Market Overview
Equity markets worldwide gained in the second quarter of 2024, as investor sentiment about the global interest-rate outlook swung from pessimism to cautious optimism. With concerns about inflation continuing to hang over markets, the focus during the quarter was squarely on the interest rate policy paths of key central banks. The US Federal Reserve held interest rates steady in May and June, acknowledging that progress in driving domestic inflation down towards its 2% target had slowed. The European Central Bank lowered interest rates in June, citing a marked improvement in the eurozone’s inflation outlook. In the UK, the Bank of England held its main interest rate, even as inflation was slowing toward its 2% target.
Portfolio Review
In the second quarter, the Lazard Equity Franchise Portfolio (MUTF:LZFIX) fell in absolute terms and underperformed its benchmark, the MSCI World Index. (Return is measured net of fees and in US dollars.)
The Lazard Equity Franchise Portfolio has not performed in line with our expectations, as this type of market is particularly challenging for valuation-sensitive investors, and the Portfolio was no exception. The Portfolio’s main sources of recent underperformance came from stock selection in health care and utilities. The Portfolio’s underweight position in information technology, the top-performing sector in the MSCI World Value Index during the quarter and having no positions in the Magnificent Seven artificial intelligence stocks, also hurt performance.
H&R Block (HRB) (4.6% weighting in the Portfolio), the largest tax agent in the US, continued its strong share price performance since reporting its better-than-expected full-year results in August last year. HRB is a highly seasonal business, with more than 100% of its operating profit generated in the fourth quarter due to the timing of the US tax year. In May, HRB announced its third quarter results outperforming market estimates. HRB reaffirmed its full-year F2024 guidance. Based on consensus estimates, HRB trades at around 10 times earnings per share, has no net debt, and pays a quarterly dividend of 32 cents per share, implying an annual dividend yield of around 3%. Since 2016, HRB has grown its dividend by over 60% and has returned over US$3.5 billion to shareholders through dividends and share repurchases.
The world’s number one pest control company, Rentokil (RTO, 3.0% weighting), rose sharply in June after a Bloomberg News report revealed that activist investor Nelson Peltz’s Trian Fund Management LP has acquired a significant stake in the company. The investment firm stated that it is now among the top 10 shareholders in Rentokil, which owns Terminix in the US. It was reported that Trian has reached out to Rentokil to discuss ideas for boosting shareholder value. Although Rentokil is down 40% from its 2022 peak, the stock is up around 20% since our initiation. This follows a strong fourth-quarter result announced in March, with EPS 3.5% ahead of consensus, a 15% increase in the dividend, and raised expectations for annual pre-tax synergies from the Terminix integration by an additional US$50 million to approximately US$325 million.
Global consumer product and adhesives company Henkel (OTCPK:HENKY, 0.0% weighting) added to performance in during the period, with most of the performance coming in early May after it published strong first quarter results. At the first quarter 2024 result, management raised guidance for 2024 organic revenue growth, operating margin and EPS (EPS to grow in a range of 15-25%, up from guidance of 5-20%). The adhesives business is performing well, and the rationalization of the consumer product division (beauty and laundry) is progressing. During the period, after strong share price performance, we sold our position in the stock.
Shares of CVS (6.4% weighting), a US healthcare company, were dragged down in late June by a profit warning issued by pure-play pharmacy retailer Walgreen, citing continued consumer pressures. CVS has a top-3 US Pharmacy Benefit Management (‘PBM’) company and since 2018 has owned US health insurer Aetna which leverages its third business, the legacy CVS Pharmacy chain.
The combined three businesses offer a total healthcare solution at lower costs for consumers. Like Walgreens (WBA), CVS’ pharmacy retail business has sustained margin pressures over the last few years. As pharmacy closures accelerate throughout the US, CVS is attempting to shift its operating model to a margin-focused business to limit risk. Success in this initiative is not yet reflected in the company’s earnings guidance. Today, CVS trades on barely 8x earnings, with mid to high single-digit EPS growth.
Dentsply Sirona (XRAY, 5.0% weighting), the world’s largest manufacturer of professional dental products and technologies, detracted from performance following its quarterly announcement, which reported organic growth falling short of market expectations. That said, XRAY did not change its 2024 EPS guidance of $2.00 to $2.10 and continues to reaffirm its medium-term target of $3 in 2026 EPS. Our expectations for XRAY are well below these management forecasts, yet we still see value in the stock. If management’s forecasts are realized, we believe XRAY is trading at barely 8 times the targeted 2026 earnings as of 30 June 2024, which is less than half its decade average of around 20 times earnings.
Leading dental distributor Henry Schein (HSIC, 3.9% weighting) detracted during the quarter after reporting first quarter results in May. Initially, the results were well-received, with margin expansion ofsetting weakness in the dental end market. The full year 2024 revenue midpoint was slightly lowered, but the EPS range was reaffirmed. Private-label and value implants were a bright spot as consumers traded down. The recovery from last year’s cyber impact also appeared to be progressing well. With conservative assumptions around end market demand and the recovery from the cyber incident, the stock remains attractively priced.
Outlook
In aggregate, we have been pleased with the operating performance of the companies in the Portfolio over the last 12-months. In the last three quarters, more than 80% of the holdings have exceeded management and/or market expectations in terms of earnings. Future market expectations for stocks in our Portfolio appear strong, with forecasted earnings growth of an aggregate of more than 40% over the next 3 years. The Portfolio today trades at one of the largest discounts to the market in terms of PE and EBIT multiples, while still maintaining large premiums in term of return on assets and stronger free cash Aow generation. We believe the market today presents a strong opportunity to buy global leaders and monopolies at a significant discount and our Portfolio is positioned to capture any potential re-rating in these names.
Important Information Please consider a fund’s investment objectives, risks, charges, and expenses carefully before investing. For more complete information about The Lazard Funds, Inc. and current performance, you may obtain a prospectus or summary prospectus by calling 800-823-6300 or going to www.lazardassetmanagement.com. Read the prospectus or summary prospectus carefully before you invest. The prospectus and summary prospectus contain investment objectives, risks, charges, expenses, and other information about the Portfolio and The Lazard Funds that may not be detailed in this document. The Lazard Funds are distributed by Lazard Asset Management Securities LLC. Information and opinions presented have been obtained or derived from sources believed by Lazard Asset Management LLC or its affiliates (“Lazard”) to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of the published date and are subject to change. The performance quoted represents past performance. Past performance does not guarantee future results. The current performance may be lower or higher than the performance data quoted. An investor may obtain performance data current to the most recent month-end online at www.lazardassetmanagement.com. The investment return and principal value of the Portfolio will fluctuate; an investor’s shares, when redeemed, may be worth more or less than their original cost. Different share classes may have different returns and different investment minimums. Please click here for standardized returns: https://www.lazardassetmanagement.com/us/en_us/funds/mutual-funds/lazard-equity-franchise-portfolio/F2181/S190/ The performance quoted represents past performance. Past performance is not a reliable indicator of future results. Allocations and security selection are subject to change. Mention of these securities should not be considered a recommendation or solicitation to purchase or sell the securities. It should not be assumed that any investment in these securities was, or will prove to be, profitable, or that the investment decisions we make in the future will be profitable or equal to the investment performance of securities referenced herein. There is no assurance that any securities referenced herein are currently held in the portfolio or that securities sold have not been repurchased. The securities mentioned may not represent the entire portfolio. Equity securities will fluctuate in price; the value of your investment will thus fluctuate, and this may result in a loss. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. The MSCI World Index is a free-float-adjusted market capitalization index that is designed to measure global developed market equity performance comprised of developed market country indices. The index is unmanaged and has no fees. One cannot invest directly in an index. Certain information included herein is derived by Lazard in part from an MSCI index or indices (the “Index Data”). However, MSCI has not reviewed this product or report, and does not endorse or express any opinion regarding this product or report or any analysis or other information contained herein or the author or source of any such information or analysis. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any Index Data or data derived therefrom. Certain information contained herein constitutes “forward-looking statements” which can be identified by the use of forward- looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “intent,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events may differ materially from those reflected or contemplated in such forward-looking statements. |
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