect. An individual cannot invest directly in an index. In the case where this report displays model results, please be aware that such results do not represent actual trading and that results may not reflect the impact that material economic and market factors might have had on the Adviser's decision-making if the Adviser were actually managing clients' money. Model and actual results reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid (Net of Fee performance) and reflect the reinvestment of dividends and other earnings. Schafer Cullen Capital Management, Inc. makes no representation that the use of this material can in and of itself be used to determine which securities to buy or sell, or when to buy or sell them; SCCM makes no representation, either directly or indirectly, that any graph, chart, formula or other device being offered herein will assist any person in making their own decisions as to which securities to buy, sell, or when to buy or sell them. For comparative purposes, the adviser uses the ishares MSCI EAFE ETF. All opinions expressed constitute Schafer Cullen Capital Management s judgment as of the date of this report and are subject to change without notice. Page 9 of 9