My thoughts from the road
The year ahead might be more volatile than the last, as the world navigates through higher bond yields and rising inflation, but we think a good equity portfolio will outperform most other asset classes. Here I share some thoughts on specific companies, and the implications of a trade war, following a recent overseas research trip.
While the media continues to revel in Donald Trump’s tweets and posturing, playing up the trade negotiations between the US and other nations, most global economies continue to be on sound footing, generating healthy levels of growth. While the White House is considering imposing tariffs on an additional $200 billion in Chinese products, we are still seeing the businesses in China, largely in the services sector, continue to grow at a healthy rate.
The companies at greatest risk are manufacturers that aren't at the bottom of the cost curve, exporting into the US.
I see the greatest risk to these tariffs being an acceleration of inflation in the US economy and interest rates rising faster than anticipated. I don't think Trump wants to hurt the US economy and is just bargaining but if he follows through with these tariffs, it will have a meaningful impact on economic growth.
The team at Perpetual continue to focus on investing in high quality companies at attractive valuations and we have been travelling around the world to ensure that the companies we have invested in continue to deliver on expectations but also in search of new investments. I have travelled through Europe meeting the companies we have invested in as well as their competitors and customers and thought I would take the opportunity to reflect on some of these companies and meetings.
Street talk in Europe
In central Europe, industrial companies like Siemens (ETR:SIE) and Atlas Copco (CPH:ATCO-A) continue to see mid-single digit revenue growth. They are seeing increased demand especially from sectors benefitting from higher commodity prices. Well managed financial services companies like Julius Baer (SWX:BAER), continue to generate positive net inflows from their clients despite the recent sell off in European financials.
The countries in the Mediterranean are still recovering from the financial crisis. Spain continues its recovery with Banco Bilbao Vizcaya Argentaria (BME:BBVA) generating mid-single digit loan growth for the SME segment and they expect mortgages to return to growth by the end of the year. NH Hotels (BMS:NHH) is seeing improving occupancies in Europe and have been increasing room rates to drive growth. In Spain, room rates are 3% off the 2007 peak levels.
Some of the companies that we have invested in, that are exposed to the UK consumer, are performing better than the market would have expected a few years ago, following the Brexit vote. Despite the introduction of the sugar levy in the UK, Britvic (LON:BVIC) are still managing to grow with an increase in Pepsi Max revenue more than offsetting the decrease in Pepsi sale.
A closer look at Nomad Foods
Nomad have strengthened their market share in the UK frozen foods market, holding around 20% market share. They are one of our biggest positions and are slowly being re-rated by the US market as the word gets around that they are building a European foods powerhouse. We like owner managed businesses in growing industries, where the earnings stream is not highly volatile. We have been increasing our positions in consumer staples companies as these businesses will perform well when economic growth eventually starts to weaken. We think Nomad foods has the right structure and fundamentals to grow its earnings and share price over the next decade.
The business was created when Noam Gottesman (founder and managing partner of TOMS Capital and co-founder of GLG) and Martin Franklin (founder and executive chairman of Jarden Corp) acquired the assets of Iglo Foods and Findus Group in 2015. This gave them the Bird’s Eye brand throughout the UK, the Findus brand in Italy, France and Spain and the Iglo brand in Germany and other continental markets. The company instantly became the leader in Europe’s $25 billion frozen foods category with 17% share, which is 2.7x the market share of their closest competitor. They have leadership positions in the UK, Italy, Sweden, France and several other European markets and are focussed on building out their core brands, realising synergies from optimising their supply chain and growing margins while generating a lot of free cash flow for shareholders.
Diversified portfolio across savoury frozen food
Source: Nomad Foods presentation at Deutsche Bank Conference June 2018
What initially drew us to the business was the heavily discounted valuation multiple the stock was trading on relative to its peer group. Early on when we first entered a position, the stock was trading at only 10x earnings as the market was giving management no credit for being able to grow the business. There was also a lack of awareness about the business as only one or two investment banks actually covered the stock.
We began by looking through the history of the businesses and quickly realised that some previous market share losses and underperformance was due to strategy issues. Previous management had underinvested in the core and overinvested in as many non-core extensions as possible. They hadn’t run a Captain Birds Eye advert on television for several years. We then spoke to the previous CEO of the business, buying managers at their larger retail customers, and senior management of several competing businesses in order to gain a better understanding of the potential outcomes from the new CEO’s strategy of refocussing on the core business and ‘must win battles’. We spoke to Nomad management and quickly realised that the actions they were taking to re-invigorate the core brands made perfect sense and would accelerate sales growth.
We are starting to see the fruits of these actions with organic revenue growth of 3% in the last quarter and operating earnings growth of 16%.
After seeing Stefan Drescheemaeker in June, it is clear that the business has moved from being about turning around underperforming brands to one which is on firm footing where the core brands are delivering. They have recently been on the acquisition trail in the UK, purchasing Aunt Bessie’s and Goodfella’s. These brands are the leaders in frozen Yorkshire puddings, potatoes and pizza in the UK. Strategically it is quite important as it increases their market share in the UK frozen foods market to 20%, increasing their bargaining power with their core retail customers. We are confident in the direction that the company is going and expect the company to deliver for its investors over the short and medium term.
Driving lessons in Munich
I had the opportunity of spending half a day at BMW's (ETR:BMW) autonomous driving car headquarters, an hour of out Munich. While we are not an investor in BMW directly, we have an investment in Aptiv, one of BMW's main parts and service providers. Aptiv (NYSE:APTV) is helping BMW to build out their portfolio of electric vehicles and move up the stages of autonomous driving cars.
There are numerous levels that we will see over the next decade before cars become completely driverless. At the moment, the most advanced cars are at level 2 autonomy where a car provides partial driving assistance and might automatically brake if it senses a collision. The BMW 5 series has 23 sensors in the car with cameras, lidars and radars. The next stage of autonomy will be level 3 where the driver will be able to take a break from driving and the car will signal to the driver when they need to take over the driving task after sufficient warning. HD mapping will be added to vehicles on top of cameras and sensors. Level 4 is the stage of robo taxis where you will still need the driver in the car but the car should effectively be able to control the vehicle. BMW expects to get to this level by 2025. Level 5 is when Singapore is targeting to get to full automation. Obviously completely autonomous driving is dependent on governments having the confidence to regulate in favour of it.
BMW believes that each manufacturer will continue to differentiate on features within a vehicle and that brands are important but either way, we think that Aptiv will be a strong beneficiary of this transition to autonomous driving. Watch the following video which showcases Aptiv’s autonomous driving technology. Aptiv has recently launched a fleet of 30 autonomous vehicles in Las Vegas on the Lyft network (which is a competitor to Uber).
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