MUTUAL FUND
COMMENTARY
Q1
2017
Growth Fund
Portfolio Review
FUND FACTS
OBJECTIVE
Seeks to produce long-term growth
of capital
Share class
Inception
Y
5/16/1991
Ticker
LSGRX
CUSIP
543487110
• The fund underperformed its benchmark, the Russell 1000® Growth Index, largely due to
stock selection in the information technology, financials and industrials sectors as well as
our allocations to the energy, consumer staples and consumer discretionary sectors. On the
positive side, stock selection in the consumer discretionary, consumer staples, healthcare,
and energy sectors as well as our allocation to the information technology and industrials
sectors contributed to relative return.
• The fund is an actively managed strategy with a long-term, private equity approach to
investing. Through our proprietary bottom-up research framework, we look to invest in
those few high-quality businesses with sustainable competitive advantages and profitable
growth when they trade at a significant discount to intrinsic value (our estimate of the true
worth of a business, which we define as the present value of all expected future net cash
flows to the company).
• All aspects of our quality-growth-valuation investment thesis must be present for us to
make an investment. Often our research is completed well in advance of the opportunity
to invest. We are patient investors and maintain coverage of high-quality businesses in
order to take advantage of meaningful price dislocations if and when they occur. During
the quarter, the only addition was Varex Imaging, a spinoff from existing portfolio holding
Varian Medical Systems. We subsequently trimmed this position based on the reward-torisk.opportunity. There was no other portfolio activity in the quarter.
CLASS Y PERFORMANCE AS OF MARCH 31, 2017 (%)
CUMULATIVE TOTAL RETURN
3 MONTH
YTD
AVERAGE ANNUALIZED RETURN
1 YEAR
3 YEAR
5 YEAR
10 YEAR
FUND
8.42
8.42
15.39
11.93
15.06
7.66
BENCHMARK
8.91
8.91
15.76
11.27
13.32
9.13
Performance data shown represents past performance and is no guarantee of, and not necessarily
indicative of, future results. Investment return and value will vary and you may have a gain or loss when
shares are sold. Current performance may be lower or higher than quoted. For most recent month-end
performance, visit www.loomissayles.com.
Additional share classes may be available for eligible investors. Performance will vary based on the share class. Performance
for periods less than one year is cumulative, not annualized. Returns reflect changes in share price and reinvestment of
dividends and capital gains, if any. You may not invest directly in an index.
Gross expense ratio 0.66% (Class Y). Net expense ratio 0.66%. As of the most recent prospectus, the investment advisor
has contractually agreed to waive fees and/or reimburse expenses once the expense cap of the fund has been exceeded.
This arrangement is set to expire on 1/31/2018. When an expense cap has not been exceeded, the fund may have similar
expense ratios.
The Class Y inception date is 5/16/1991. Class Y shares are sold to eligible investors without a sales charge; other Classes
are available for purchase.
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Winners
TOP TEN EQUITY
HOLDINGS (%)
Amazon.com Inc
7.5
Facebook Inc
7.0
Alphabet Inc
5.8
Cisco Systems Inc
5.2
Alibaba Group Holding Ltd
4.9
Visa Inc
4.9
Oracle Corp
4.4
Monster Beverage Corp
3.7
Qualcomm Inc
3.5
Autodesk Inc
Total
www.loomissayles.com
3.3
50.2
Data is based on total gross assets
before any fees are paid; any cash held
is included. The portfolio is actively
managed and holdings are subject to
change. References to specific securities
or industries should not be considered
a recommendation. Holdings may
combine more than one security from
the same issuer and related depositary
receipts. Portfolio weight calculations
include accrued interest. For current
holdings, please visit our website.
• Facebook is an online social networking platform that allows people to connect, share
and interact with friends and communities. People register to use the site, set up personal
profiles and add other users as friends. The basic platform allows message exchange, photo
sharing and common-interest user groups.
Facebook, a holding in the fund since its IPO in the second quarter of 2012, was among
the top contributors to performance in the quarter. The company showed strong results
across all key metrics in its most recent quarterly report, with total revenue up 51% yearover-year to $8.8 billion, 5% above expectations. Advertising revenue, which accounted for
$8.6 billion or 98% of Facebook’s total revenue, grew an impressive 53% year-over-year,
over three times our estimate for total growth in online advertising. Advertising revenue per
user for the quarter of $4.73 was up 32% year-over-year, reflecting improved monetization
per user in all regions. Per user monetization ranges from $19.30 per user in North America
to $1.30 per user in the company’s Rest of World (ROW) category. Facebook ended the
quarter with almost 1.9 billion users worldwide, a 17% increase year-over-year, with about
66% of users engaging daily with the platform. International users increased 18% year-overyear and accounted for about 88% of all users, while North America accounted for about
12% of users. More than 1.74 billion users accessed Facebook on mobile devices, with daily
mobile engagement nearing 66%. Mobile advertising revenue of $7.2 billion represented
84% of Facebook’s total advertising revenue and was up 61% compared with the year-ago
quarter. To put this growth in perspective, when Facebook began monetizing its mobile
platform in June 2012, mobile accounted for just 1% of advertising revenue or $13 million.
Facebook is one of very few mobile platforms where advertisers can reach consumers at such
a scale.
Facebook’s strong financial profile is a component of our quality assessment of the
business. Operating income grew faster than revenue during the quarter and was well
above expectations. Facebook generated attractive gross margins of 89% and earnings
before interest and taxes (EBIT) margins increased by an impressive 400 basis points
year-over-year to 64%, which contributed to earnings that exceeded expectations by 8%.
Strong margin performance was driven by improvement in operating expenses and lower
cost of goods sold, which improved to 11% of revenue from 13% in the year-ago quarter.
Quarterly operating cash flow represented 56% of revenue at $4.9 billion and grew 45%
year-over-year. Capital expenditures of $1.3 billion grew 83% and remained elevated at 16%
of revenue, driven by investments in existing and new data centers that will support future
growth for the company. Free cash flow generated during the quarter of $3.7 billion was up
36% compared with the year-ago quarter and represented 42% of revenue. The company’s
balance sheet is strong, with net cash of $29.4 billion or $10 per share.
Other platforms owned by the company also continued strong user growth. Instagram
now has over 600 million monthly users and 400 million daily users, while Messenger
and WhatsApp each have over 1 billion active monthly users. Instagram already has over
500,000 active advertisers, and as Facebook further develops Messenger and WhatsApp to
make it easier for users to connect with groups and businesses, we believe monetization will
follow. Sixty-five million small businesses use Pages on Facebook. Relevant, personalized
marketing can drive scale and revenue for Facebook’s advertising clients, and the company
is committed to new product innovation to create more immersive experiences for target
audiences, including video, where users are spending more time, and quick-loading, full-
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screen canvas ads. In our view, increased users and business partners create a virtuous
cycle that strengthens the company’s network advantage. Facebook’s market share is in
the low single digits of the global advertising industry and approximately 15% of global
online advertising. We believe Facebook is well positioned for strong, sustained growth.
We see attractive long-term upside potential for Facebook in this large, growing and
underpenetrated market. We believe shares of Facebook continue to be priced significantly
below our estimate of intrinsic value, offering an attractive, long-term reward-to-risk
opportunity.
• Online retailer Amazon offers millions of products – sold by Amazon or by third parties
– with the value proposition of selection, price, and convenience. Amazon Web Services
(AWS) offers a suite of cloud-computing services. Amazon has four primary customer sets:
consumers, sellers, enterprises, and content creators.
A long-term fund holding, Amazon was among the largest contributors to performance
during the quarter. The company reported quarterly results that demonstrated healthy
fundamentals, strong market share gains and revenue and earnings that met or exceeded
management guidance. Amazon again achieved massive share gains in its e-commerce
and enterprise IT businesses. We estimate gross merchandise volume (GMV) for Amazon
increased more than 30% year-over-year, well above our estimates for US e-commerce
growth in the teens and global retail sales growth in the low single digits. AWS revenue was
up 47% compared with the year-ago quarter while we estimate enterprise IT spending by
businesses increased by a single-digit percentage.
Amazon reported worldwide net revenue for the quarter of $43.7 billion, a 24% increase
year-over-year in constant currency. E-commerce revenue accounted for approximately 90%
of total revenue. First-party e-commerce sales accounted for 70% of revenue and grew by
15%. Third-party e-commerce sales and related fees, where Amazon provides fulfillment
and marketplace services but owns no inventory, were up 41% year-over-year and accounted
for about 21% of revenue. Revenue for AWS, 8% of Amazon’s total revenue for the quarter,
increased 47% year-over-year. With more than one million worldwide customers, AWS has
exceeded a $14 billion annual revenue run rate. AWS is focused on innovation to improve
its value proposition of speed, agility and savings. Other revenue, which includes advertising
and co-branded credit card fees, accounts for about 1% of revenues and increased 70%
compared with the year-ago quarter. Looking at revenue by e-commerce product category,
sales in the electronic and general merchandise category, about 80% of global e-commercerelated revenue, were up 25% year-over-year in the US and 24% in international markets.
Media sales represented 19% of e-commerce revenue and grew 7% in North America and
3% in international markets. By geography, sales in North America increased 22% yearover-year and represented approximately 65% of e-commerce revenue, while international
sales increased 23% and represented about 35% of e-commerce revenue.
Amazon maintained an elevated level of investment spending on fulfillment, digital video
content, marketing, benefits for Prime customers, its Echo/Alexa smart home device and
India, all of which we expect to contribute to the company’s long-term growth. Amazon
added a total of 26 fulfillment centers in 2016, driven by growing demand for Prime and
Fulfillment by Amazon (FBA) services. The company reported the number of sellers using
FBA increased 70% in 2016 and included sellers in 130 countries. FBA accounted for
55% of third-party units sold in the fourth quarter. For Prime customers, the number of
items available for two-day delivery now totals 50 million, up 73% over the prior year. The
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company also announced it launched Prime Video in over 200 countries in the quarter, as
its investments in content attract new members and increases the retention rates of existing
Prime customers.
With its sales mix shifting increasingly to third-party e-commerce sales, AWS, advertising
revenue and higher margin product categories, Amazon’s gross margins expanded by 190
basis points to 33.8% compared with the year-ago quarter. Gross income increased 29.6%
year-over-year. Overall, Amazon reported solid operating income of $2.17 billion, up 24%
compared with the year-ago quarter and above management’s guidance. Operating expenses
for fulfillment increased as a percentage of revenue by about 30 basis points to 12.6% of
sales, and technology and content also rose 30 basis points to 9.3% of sales. General and
administrative expenses were up by 40 basis points to 1.4%, and marketing costs as a
percentage of sales increased 70 basis points to 5.5%. Overall operating margins were 5%,
up 10 basis points from the year-ago quarter. At a segment level, North America increased
its operating income 32% to $1.3 billion. Its operating margin was 5%, an improvement
compared with 4.7% in the year-ago quarter. The international segment reported an
operating loss of $487 million and a -3.5% operating margin, down from last year’s -1%
margin. AWS grew operating income 61% to $1.1 billion with operating margins of 31.3%,
compared with margins of 28.6% in the year-ago quarter. During the trailing 12-month
period, Amazon increased operating cash flow 38% to $16.4 billion and free cash flow was
up 33% to $9.7 billion compared with $7.3 billion generated in the prior 12-month period.
Amazon has a strong balance sheet with about $18.2 billion in net cash, or $37 per share.
We believe Amazon, led by visionary founder Jeff Bezos, is one of the best-positioned
companies in e-commerce and enterprise IT – each addressing large, underpenetrated
markets. We believe Amazon remains well positioned for attractive and sustainable revenue
growth, faster EBIT (earnings before interest and taxes) margin expansion, and free cash
flow growth that is not reflected in the current share price. We believe Amazon shares
are trading at a significant discount to intrinsic value (our estimate of the true worth of a
business, which we define as the present value of all expected future net cash flows to the
company) and offer a compelling reward-to-risk opportunity.
• Alibaba Group, launched in 1999, is the leader in China e-commerce, operating as a
marketplace that brings together retail buyers and sellers as well as wholesale buyers and
sellers. Alibaba does not engage in direct sales or hold inventory.
A long-term fund holding, the company was among the top contributors to performance
during the quarter. The company’s most recently reported quarterly results were strong
with revenue and earnings per share (EPS) above market expectations by 5% and 16%,
respectively. Total revenue increased to $7.67 billion, a 54% increase compared with
33% growth in the same quarter last year. The company posted revenue growth across all
segments and attributed accelerated year-over-year growth in part to the effectiveness of
its broad ecosystem. The Alibaba Group includes three major marketplace sites in China –
Taobao, Tmall, and Juhuasuan. Probably best known outside of China, Alibaba.com is an
English-language platform for cross-border trade designed to help small businesses expand
overseas. In addition to its marketplace platforms, Alibaba is also a cloud computing and a
digital media and entertainment company.
Alibaba’s marketplace businesses are part of its core commerce business segment and
represented 87% of total revenue and 100% of earnings before interest taxes and
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amortization (EBITA). Core commerce grew 45% year-over-year. China commerce retail,
approximately 88% of core commerce revenues, increased 42% and benefitted from 47%
growth in online marketing revenue and 32% growth in commission revenue. Increased
use of the commerce platform by brands and merchants for client acquisition and brand
building drove growth in the segment’s marketing business. Alibaba’s increasingly relevant
content helped improve consumer engagement, which in turn benefits the marketing
business. Up 73% year-over-year, mobile revenue accounted for 80% of China commerce
retail revenue. Monetization increased to RMB 241 per annual active buyer, up 31%
compared with approximately RMB 184 in the year-ago quarter. During the quarter, active
buyers on Alibaba sites increased 9% to 443 million users, which is larger than the US
population. Mobile monthly active users grew 25% to 493 million, which was driven by
increased investment in content and user engagement.
International commerce retail revenue, approximately 5% of core commerce revenue,
increased 288%, benefiting from the April 2016 consolidation of Lazada Group SA, a
Singapore-based e-commerce company serving six southeast Asian markets and Alibaba’s
biggest acquisition outside of China. International revenue is also benefiting from the
acceleration of growth in the company’s AliExpress business. Core commerce grew adjusted
EBITA by 43% year-over-year. Operating margins of 64% were down 100 basis points.
This figure reflects positive operating leverage from the core businesses offset by investments
in initiatives such as rural Taobao, grocery services through Tmall Supermarket, and
expansion into southeast Asia through its Lazada acquisition.
Well positioned for the secular migration to cloud computing, Alibaba’s cloud-computing
revenue rose 115% to $254 million, approximately 3% of total revenue. Growth in spending
for additional services aided revenue growth. The customer base increased by 114,000 to
764,000, and Alibaba launched new data centers in Japan, Germany, the Middle East
and Australia. While the cloud-computing business is in investment mode and generated
a quarterly operating loss of $13 million, operating margins improved from -41% in the
year-ago quarter to just -5% this quarter. Digital media and entertainment revenue of $585
million, approximately 8% of total revenue, grew 273%, primarily due to the consolidation
of China-based video streaming acquisition Youku Tudou and growth in UCWeb, which
benefited from mobile value-added services. Media offerings boost the length of user
sessions and user stickiness, expand the ecosystem for customer acquisition and brand
building, and improve Alibaba’s overall consumer value proposition. The segment remained
in investment mode, reporting an operating loss of $350 million for the quarter. The
company’s innovation initiatives and others revenue of $122 million, about 2% of total
revenue, grew 61% year-over-year, largely due to early-stage businesses for mobile operating
systems, cars, Internet of Things (IoT), AutoNavi, and enterprise messaging. Operating
losses in these initiatives of $114 million and an adjusted operating margin of -93%
represent an improvement over margins of -183% in the year-ago quarter. Management
continues to use strong cash flows generated by core commerce’s marketplace to invest
in cloud computing, digital media and entertainment and other initiatives. Similar to its
investment approach with core businesses Taobao and Alipay, Alibaba takes a long-term,
patient philosophy and will invest for seven to ten years in growth areas. Alibaba’s operating
margins are attractive. EBITDA margins (earnings before interest, taxes, depreciation and
amortization) were 51% in the quarter, but were down 4% year-over-year due to the Youku
Tudou and Lazada acquisitions, as well as investment in Tmall Supermarket. Adjusted EPS
was $1.30, up 38% year-over-year and 16% above market expectations. Management’s goal
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is to drive profit and grow the overall ecosystem. For the quarter, Alibaba reported free cash
flow of $4.9 billion, up 34% year-over-year, which represented 64% of quarterly revenue.
The company ended the quarter with a net cash and investments position of around $31.5
billion or $12 per share, approximately 12% of its share price.
Management provided an update to its long-term “new retail” strategy, where it leverages
mobility, information technology, data and its strong position in the value chain to drive
efficiencies in offline retail. As part of this strategy, management has made investments in
offline retailers, including China department store Intime, electronics retail store Suning
and supermarket chain Sanjiang. Management will work closely with all three companies
to improve inefficiencies in all layers of their supply chain. The focus over the long term is
to digitally enable the entire China retail value chain, representing a $4.8 trillion market
opportunity versus approximately $1.2 trillion in projected China e-commerce spending.
Alibaba continues to execute well on its business model, allowing it to expand its already
dominant market position and to invest to strengthen its competitive advantages. The
company benefits from the secular growth of China’s structural shift to e-commerce,
its strong brand, the powerful network and ecosystem of its interconnected sites, and
economies of scale. The key growth areas for the company are globalization, rural China,
and cloud computing. We believe the current market price embeds expectations for
key revenue and cash flow growth drivers for Alibaba that are well below our long-term
assumptions. As a result, we believe Alibaba is selling at a significant discount to intrinsic
value (our estimate of the true worth of a business, which we define as the present value of
all expected future net cash flows to the company) and offers a compelling reward-to-risk
opportunity.
Laggards
• Qualcomm designs, manufactures and markets digital telecommunication integrated
circuits (chipsets) and services. The QTL (Qualcomm Technology Licensing) segment
collects license fees from manufacturers for the right to use Qualcomm’s intellectual
property in chipset designs as well as follow-on royalty fees on worldwide sales of devices
incorporating these chipsets. The QCT (Qualcomm CMDA Technologies) segment is the
leading developer and supplier of chipsets enabling wireless communication, particularly in
mobile devices. QCT collects revenue from the sale of its chipsets to device manufacturers.
A long-term fund holding, Qualcomm reported quarterly results that were in line with
consensus expectations but shares fell on news of a lawsuit filed by Apple alleging unfair
practices. With respect to recently announced litigation, we believe the following. The
industry-standard business model for mobile OEMs (original equipment manufacturers)
has been in place for decades and withstood much scrutiny and many challenges. The
model is that patent royalty rates are based on the value of the total device, not the value of
the communication chipset itself. Qualcomm has demonstrated that a material amount of
the perceived value of a mobile device is due to the capability of the cellular connectivity,
not only due to non-cellular communication features and characteristics. The phone is
primarily valuable because of its communication capability, including movement of data.
Demonstrating the value of its contribution, Qualcomm has successfully argued that it
must be allowed to recoup its research and development investments in order to fund
ongoing innovation. Innovation in high-quality cellular communications benefits all players
in the value chain, including phone manufacturers, mobile service providers, and players in
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emerging business models.
Challenges to Qualcomm’s business model and royalty rates are not new. Qualcomm
successfully defended its business model in 2006 in a challenge brought by Reliance, in
2007 with the US International Trade Commission, and in 2008 versus Nokia in a case
that took three years to settle. These cases can take many years to resolve. A 2010 ruling by
the Japan Fair Trade Commission (FTC) as well as the 2009 and 2015 rulings by South
Korea’s FTC is still under appeal. Two cases brought against Qualcomm in 2015 by the
European Union are still pending as is a case in Taiwan. Because many of these cases are
initiated at the request of device manufacturers, we believe it is a strategy to try to force any
concession on paying royalties. However, we believe the business model has been validated
on multiple occasions over the last 10 to 20 years.
In a particularly successful case, Qualcomm recently prevailed in China, where the NDRC
(National Development and Reform Commission) had the opportunity to rewrite local
industry rules for intellectual property (IP) royalties, but instead validated Qualcomm’s
business model. The Chinese government recognized the high-value contribution of
Qualcomm’s technology to the value chain – and the need for ongoing innovation.
Qualcomm has consistently succeeded in defending its licensing structure. The settlement
of these cases not only repeatedly upheld and validated Qualcomm’s business model, but
established a body of legal precedence in a variety of jurisdictions around the world.
Distinct but related, a case now before the US FTC and Apple’s lawsuit against Qualcomm
are the latest in a series of challenges to the business model. Organizations such as the FTC
or the NDRC can generally be, and many times are, nudged to investigate issues upon
stakeholders’ complaints. This latest lawsuit by the FTC against Qualcomm was rushed
ahead of the change in the US presidential administration, developed by a commission
with two of its five commissioner seats vacant, and issued just days prior to the announced
departure of the commission’s chairperson, who voted against Qualcomm. The vote
was 2-to-1 against Qualcomm, with the commissioner who since became the interim
chairperson objecting to the ruling with the issuance of a public statement of dissent. Once
the commission is fully staffed, Qualcomm will present its case; we believe the company
will employ an approach similar to that used with the NDRC in China noted above. If
Qualcomm fails to persuade the commission, we believe Qualcomm will file suit.
In our view, the current challenges to Qualcomm’s business model involving Apple are
no different from previous challenges, except for Apple’s aggressiveness in its pursuit.
This is not necessarily indicative that Apple has a strong case. Part of what we are seeing
here is that Apple is trying, as others have, to lower its royalty payment to Qualcomm.
Apple does not have a direct contract with Qualcomm, but it pays indirectly through
its contract manufacturers which have licensing contracts with Qualcomm. Relative to
its competitors, Apple already pays a lower royalty fee to Qualcomm as a result of this
structure, but Apple does not have access to Qualcomm’s full library of patents. Because the
royalty fees paid by mobile device manufacturers to Qualcomm are not insignificant, it is
a rational decision to attempt to try to force the fees lower. In such an attempt, Apple filed
its lawsuit against Qualcomm claiming the basis for royalty revenue is flawed and inflated
because Qualcomm, through its multi-decades-long-licensing structure, collects royalty
fees from device manufacturers, not integrated chip manufacturers. By collecting royalty
fees based on the device’s selling price, Qualcomm benefits from the respective device
manufacturer’s innovation. Apple has previously taken a similarly aggressive approach with
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other IP providers. In January 2015, after two years of negotiation with Apple, Ericsson
filed a lawsuit against Apple for nonpayment of royalties on the use of Ericsson’s patents.
In this case, Apple tried the same strategy of attacking the validity of Ericsson’s global IP
portfolio. In December 2015, Apple settled the suit with Ericsson, which subsequently
reported a significant increase in IP revenue, signaling to us that basis of the agreement
remained intact. Nokia is currently suing Apple for nonpayment of royalties and has filed
an injunction to prevent the importation of iPhones in many countries, including the US.
Ericsson and Nokia, which along with Qualcomm are the largest contributors of Standard
Essential Patents to the industry, strongly support the decades-long structure of royalties
based on the device’s selling price.
As for the potential size of this case, we estimate Apple indirectly makes up approximately
one-third of Qualcomm’s royalty fee business. We believe the decades-long industry practice
that has been repeatedly validated, and is backed by regulations around the world, is not
likely to be overturned. We also believe Qualcomm adds significant value to the industry
with its IP, and this long-term practice is based on this significant value the company brings
forward for the value chain. We continue to stay informed of the situation.
For the quarter, overall revenue was up 4% year-over-year to $6.0 billion, in line with
management guidance, and operating income rose 19%. Revenue in the QTL segment
increased 13% year-over-year with improved catch-up payments from licensing compliance
by device makers in China. By year end, Qualcomm announced it had reached agreement
with the ten largest device manufacturers in China, including Meizu, the last outstanding
manufacturer of significance and against which Qualcomm had initiated legal proceedings
in multiple jurisdictions. The company has now reached agreement with 120 device
manufacturers in China, which it believes collectively represents 80% of global revenue
generated by China-based device makers. The outcome reinforces the value of Qualcomm’s
IP and royalty model and highlights the company’s ability to enforce its agreements
globally. Average selling prices (ASP) declined a better-than-expected 4% as consumers
upgraded their mobile phones, particularly in China and other emerging markets. Total
reported device sales (TRDS) of $63 billion was in line with management guidance.
Overall, the implied royalty rate remained flat at 2.9%, and segment margins were 85%.
QCT segment revenue was flat year-over-year. Shipments of mobile satellite modems
(MSMs) were down 10%, in line with management’s guidance. Continued traction in
China contributed to performance, with strength in all product tiers. However, Qualcomm
lost market share for its premium thin modem at Apple, which is using Intel modems in
some iPhones, and at Samsung, due to the recall of the Galaxy Note 7 smartphone. Implied
ASPs were up 14% due to product and customer mix during the period. QCT segment
margins of 18% rose from 14% in the prior-year quarter as the company realized savings
from its strategic realignment plan and from strong adoption of its premium products.
In late October, the company announced a definitive agreement to acquire NXP
Semiconductors, a Netherlands-based chip manufacturer focused primarily on automotive
markets, in a $47 billion all cash deal. While the acquisition would dilute the relative
contribution of Qualcomm’s highly profitable QTL business, NXP has sustainable
competitive advantages in attractive areas of the semiconductor industry that are
complementary and higher margin than Qualcomm’s QCT business. The deal is expected
to be completed by the end of 2017.
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We believe Qualcomm is well positioned to benefit from long-term secular growth in
mobile devices and that market expectations embed future growth well below our estimate.
We believe Qualcomm is selling at a meaningful discount to intrinsic value (our estimate of
the true worth of a business, which we define as the present value of all expected future net
cash flows to the company) and offers a compelling reward-to-risk opportunity.
• United Parcel Service (UPS) is the world’s largest package delivery company and a leading
global provider of specialized transportation and logistics services. The company delivers
more than 18 million packages each day to approximately 10 million customers, with
430,000 employees in more than 220 countries.
UPS, a long-term fund holding, was among the largest detractors for the quarter. The
company reported quarterly shipping volumes and revenues that were generally in line
with expectations, but domestic margins declined, lagging expectations, and the company
announced a substantial increase in midterm capital expenditure guidance. Quarterly
revenue of $16.9 billion rose 5.5% year-over-year on strength in domestic shipping volumes.
Domestic shipments constituted 64% of revenue, which increased 6.3% year-over-year to
$10.9 billion on 5% growth in shipping volume. Ground shipments accounted for 83% of
domestic volume and 71% of domestic revenue for UPS, with volume growth of 5.4% and
revenue growth of 7.1% compared with the same quarter last year. Next day air shipments,
approximately 8% of domestic volume and 17% of domestic revenue, grew volumes by
4.4% and revenues by 4.2%. Domestic deferred air shipments (shipper-designated lower
priority packages with delivery flexibility priced at a lower tariff) accounted for 9% of
domestic volume and 12% of domestic revenue, with volumes up 2.8% and revenue up
4.4%. Growth was driven primarily by business-to-consumer (B2C) shipping, which grew
11.5% and accounted for 55% of volume in the quarter, including 63% in December,
representing the biggest quarterly shift in business mix the company has experienced.
Surepost volumes, in which UPS delivers packages to the US Postal Service for final mile
delivery, grew 25%. Business-to-business (B2B) shipping declined slightly. The shift in
business mix impacted revenue per package which was flat year-over-year. Cost per package
increased by 60 basis points, with 30 basis points due to higher fuel costs, and contributed
to an 85 basis point decline in operating margins to 12.3% for the quarter. During the
quarter, the company announced it was increasing its expected 2017 capital expenditures
(capex) to $4 billion, approximately 6% of revenues. This compares with recent capex
of closer to 4% of revenues and long-term corporate guidance of 4.5% - 5%. We believe
this represents capital investments being pulled forward to more quickly modernize the
company’s network in response to the increased growth in B2C volumes. While capex is
likely to remain elevated in the midterm, as B2C grows as a percentage of the business
mix, the company should become less capital intensive as B2C growth is less dependent on
adding aircraft.
International segment results remained positive, constituted 20% of quarterly revenue, and
increased 5% year-over-year to $3.3 billion. International shipment volume grew 7.3% with
20% growth in Asia and 10% growth in European cross-border shipments. Cross-border
shipments accounted for 77% of international revenues. Revenue per package declined
by 1.7% in constant currency, but margins rose 150 basis points to 21.2%, aided by 300
basis points of currency hedging gains that are likely to become a headwind in 2017.
Management announced it has completed one-third of a $2 billion European network
expansion program.
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The company’s supply chain and freight business constituted 16% of revenue and rose 2.6%
to $2.7 billion. The forwarding and logistics services revenue, which accounted for 68%
of segment revenues, increased year-over-year revenue by 3.5%. Tonnage in air and ocean
forwarding increased for the first time in over a year, including mid-single-digit growth in
air tonnage. UPS Freight, 26% of segment revenues, delivered year-over-year growth for the
first time since the first quarter of 2015. Overall segment margins declined 90 basis points
to 6.7%, in part due to narrowing buy/sell spreads in air tonnage.
With strong competitive advantages, such as its global brand, scale, and large and unique
network infrastructure integrated by cutting-edge technological know-how, we believe UPS
is well-positioned to benefit from the secular growth in demand for global shipping and
logistics. With its long-term perspective and focus on return on invested capital, we believe
the company will benefit from the investments it is making to support its growth in B2C
business. We believe UPS is selling at a meaningful discount to intrinsic value (our estimate
of the true worth of a business, which we define as the present value of all expected future
net cash flows to the company) and thereby offers an attractive reward-to-risk opportunity.
• Schlumberger is the world’s leading supplier of technology, equipment, integrated project
management, and information solutions to the international oil and gas exploration and
production industry. A long-term fund holding, Schlumberger was among the largest
detractors from performance during the quarter. The company reported revenues and
earnings per share that were in line with consensus expectations. Quarterly revenue of
$9.8 billion declined 28% year-over-year but rose 1.3% over the prior quarter. Regionally,
Schlumberger reported activity growth in North America and the Middle East. Comprising
about 25% of total revenue, North America revenue fell 9.7% compared with the year-ago
quarter, but increased 3.9% sequentially. Although year-over-year rig count in the region
fell 18%, compared with the prior quarter it increased 27%, as the industry appears to have
reached a trough in the second quarter of 2016. The use of longer lateral drilling continues
to increase, and Schlumberger reported strength in both directional drilling and pressure
pumping. Results in international markets, about 75% of total revenue, were mixed even as
the company reported it was capturing a higher share of overall industry profits. Revenues
from the Middle East and Asia increased 4.6% sequentially and 10.9% year-over-year.
Growth was due in part to the April 1, 2016 acquisition of Cameron International (CAM),
but also from underlying growth in pressure pumping in the Middle East. Latin America
revenue declined 4% sequentially, generally in line with a 2.5% regional decline in rig
counts. Revenues for Europe, the Commonwealth of Independent States and Africa were
down 2% sequentially, also directionally similar to regional rig counts which declined 1%.
From a segment standpoint, reservoir characterization comprised 24% of quarterly revenues,
which were down 22.5% compared with the year-ago quarter and up 0.6% compared with
last quarter. Approximately 76% of segment revenue came from international markets.
Many businesses within Schlumberger’s reservoir characterization segment have significant
exposure to exploration, which has been under pressure since peaking in 2012. However,
the company reported strong performance in the Middle East in its testing and process
business, which provides well testing and measurement services, such as evaluating fluid
pressure and flow rate. Operating margins of 18.6% were down 520 basis points year-overyear and down 50 basis points over the prior quarter. Drilling accounted for 28% of total
revenues and fell 32% year-over-year and less than 1% from the prior quarter. International
markets contributed approximately 76% of segment revenues and weighed on results, but
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the effect was largely offset by strength in North America, where the company noted that
it had sold out of certain drilling products despite adding capacity over the prior quarter.
Margins of 11.6% were down 510 basis points year-over-year, but improved 80 basis points
over the prior quarter. The production segment accounted for 31% of total revenues, which
declined 17% year-over-year but rose 5% compared with last quarter. Production also
experienced a recovery in North American land well activity as well as strength in the
Middle East. Management has previously maintained that pressure pumping in North
America is over-supplied but the company saw some gains in North America pricing.
Management continued to reiterate that they would not participate in unprofitable activity.
Margins of 6.1% were down 540 basis points year-over-year, but improved 140 basis points
over the prior quarter. Recently acquired CAM comprised 19% of total quarterly revenues,
which declined 36% year-over-year but were flat versus the prior quarter. International
markets contributed approximately 71% of revenues. Weakness was concentrated in highmargin drilling equipment, which weighed on overall margins of 14%, down 300 basis
points year-over-year and 210 basis points sequentially. The company also announced CAM
had entered a $350 million, ten-year service and lease contract with Transocean for the
provision of blowout preventers and risers for offshore rigs.
Consolidated operating margins for the company were 7.9% for the quarter, down 690 basis
points year-over-year and flat versus the prior quarter. Schlumberger continues to generate
strong free cash flow, which totaled $2.6 billion in the quarter, substantially better than
industry peers that struggle to generate any positive free cash flow. The company ended the
quarter with $10.1 billion in net debt, comprised of $9.3 billion in cash and $19.4 billion of
debt. Schlumberger is finding demand for its products and maintaining exemplary margins
and cash flow for this point in the cycle. We believe Schlumberger will continue to execute
well and the company is well positioned to drive growth as the demand for oil services
rebounds. The company is showcasing its industry-leading products and services which we
believe will result in long-term pricing power and market share tailwinds. We believe the
shares of Schlumberger are selling below intrinsic value (our estimate of the true worth of
a business, which we define as the present value of all expected future net cash flows to the
company) and offer a compelling reward-to-risk opportunity.
Outlook
• Our investment process is characterized by bottom-up, fundamental research and a longterm investment time horizon. The nature of the process leads to a lower-turnover portfolio
in which sector positioning is the result of stock selection.
• The fund ended the quarter with overweight positions in the information technology,
consumer staples, financials and energy sectors and underweight positions in the consumer
discretionary, industrials and healthcare sectors. We did not own positions in the materials,
real estate, telecommunication services and utilities sectors.
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About Risk
Equity securities are volatile and can decline significantly in response to broad market and
economic conditions. Foreign and emerging market securities may be subject to greater
political, economic, environmental, credit, currency and information risks. Foreign securities
may be subject to higher volatility than US securities due to varying degrees of regulation and
limited liquidity. These risks are magnified in emerging markets. Currency exchange rates
between the US dollar and foreign currencies may cause the value of the fund’s investments
to decline. Investments in small and mid-size companies can be more volatile than those of
larger companies.
Russell 1000® Growth Index measures the performance of the large cap growth segment of the
US equity universe. It includes those Russell 1000 companies with higher price-to-book ratios
and higher forecasted growth values.The Russell 1000 Growth Index is constructed to provide a
comprehensive and unbiased barometer for the large cap growth segment. Indexes are unmanaged
and do not incur fees. It is not possible to invest directly in an index. Russell Investment Group is
the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes.
Russell® is a trademark of Russell Investment Group.
Outlook as presented in this material reflects subjective judgments and assumptions of the portfolio
team and does not necessarily reflect the views of Loomis, Sayles & Company, L.P. There is no
assurance that developments will transpire as stated. Opinions expressed will evolve as future
events unfold.
Before investing, consider the fund’s investment objectives, risks, charges, and
expenses. Please visit www.loomissayles.com or call 800-225-5478 for a prospectus
and a summary prospectus, if available, containing this and other information.
Read it carefully.
NGAM Distribution, L.P. (fund distributor) and Loomis, Sayles & Company L.P. are affiliated.
LS Loomis | Sayles is a trademark of Loomis, Sayles & Company, L.P. registered in the US Patent
and Trademark Office.
1037399.13.1
Exp. 7/31/17
LSGF03-0317
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