Why Polen Capital exited these positions in the December 2022 Quarter
2022 was a challenging year in the market, particularly for growth stocks, and now we enter 2023 with the consensus expectation for a recession. Portfolio activity for the Polen Capital Global Growth Fund picked up during the fourth quarter of the year. Four long-term holdings were sold during the December 2022 quarter – Nike, Adidas, Starbucks, and Meta Platforms. Each of the exited positions were smaller weights within the portfolio, reflecting some concerns on outlook.
We liquidated our position in Meta Platforms during the quarter. We had trimmed the position a year ago after Zuckerberg announced an aggressive plan to accelerate internal investment into developing the Metaverse. The magnitude of the planned investment gave us pause, which led us to trim the weighting, but we maintained a small position because the core business remained healthy from our perspective, despite several challenges. The notable challenges during the past year were Apple platform changes, which made ad measurement and attribution more difficult, TikTok competition, very difficult growth comparisons from the prior year, and then more recently the online ad market starting to slow due to economic pressures.
While each of these are very real challenges, we felt that they were temporary headwinds that could be overcome and that Meta maintained a strong competitive position. Even in the most recently reported quarter, user growth and engagement on the platform look healthy. But the aggregate of these headwinds and now additional economic pressure continues to weigh on growth, and management has not been responsive to these realities. We would have expected that aggregate expenses and particularly long-term investments, like developing the Metaverse, would have been moderated to better match the growth of the business. However, the company is planning to grow expenses and investments at a shocking pace in 2023 in light of current realities. In short, this seems like a governance failure to us with management failing to balance stakeholders’ interests effectively.
We liquidated our positions in Nike and Adidas as well. Adidas continues to face challenges that began before the onset of the pandemic. Prior to the pandemic, Adidas had been intentionally slowing wholesale expansion to better align inventory with tier two and three cities with lower income in China. Management has admitted that, at the same time, the company didn’t invest enough in its brand heat to counter competition from both Nike and domestic Chinese brands. COVID forced Adidas to reset everything in the country, resulting in further inventory surpluses. On top of this, the company faced a serious backlash within China from the Xinjiang boycotts. This year has been an extension of these issues, which recently culminated with the announcement that CEO Kasper Rorsted is leaving sometime in 2023 once a suitable replacement can be found.
While we believe Nike remains a unique and advantaged business with solid long-term growth prospects, the company also faces a variety of challenges in the near term. In addition to ongoing challenges in China, due to zero-COVID policies, and substantial currency headwinds from the recent strengthening of the U.S. dollar, supply chain challenges have resulted in bloated inventories. The company will need to discount and liquidate some of its inventory to clear the way for new product in what may be a slowing and likely more promotional environment.
While the company remains a unique and resilient franchise, China is a very important growth market for the company, and zero-COVID policies have made it challenging for the company to operate in this important market. While we expect China to return to more “normal” operation at some point, any COVID flare-ups, in China or other markets, present a very real headwind to Starbucks’ profitability.
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