The global stocks and long-term themes Nikko AM is backing (and a few it is not)

The negative effects of inflation will persist for longer than many expect, but so will the commodity-linked uplift for companies in Industrials and other sectors, say global equity managers Nikko AM.

They’re also firmly backing other themes including parts of the energy and healthcare sectors, as reflected in their current positioning of the Nikko AM Global Share Fund.

The asset manager’s Q2 2022 Global Equity Portfolio Update touched on three big themes that are reflected in the fund:

1. The energy efficiency challenge, as the world moves toward net-zero – The investment team seek to own companies that can benefit from that change.
2. Rising healthcare costs and how the sector combats this global trend – As a sector that combines a mixture of defensive and high cash flow characteristics, the team believe several healthcare companies have excellent long-term growth prospects.
3. Increasing labour market tightness and rising inflation more broadly – “We need to find businesses that can enhance productivity and deliver the savings they’re going to need as these pressures remain prevalent within economies,” the team says.

Within the report, the team discuss a selection of companies they’re backing – and others they’ve allocated away from. 

What stocks have they added?

In recent months, the team have continued focusing on identifying good quality, high-returning businesses. As part of this, they’ve increased the portfolio’s ownership of industrial companies, particularly several names in engineering and construction.

Energy infrastructure

A few new holdings reflecting this theme, as called out by the team, include:

• Oil and gas services company Jacobs Engineering (NYSE: J)
• Engineering, procurement, and construction firm KBR Holdings (NSYE: KBR)
• ASX-listed EPC firm Worley (ASX: WOR)

Outside of this sector, other new additions to the portfolio include:

• US-based cloud software firm Box (NSYE: BOX)
• Global liquor distributor Diageo
• Automotive parts distributor and retailer O’Reilly
• Industrial gas firm Linde.

What did they buy more of?

The team also increased exposure to the following companies:

• Encompass Health
• Adapt Health
• LHC, and
• Intercontinental Exchange

Reduced holdings

• Carlisle Companies
• Accenture
• Progressive
• Abbott
• Anthem, and
• Adobe

What did they exit?

Several companies were also dropped from the portfolio entirely, with the proceeds used to fund some of the purchases mentioned above. These completed sales include:

Global Payments (NYSE: GPN) – “We believe the fall in consumer spending – due to a sharp rise in living costs – will lead to a period of lower transaction volumes,” said the team.

“With the shares having recovered somewhat in recent weeks and more upside at Box, we decided to sell.”

Somewhat surprisingly, they also exited their remaining holding in Amazon.

“Although we don’t doubt the power of its retail business, or the enduring growth offered by AWS, we have become increasingly concerned about the level of investment going into the business in recent months and the (falling) returns that management is likely to get on these investments,” explain the portfolio managers.

They also sold out of:

• Mealkit maker HelloFresh
• Automotive parts retailer LKQ
• Chinese social media company Tencent
• Audio and imaging technology firm Dolby Laboratories.

What’s the outlook?

In line with their view that inflationary pressures will be more persistent than many expect, the team believe consumption will remain depressed throughout 2022 and into 2023.

“So, finding businesses with pricing power, that can deliver enhanced pricing and still not have price elasticity for volumes will decline dramatically,” they say.

“That can give us that defensive stream of cash flows with very high ROC and good quality, without overpaying in terms of their valuations.”

Why healthcare is so highly regarded

The fund’s reduced exposure to the Consumer sectors, and increased allocation to Industrial companies, is part of addressing this goal. So is the decision to rotate away from the consumer sector, slightly increase the portfolio’s allocation to Industrials, and ramp up its healthcare exposure. This latter sector is favoured by the team for its:

• High return on capital,
• Strong cash flows, and
• Good defensive growth prospects.

It also holds an underweight allocation to Communication Services, particularly because of the team’s thesis for digital advertising.

“We think that’s highly cyclical, and the demand patterns we’ve seen over the last couple of years have really been pulled forward. People are perhaps mistaking secular growth for what may be cyclical growth, in terms of digital ad spending – so we’re very cautious on the likes of Google and Facebook,” they say.

“And technology remains a slight underweight for us, based purely on our valuation discipline”

The commodity sector

Even with a cyclical recovery in prices and returns, the team emphasises their view that oil and gas don’t historically deliver sustained high returns on capital.

But at the same time, they believe higher energy prices will accelerate the push toward net-zero and the associated transition to lower-carbon energy sources.

“The picks and shovels will be required to enable this growth, and it’s here where we can find high sustained returns on capital,” says the team.

The above article is a summary of Nikko AM's recent quarterly report. For further insights, please contact the Yarra Distribution Team (sales.au@yarracm.com).

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