A trio of fund managers provide answers on the crucial “who”, “what” and “why” of global small-caps in the final instalment of our three-part series. This should provide a clear picture and actionable insights, on top of the "where" and "how" discussed previously.

The offshore focus here is driven by our most recent subscriber survey, where you, our readers identified global stocks as one of several areas you wanted us to cover more frequently. It’s no accident my colleague Ally Selby's maiden Buy Hold Sell episode also has a global theme.

Recapping some of the key topics canvassed in parts one and two of this Collection, by portfolio managers Edward Rosenfeld and Catriona Burns CFA, of Lazard Asset Management and Wilson Asset Management, and Paul Mason, Paradice Investment Management senior analyst:

• Europe offers more opportunities than the US, with all three managers carrying underweight “Stateside” positions
• Real assets are perhaps the only exception here, Mason said.
• Opening their process playbooks, Rosenfeld reveals how the “eye-popping” influence of unprofitable Growth stocks have informed his stock selection
• Burns detailed key fundamentals and “catalysts” her team tracks, while Mason warned investors of fairytales or “narrative-driven” investing.

And below, they each reveal a stock they’d find it near-impossible to part with. Drawn from a diverse range of sectors – FMCG, technology and chemical manufacturing ­– two are Japanese and the other Canadian. 

Delivering compound growth

Edward Rosenfeld, Lazard Asset Management

There are many holdings in the portfolio we’re very excited about, and which have been held for a long time. And the unusual market dynamics (largely speculative driven) is throwing up some rare opportunities to buy quality companies at a discount.

Descartes (TSE: DSG), for example, is a Canada-listed logistics software provider that the portfolio has held since 2013, and it is our type of business because it has:

• high demand visibility,
• high profitability,
• low capital intensity, and
• a successful capital allocation track record.

This combination of characteristics has resulted in sustainably high financial productivity, as shown in Descartes’ favourable return-on-equity and return-on-capital metrics. These factors, combined with the attractive valuation at which we purchased the position, has seen the share price growth compound over the years.

We continue to believe this high-quality company has a long runway with respect to customer adoption as well as industry consolidation, and our investment thesis today remains largely the same as eight years ago.

Don’t fall in love

With that said, we try hard not to “fall in love” with our holdings, because it can be a dangerous behavioural bias when company fundamentals change. In fact, that is one of the reasons our sell-discipline is clearly defined: to help take the emotion out of these types of decisions.

If the risk versus reward proposition no longer looks favourable – hopefully due to significant share price outperformance – or the fundamental investment case has changed for the worse, we will exit.

Scaling up from "trading down"

Catriona Burns, lead portfolio manager, Wilson Asset Management

Kobe Bussan (TYO: 3038) is a Japanese discount supermarket chain business that we have held since February 2019. Globally, we are seeing a trend in consumers “trading down” to price points where the perceived value is highest. This trend has certainly been evident in Japan, and like Aldi and Lidl Stiftung and Co (Lidl) in Europe, Kobe Bussan’s no-frills supermarket business, Gyomu Super, has been able to consistently take market share in Japan’s fragmented supermarket industry.

With 896 supermarkets in the group today, management believes it can grow the number of stores beyond 1,100 over time. With a significant store rollout still ahead of the business, we anticipate Gyomu Super will capture a larger share of the market, thanks largely to its scalable franchise model of low-priced, private label and differentiated imports. The chain offers extremely compelling price points on select items that are between 30% and 70% lower than competitors.

COVID has amplified the decline in Japanese consumer confidence, boosting the popularity of discount supermarkets and further supporting Gyomu Super’s growth. The company uses an asset-light franchisee model, which has allowed it to consistently add new stores with minimal capital requirements. Additionally, Gyomu Super’s ecosystem benefits from disintermediation, with Kobe Bussan excelling as a wholesaler and partial food manufacturer by owning 23 factories in Japan, which produce around 200 products. Greater scale and more private label products will help drive higher profitability over time. In the medium-term, the introduction of online ordering or loyalty programmes could provide further upside to earnings.

Paint a positive picture

Paul Mason, senior analyst, Paradice Investment Management

Kansai Paint (TYO: 4613) in Japan has been part of our portfolio for more than eight years. Broadly speaking, the following attributes – which are incredibly scarce among paint assets – underpin our conviction in the company:

• Entrenched market position
• Powerful brand recognition
• Diversification.

Kansai Paint is tough to part ways with for two main reasons:

1. Mergers and acquisitions. A very common theme in the global coatings market is M&A, where smaller companies are taken private by much larger global players at significant premiums. There are many examples of this, including:

• Dulux Corp being taken private by Nippon Paint in 2019
• Warren Buffet’s Berkshire Hathaway buying Benjamin Moore way back in 2001.

In fact, there is a merger happening right now in Finland. Tikkurila, a national champion within the space, is being taken private by US coatings giant, PPG. While predicting the timing of M&A is largely impossible, we wouldn’t be surprised if Kansai Paint engaged in some form of corporate activity in the coming years.

2. Emerging Markets Growth. Kansai has incredibly powerful positions in the Indian, Thai and Indonesian automotive markets, delivering a powerful growth angle for the business.

Kansai Paint has compounded at 19.2% a year in Australian-dollar terms since the inception of the fund, delivering significant returns for investors.

The wrap-up

As a stop-start recovery takes shape in parts of the world, it’s interesting to note that Europe dominates the attention of the above fund managers on a broader geographical basis. The fact that two of their three stocks were Japanese was also surprising. This perhaps reflects why key country exposures of specific businesses are arguably more important than the home market or listing country of specific stocks.

Missed the start of this series?

Please give this wire a 'like' if you enjoyed hearing about these global companies. You can access parts one and two of this series via the links below.

• Where in the world to find winning small-caps
• How to find small cap success and steer clear of "speccies"

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