Oakmark Fund: Third Quarter 2022 and Fiscal Year-End

The Oakmark Fund returned -1.9% during the third quarter, outperforming the S&P 500 Index’s return of -4.9%. For the fiscal year ending September 30, the Oakmark Fund declined -17.7%, underperforming the -15.5% decline for the S&P 500 Index. At Oakmark, our job is to take advantage of dislocations between a company’s share price and our estimate of its long-term business value. Market drawdowns and heightened volatility enhance our ability to uncover undervalued securities, creating an actionable environment for those of us who invest with a long time horizon. The companies we invest in will inevitably experience recessions, but even a few years of below trend earnings will typically result in a rather modest impact to long-term business value. Indeed, these periods often sow the seeds of future outperformance.

Our highest contributing securities for the third quarter were Netflix and Pinterest, and our largest detractors were Ally Financial and Charter Communications. From a sector perspective, our strongest contributors were energy and health care, and our biggest detractors were communication services and financials. Netflix remains the global leader in streamed entertainment and is run by a highly accomplished management team. Progress is being made on its ad-supported offering as well as its efforts to reduce password sharing, both of which should enhance growth. We believe the shares remain attractive based on our estimate of normal operating margins. Pinterest also performed well this quarter. We remain optimistic about the company’s opportunity to improve monetization and believe the company’s new CEO, Bill Ready, is well equipped to help realize its potential.

As for the detractors, fears of a recession have weighed heavily on consumer finance companies, like Ally Financial, due to concerns about deteriorating credit quality and used car price declines. Bad debt expense is likely to rise from the unusually low levels we’ve been experiencing, but we believe the company is well-positioned to absorb this normalization. With Ally’s shares trading for just 4x consensus EPS, we believe investors’ fears are already heavily discounted into Ally’s share price, creating an attractive risk/reward proposition. Charter is also trading like a bank stock due to concerns about broadband subscriber growth and competition. With the stock trading for a high-single-digit P/E on next year’s consensus earnings forecasts, we believe the market’s assumptions are overly punitive. Charter remains the dominant broadband provider in 60% of its footprint, and we expect continued operating profit growth even in a tougher competitive and macro environment.

For the fiscal year ending September 30, our highest contributing securities were EOG Resources and ConocoPhillips, while our biggest detractors were Ally Financial and Meta Platforms. From a sector perspective, our strongest contributors were energy and consumer staples, and our biggest detractors were financials and communication services.

During the quarter, we initiated new positions in Fortune Brands Home & Security, Uber Technologies, and Warner Bros. Discovery (see descriptions below), and we eliminated our positions in Humana, Regeneron and T-Mobile US, each of which approached our estimate of intrinsic value. Humana’s more defensive business profile has enabled it to weather this year’s downturn well, while positive results for a higher dose formulation of Regeneron’s blockbuster biologic, Eylea, sent its stock toward our estimate of fair value. T-Mobile US has also performed well since our initial investment in 2020, consistently outexecuting its wireless peers with market-leading revenue and account growth.

The following is a brief description of our new holdings:

Fortune Brands is a leader in home improvement products with strong competitive positions across its primary categories of decorative plumbing, cabinets, outdoor living and security. These are high-quality businesses that benefit from strong brand recognition, scale and deep channel relationships. Under the leadership of CEO Nick Fink, management has expanded margins, invested heavily to drive above-market growth and deployed capital in a value-enhancing manner. We had the opportunity to purchase shares of Fortune Brands at an attractive price due to concerns over the impact that slowing economic growth and higher interest rates will have on the housing market. Although we expect these macro headwinds will pressure short-term results, we believe the long-term outlook for housing and repair and remodel spending remain attractive given favorable demographic trends and historical underinvestment. Trading for roughly 9x next year’s consensus earnings, we believe Fortune Brands presents an attractive opportunity to invest in a well-managed, high-quality portfolio of businesses in a sector that’s deeply out of favor.

We believe the market is underestimating the competitive position and earnings potential that Uber Technologies has in its core Rides and Eats businesses. Uber holds the #1 position in 90% of its rideshare markets globally and is typically more than twice the size of its next competitor. Having the largest and most dense driver network is a key advantage as it enables Uber to offer shorter pickup times and lower prices than competitors while also earning higher margins. We believe the synergies between Rides and Eats will further improve Uber’s service quality and cost position. In recent years, competition from well-funded but unprofitable challengers has pressured Uber’s economics. However, as these challengers are forced to compete more rationally, we expect Uber to generate significant margin improvement alongside continued high growth. We began buying shares at just over 1x revenue and a double-digit free cash flow yield based on management’s guidance for 2024. We view this as an attractive valuation for a business with Uber’s future growth outlook.

Warner Bros. Discovery was created through the merger of Discovery, Inc., and WarnerMedia earlier this year. The combination created one of the largest media companies in the U.S. with a massive back catalog of valuable content from the Warner Bros. Studio, HBO, and the Discovery and Turner television networks. The company is on pace to earn around $1.50 per share this year despite directing much of its content catalog toward its streaming services HBO Max and discovery+, which are collectively generating significant losses. We believe that this content catalog will be profitably monetized over time—whether through the company’s own streaming services or through licensing content to other platforms. Either path will significantly bolster earnings from current levels. Meanwhile, the combination will also allow for significant cost reductions across the cable network and streaming businesses, thereby further boosting profits. Warner Bros. shares are currently trading at just a mid-single digit multiple of our estimate of underlying earnings power after accounting for these factors. We believe that is far too cheap given the quality of its content assets.

We take into consideration tax efficiency of the Fund to help maximize after-tax returns. We anticipate that our capital gains distribution will be zero this year. We thank you, our fellow shareholders, for your investment and continued support of the Oakmark Fund.

The securities mentioned above comprise the following percentages of the Oakmark Fund’s total net assets as of 09/30/2022: Ally Financial 2.7%, Charter Communications Cl A 1.3%, ConocoPhillips 1.9%, EOG Resources 3.1%, Fortune Brands 1.0%, Humana 0%, Meta Platforms Cl A 2.4%, Netflix 2.9%, Pinterest Cl A 2.3%, Regeneron 0%, T-Mobile US 0%, Uber 1.0% and Warner Bros Discovery 1.3%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

Access the full list of holdings for the Oakmark Fund as of the most recent quarter-end.

EPS refers to Earnings Per Share and is calculated by dividing total earnings by the number of shares outstanding.

The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.

The Oakmark Fund’s portfolio tends to be invested in a relatively small number of stocks. As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Fund’s volatility.

Options may be used for hedging purposes, but also entail risks related to liquidity, market conditions and credit that may increase volatility. The value of the fund’s positions in options may fluctuate in response to changes in the value of the underlying asset. Selling call options may limit returns in a rising market.

The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change and may change based on market and other conditions and without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.

Certain comments herein are based on current expectations and are considered “forward-looking statements”. These forward looking statements reflect assumptions and analyses made by the portfolio managers and Harris Associates L.P. based on their experience and perception of historical trends, current conditions, expected future developments, and other factors they believe are relevant. Actual future results are subject to a number of investment and other risks and may prove to be different from expectations. Readers are cautioned not to place undue reliance on the forward-looking statements.

All information provided is as of 09/30/2022 unless otherwise specified.