Partner Letter 2022

Before proceeding, please read the regulatory information on https://www.samuelsweber.com/regulatorische-informationen

Background info: I have several clients with separately managed accounts. As each relationship is unique, I have redacted the individual letters into a general version. The following overview shows performances in Swiss francs including dividends as of March 31st, 2023:

* Performance figures based on a representative client portfolio (Time-Weighted Return (TWR), after transaction and bank fees, but before SSW fees, which are negotiated individually between client and SSW and have to be subtracted from the above numbers to arrive at a net performance result). The data represent past performance and assume reinvestment of dividends. Past performance does not guarantee future results.

January 14th, 2023

Dear Partner

For my investment theses and other investment-philosophical thoughts, I would like to refer to my website https://www.samuelsweber.com with a special focus on the sections Interviews & Presentations and Blog. There you will find, among other things, detailed presentations on Deutsche Bank, Holcim, Lanxess and Swatch Group as well as a current update as of October 2022. I reported extensively on Alibaba in the last annual report. We also talk to each other regularly and I use to keep you up to date with various e-mails during the year.

For 2022, the portfolio delivered a return of -9% and has done well in an international comparison, as can be seen by looking at the various index performances (in Swiss francs including dividends):

• Swiss Market Index -14%

• Swiss Performance Index -16%

• EURO STOXX 50 -14%

• DAX -17%

• CAC 40 -10%

• FTSE 100 -5%

• S&P 500 -17%

• Nasdaq 100 -32%

My unsatisfactory performance during the last year therefore had good company, which is rather unusual. As we know, value investing with a focus on a few stocks can be very volatile and swing in all directions in the short term. In this respect, I was treated well by the stock market in 2022. However, I can't be happy. My goal is clear: Significant outperformance compared to all broadly diversified stock indices over time. I have not (yet) succeeded in doing this with respect to all such indices, though recent experience has been much better with an annualized return of 11% since 2019 compared to a slightly negative performance from 2016 to 2018.

During these intial few years, I invested aggressively in a few turnaround/transformation cases, such as Tesco, Deutsche Bank, Holcim and Lanxess, that took much longer to turn around than I expected. This is the main reason why the portfolio returned "only" 6% p.a. since 2016 (as of January 14, 2023), which is not fully satisfying. However, I mostly turned out to be right in my assessment of the ultimate success of these companies, and their still lagging share price development by now is rather surprising. They achieved significant and widely respected operational improvements in the last few years and get cheaper by the day. For example, since 2017, Holcim significantly increased operating margins and free cash flows, simultaneously deleveraged its balance sheet and now trades at below 8 times owner earnings (=free cash flow plus growth capex or operating cash flow minus maintenance capex):

Deutsche Bank almost quintupled 9m pre-provision profits during the last three years in its core bank and, for 2022, it will deliver on its 8% Return on Tangible Common Equity target with a clear roadmap to achieve more than 10% in a few years and is currently valued at only 6* net income:

Lanxess is a similar case (see my comments below). The collective impact of these three companies' share prices on the past performance of the portfolio is quite important. For example, would those firms trade on a rationally reasonable valuation of 15* owner earnings for Holcim, 12* net income for Deutsche Bank and an EV/EBITDA-multiple of 10* for Lanxess, the portfolio would be valued around 50% higher today and its past performance since 2016 would have easily beaten all broadly diversified indices. Does that mean all is well? No. But it means that my expectation of a few years ago that these companies would trade significantly higher today, anticipating their massive performance improvements, wasn't unreasonable. It seems that we need some more time for this to play out, and I am excited about the next few years. As investor Bill Ruane has said: "Over long periods of time, strong business performance translates into strong investment performance."

For the stock markets as a whole I am not quite so optimistic. As I wrote one year ago in my last annual report: "I see two main scenarios for the future development of the stock market. On the one hand, high inflation rates could lead to interest rate increases, which would abruptly slow down the expansion in valuations on the stock exchanges. Or interest rates will remain low and continue to drive up nominal stock market valuations despite higher inflation rates. The decisive variable is the level of interest rates."

Now we know which of these two scenarios happened. Central banks around the world raised interest rates significantly within a very short period of time. All broadly diversified equity and bond indices lost value. The past year was characterized by massive uncertainty regarding the development of inflation and interest rates and the war in Ukraine. Many so-called COVID-winners - and the wealth managers who have invested in them - have literally imploded. This development was not predicted by most market participants. On the contrary, a large majority entered 2022 with positive expectations. The pandemic seemed to be more or less over and a boom, powered by pent-up consumer demand, was expected. People felt safe that inflation would not overshoot, despite the upturn in the economy.

The past year presented many asset managers with major challenges, myself included. After a positive start, the assets under management went downhill quickly and steeply. The uncertainty was great and continued throughout the year. Is the war in Ukraine escalating? Even if the war does not escalate, what does the changed environment mean for the value creation of European companies? Will there possibly even be an escalation between China and the USA? Can central banks get inflation under control? How far are they willing to go to curb inflation? Should we expect stagflation, i.e. a recession combined with inflation? How does a debt-ridden global economy respond to sharp hikes in interest rates? Where are the systemic weaknesses (often only recognizable in hindsight)? Can companies raise prices and thus pass inflation on to customers, or do we have to be prepared for falling profits? These and many other questions are currently on my mind. As far as the stock markets are concerned, however, events on the interest rate front dominate.

As Warren Buffett once said: "Interest rates are to assets prices what gravity is to the apple." The following graphic shows how extraordinary the current market phase is in this respect:

Source: https://citywire.com/za/news/the-fed-is-hiking-faster-and-further-than-it-ever-has-in-modern-history/a2399103

With the logical consequence:

The majority of the companies I have selected are performing well operationally in this difficult environment. And they are very cheap, so they offer their investors attractive returns. Nevertheless, one senses the uncertainty in relation to the coming months. Nobody knows exactly what is in store for us. We have been in constant crisis mode for almost three years now. And we grapple with crises for which there are no obvious solutions. It is important to persevere and face a rapidly changing world with open eyes. Value investing is well suited for this:

Source: Translated with Google Translate from my original website in German

In the last section of this letter, I would like to comment on the two biggest performance detractors of 2022, Alibaba and Lanxess (both have made an impressive comeback so far in 2023).

Alibaba: See Annual Report 2021 and various emails on the subject.

In my opinion, 2022 has opened up a once-in-a-lifetime opportunity in China. The country certainly has big and unique problems that need to be solved, and I, too, have much more sympathy with Western culture, but the Chinese people are fundamentally misunderstood by the West. The war in Ukraine did not help in this regard. Many Western minds cannot distinguish between Russia and China, Putin and Xi. Furthermore, the Communist Party, with its strong hand, especially when it comes to lockdowns, and clumsy communication and foreign policy has worried Western market observers. It is striking that the biggest critics of the lockdown policy are now afraid of the consequences of an uncontrolled opening. And right up to now, many Western "experts" think to observe a return to communist ideology in China, even though the signs are now again clearly pointing towards pragmatism. One gets the feeling that China cannot please the West. The latter acts as if it wants to avoid being overtaken economically by China. Therefore, there seems to be a real risk of a violent US-China conflict. In my view, the main danger here is the United States. Such a conflict would be incredibly damaging for both sides, which is why I assume for the time being that it will not come to that, i.e. that the current tensions between these two countries won't escalate significantly. Micro-economically, the situation is a no-brainer. Considering Alibaba's high quality, the current valuation is far too low.

Lanxess: See presentations on my website from October 2022 and 2021.

The company is carrying out its transformation towards specialty chemicals with impressive consistency and should also be rewarded by the stock market. I've been waiting for this for a long time. The main reason for the hesitant price development is that Russia's invasion of Ukraine led to an extreme flight reaction from German stocks, especially chemical companies, mostly because of fears of gas rationing. At first I was concerned about this too. However, it quickly became clear that Lanxess would not suffer significantly from such rationing. With the warm start to the winter, these worries are now finally off the table (although many newspapers continue to write about them), such as a look at the full gas storage facilities (>90% full in Germany) and the European gas price development (back to pre-war levels) shows:

In addition, in the past few years Lanxess has built up large debts to finance acquisitions. However, these should be reduced significantly in the next few months. On the one hand, the company is expected to receive around EUR 1 billion from a joint venture in the first quarter of 2023, and the inflation-related build-up of net working capital should partially reverse again.