Summitry Select

Summitry Select Portfolio Update – Q1 2024

 

4/9/24

Our portfolio has had a strong start to the year. The Summitry Select Composite appreciated +14.8% (+14.6%, net) during the first quarter, and each of our holdings generated a positive return.

Our best performers during Q1 were Meta (+37%), Taiwan Semiconductor Manufacturing (+31%), and Netflix (+25%).

  • Meta’s investments in machine learning continue to bear fruit, driving increased engagement and improved ad targeting across Facebook and Instagram. The company reported Q4 2023 results in February that showed +25% higher revenue, +21% higher ad impressions, and +5% more daily active users across the company’s “Family of Apps,” compared to the same quarter last year. We believe the company is well positioned to drive further improvement in engagement and monetization over the course of 2024. Despite the shares having run up more than +400% from their 2022 lows, we believe their current valuation remains attractive.
  • In January, TSMC issued guidance for 20%+ revenue growth during 2024, and it appears that conditions have improved since. TSMC customers like Nvidia, Google, Amazon, and AMD are seeing greater demand for GPU, TPU, and other chips powering AI applications in datacenters and at the edge. While AI has captured much investor attention, TSMC is also likely to benefit from an upturn in demand for chips that power mobile phones and PCs, as replacement demand for those devices is set to improve, following several years of OEMs digesting sales pulled forward by the COVID-19 pandemic. While Intel has been executing well against their IDM 2.0 strategy, we are skeptical Intel fabs will be able to deliver process technology to external customers that offers superior performance to TSMC at the leading edge. We are even more skeptical that Intel fabs will be able to offer superior performance at a competitive price.
  • Netflix reported an exceptionally strong Q4 in January. A compelling slate of content and the company’s paid sharing initiatives led to over 13mm net adds, resulting in a total subscriber base of more than 260mm at quarter end. Subscriber growth was broad-based across all regions, and management expects that further subscriber additions and higher revenue per member will lead to wider operating margins in 2024. After their recent run, Netflix shares are not priced as attractively as when we initiated our position, so we are less excited about their future return profile. However, Netflix’ advertising business is gathering steam, with the number of ad-supported plans growing +70% sequentially for the second quarter in a row. As management phases out the basic ad-free tier in major markets and introduces more live content like the just-announced WWE deal, ad revenue is likely to become a bigger driver of results and could provide additional upside.

Our worst performers during Q1 were Ulta Beauty (+7%), Universal Music (+5%), and Agilent (+5%).

  • Competition in beauty retail has intensified over the past two years. Beauty is an attractive category for retailers because beauty customers make frequent recurring purchases at attractive margins, and the category is less sensitive to changing economic conditions. As a result, retailers like Target, Walmart, and Kohl’s are increasing the square footage dedicated to beauty products in their stores. However, we expect competitive intensity will improve, as these retailers approach the upper limits of their expansion opportunities. For example, Kohl’s has added over 900 Sephora boutiques within their stores over the past 2.5 years, but only plans to add 140 locations this year and a similar number in 2025, after which they will have saturated the Kohl’s store base. Despite increased competition, Ulta’s business continues to generate positive comparable store sales and attractive margins by offering customers access to relevant brands across price points in every category, a unique offering that competitors have struggled to match. We continue to believe the shares are attractively priced.
  • Universal Music Group reported another set of strong results in February, growing Q4 revenue nearly +16% compared to the same quarter last year, on an organic constant-currency basis. Results were driven by the growing number of streaming music subscribers globally and price increases implemented by several streaming services, including Spotify and Apple Music. Since UMG was spun off from Vivendi in 2021, the company has also been free to pursue its own independent strategy to maximize growth and profitability. Along those lines, management just announced plans to improve margins by achieving run-rate cost savings of €250mm by 2026.
  • While Agilent was one of our weakest performers in the quarter (+5%), the stock was one of our strongest performers in Q4 2023 (+25%). The company’s operating results continue to be consistent with our expectations, as we await an inflection in the company’s capital equipment business that has been pressured by high interest rates and a tough funding environment for smaller biotech customers.

During the quarter, we decided to exit our position in Disney. Because our portfolio is tightly concentrated, we believe it is critical to invest only in situations where we have the highest degree of confidence in the predictability of the underlying business. Over the past two years owning Disney shares, we have become less certain about the ultimate outcome for the business, as we have observed accelerating declines in linear subscribers, aggressive new entrants in streaming for both scripted entertainment and live sports (e.g. Amazon, Apple, and Google), and a changing dynamic in negotiations with distributors (e.g. ESPN vs. Charter), just to highlight a few examples. Despite the floor on valuation we believe is provided by Disney’s Parks business, we have concluded that there is too much uncertainty around the ultimate outcome for Disney’s sports and general entertainment businesses to justify continuing to hold the shares in the Select portfolio. Disney owns an impressive collection of entertainment franchises and sports rights, so we would not be surprised if the shares delivered an attractive rate of return from here, but now we will be cheering from the sidelines. We are confident that our investment strategy will deliver attractive results over time, but only if we stay true to our process.

Our portfolio returns last year and through the first quarter of 2024 have been exceptionally strong, and we do not expect this pace of gains to persist. Regardless, we continue to believe Summitry Select is well positioned to deliver attractive returns over time because we believe our holdings possess strong balance sheets, high profitability, and offer essential products and services to their customers. In addition, we currently maintain a sizeable cash balance that we can deploy to take advantage of new opportunities without selling existing holdings. While we do not know what the rest of 2024 has in store, we are confident the market will create opportunities. Thank you for placing your trust in us to search for those opportunities on your behalf.

As always, please do not hesitate to reach out with any questions.

 

Sincerely,

The Summitry Select Team

 

 

Note: Nothing herein constitutes investment advice or any recommendation that any particular strategy or security is suitable for any specific person. Past performance does not guarantee future returns. Investing involves risk and possible loss of principal capital. An index is a hypothetical portfolio of securities representing a particular market or market segment used as an indicator of the change in the securities market. Indexes are unmanaged, do not incur fees and expenses and cannot be invested in directly. The securities identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.