August was a weak month for equities. Investors are more and more convinced that the global economy is in a recession or is heading towards one. In light of this slowdown, the general expectation was that central banks would reduce the speed at which interest rates are raised. Comments by central banks, most notably the Fed, clearly indicate that fighting inflation is on top of the priority list at the moment. Curbing inflation by increasing interest rates will further increase the possibility of a recession. Rising rates, lower growth, and still high inflation is a combination that makes investors more cautious on equities. Within this negative environment, KGDHF outperformed the broader market. KGHDF modestly underperformed the style index (Morningstar Developed Markets Dividend Yield > 3% Index).

The sector that contributed most to the absolute and relative performance of KGHDF was the energy sector. Driven by higher energy prices, stocks like Chesapeake Energy, BP, and Technip Energies performed well. The industrials sector detracted most from the absolute performance of KGHDF. Especially European industrials performed poorly over the month of August, driven by recession fears, rising energy prices, and inflationary pressures. The worst performing sector from a relatively perspective was the communication services sector (WPP did poorly).

One of the largest contributors was Cardinal Health (+20% in August). Cardinal Health is an American company that focuses mainly on the distribution of pharmaceutical products. A part of the business is also involved with manufacturing, sourcing and distribution of branded and private label surgical and laboratory products. This division is loss-making at the moment. Recently, Elliott Advisors acquired a stake in Cardinal Health. This activist shareholder has been able to appoint 5 of the 11 board members. This provides Elliott with substantial power to change the strategic direction of the company. There are two obvious ways in which the activist can change the value of the company. The first way is to sell the loss-making medical division. Based on a recent transaction of a similar company, the potential price of Cardinal’s medical division could well be in excess of Cardinal’s market value. The second way to change the company for the better is to reorganize the distribution business. If Cardinal can improve its below average margins towards the margins that are achieved by direct peers, substantial value is created. In anticipation of a strong uplift in earnings, the shares have moved up substantially. Despite the strong price performance in August, the shares trade at 12 times expected 2023 earnings. The shares provide a dividend yield of around 3%.

One of the detractors from KGHDF’s performance was Taylor Wimpey, declining 17%. Taylor Wimpey is one of the largest housebuilders in the UK by volume. There are three negatives that are driving the disappointing share price performance, which are inflation, rising interest rates, and deteriorating consumer confidence. The housebuilders have successfully battled with inflation for a couple of months now as building materials like cement, bricks, and wood have become more expensive. So far, most of the cost inflation could be passed on to the home buyers. However, investors are increasingly worried that consumers will see their budgets squeezed by higher cost of living (e.g. food and energy) and higher interest rates. We believe that the demand/supply balance in the UK housing market remains healthy, which creates a strong pricing tailwind for UK homebuilders. Recent company results were reassuring, and Taylor Wimpey’s 2022 profit guidance was raised. Both price/earnings ratio (6 times expected 2023 earnings) and dividend yield (~10%) indicate that the shares are offering good value at current levels.

Portfolio activity over August was limited. In July we started a position in Ferguson. This position was financed by selling our position in MSC Industrial Direct. Both companies are distributors. However, Ferguson has a better competitive position than MSCI Industrial Direct. This was not reflected in the share price.

We currently expect a dividend yield of around 4.9% for KGHDF. This number is based on the consensus estimate of dividends paid out over the next 12 months. KGHDF still trades at a strong discount versus the market (the average valuation of all the holdings in KGHDF versus the broader equity market). Historically, this has led to a strong relative performance in the medium term. Also, the absolute valuation of the strategy is compelling. We continue to focus on attractively valued companies, that have good capital discipline and generate positive cash flow through the cycle. In summary, the current environment offers the opportunity to buy a well-diversified portfolio with solid earnings power at an attractive valuation. In addition, ESG (Environmental, Social and Governance) is fully incorporated in our investment process.