Megatrends v legacy industries: where to invest for growth

Megatrends might be a growth investor’s buzzword, but what are the trends to look at and where can you find the right companies?

It’s easy to get caught up in hype and short-term trends. For investment managers like Paul Loudon, Portfolio Manager at Walter Scott, maintaining a focus on a long-term outlook of 10-20 years and looking for quality companies that cater to this outlook is crucial.

Loudon is particularly excited about the potential raised by industrial automation and biologics.

His enthusiasm for automation is easy to understand given a recent report from McKinsey & Company suggests that up to 50% of the workforce could be automated. While automation has been a trend for many years now, it’s been accelerated by the COVID-19 pandemic. When you also factor in the disruption caused to supply chains during the COVID-19 pandemic by lockdowns and labour force shortages, the ability to automate has become an increasing focus for many companies.

Biologics holds similar potential, with Loudon citing cut-through gene and cell therapies as game-changers for the pharmaceutical world.

Investors shouldn’t forget legacy technology though, with Loudon pointing out that some industries still offer significant roles in supporting megatrends in the future.

One example he uses is railways and the freight industry. Railways are an increasingly attractive alternative to trucking from an environmental perspective as well as from a time and efficiency perspective.

In this interview, Paul Loudon explores some of the themes Walter Scott finds interesting, the value older industries can still play in the future and how to identify quality long-term companies targeting these themes.

Key takeaways:

• Megatrends such as industrial automation or biologics can be valuable to consider for long-term growth investments.
• Growth investors can still find opportunities in older established technology with roles to play in the future.
• Company selection should consider quality factors, such as profitability, cashflow and pricing power.

Edited transcript

Where is Walter Scott looking to deploy capital?

There are a number of very exciting areas out there. With all the noise of higher interest rates, inflation, and geopolitical challenges, clearly, it's tough to stay focused on what will really count over the next 10-20 years. But there are definitely areas that the team is very excited about. I talked about industrial automation as being a prime example of an inexorable trend, especially if you think about maybe challenges with labour inflation and with ageing demographics.

Companies around the world will really look to automate their supply chains and their manufacturing processes. So certainly, any kind of company that is facilitating this wide scale automation of industry is very exciting today. 

Other areas would be in places like biologics, for instance. That is the most exciting area in the pharmaceutical space today. We think that there is a huge runway of growth in lots of exciting areas attached to biologics. So be that cell and gene therapy, personalised medicine, or genetic sequencing, some of these technologies have the possibility to transform healthcare for the better, for patients, for companies, for the government. So we think there are some superb opportunities in that space as well. 

Are there still opportunities to be captured in legacy industries and technology?

We certainly think that there are some great businesses and maybe some more unheralded industries that are overlooked by investors, especially quality growth investors. For instance, railways feels like a 18th-19th century industry. Obviously it was to a large extent, but on the other hand, it is extremely advantaged versus other forms of transportation if you think about the freight industry. 

We think that railway as a method of freight transportation versus say trucking is actually a really exciting, longer term play. If you think about the trucking bottlenecks, shortages in truck drivers, if you think about the environmental consideration. Clearly, economies around the world will try to be far more efficient in their logistics and transportation.

Rail is a much more environmentally friendly method of transportation versus trucking. So that is one area where actually we think there is great long term opportunities. Very high barriers to entry as well. If you invest billions of dollars into your rail network, it's extremely hard for anyone to out-compete you. I think that's one interesting example where we do see, in some respects, an old-world opportunity, but with a great kind of new world potential.

How do you reconcile the pursuit of growth with the need to preserve capital?

We definitely don't think that there is a neat continuum between growth, quality and value. I know that is a handy way to think of things, but there are some growth businesses that are growing very, very nicely, but they also have extremely high quality attributes. So if you have a fast growing business, but it also is extremely profitable, it has a rock solid balance sheet and very high returns on capital, that will offer you operational resilience during downturns.

Now, valuations can come and go, but if that initial valuation isn't too elevated, we still think that there are some exceptionally high quality businesses that are growing very quickly, but will still preserve capital. We've seen that in plenty of cycles, going back to 1983, when the firm was founded, where some of those kind of faster growing businesses actually held up very, very well during downturns.

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