We deliberately build the Fund’s portfolio to have exposure to a wide range of individual stock opportunities. While the team shares a strong investment philosophy, each manager is able to express their unique investment style, without requiring consensus to build a new position. There are many reasons why we strive for breadth within the Fund, including our beliefs that:
- Those companies at style extremes have a greater potential to produce exceptional returns, and this approach allows them in.
- The Fund’s exposure to a wide range of types of company gives it the potential to outperform in a broad range of markets.
- We can add value by ‘rebalancing’ between, say, growth and value after internal discussion, without the delays of a client reallocating to a different manager.
After a period of strong absolute and relative returns in 2020, the Fund experienced weaker performance in 2021. The reasons for this are varied and include: exposure to Chinese regulation, Peruvian and Chilean political pressures, owning economically defensive businesses that derated, exposure to Video Gaming companies that had a few delays in their new release schedule, biotech holdings that performed well fundamentally but derated, and Covid recovery names that saw the recovery pushed out by the Omicron variant. There was a wide range of reasons for the challenging performance, and it was unfortunate to see so many unrelated things happening at the same time. On top of this, a handful of companies that we didn’t own such as Apple and Tesla went from being expensive to being more expensive.
At times like this, we come back to our philosophy and process – finding companies that are exposed to uncertainty and change, where our analysis is differentiated and identifies a skew of potential returns to the upside. We are lucky to have clients that understand the long-term value this approach can create and encourage them to continue to evaluate performance over an investment cycle.
What makes us particularly animated now is the breadth of the opportunities that we have identified and in which we have invested. Below we discuss a handful of these names and why we believe they have the attractive skew of potential returns that we look for. This is not a recommendation, but we hope it gives you some colour into how we think about investing and the opportunities that we, as patient, long-term investors, can exploit.
A.P. Moller-Maersk (Maersk) is one of the leading container shipping and logistics providers globally. Our initial investment was made a few years ago when our analysis suggested that after consolidating, the industry had potential to turn around from being a destroyer of economic value to being on a more rational footing. When shipping volumes fell as Covid came, the industry raised rates and has kept them high ever since. Interestingly, Maersk has used this time of supernormal profitability to develop both its booking systems and its logistics solutions business. The majority of customers now book online. Yield management systems have been introduced (think of easyJet’s dynamic pricing), as have other services such as a blockchain-based customs and a container tracking joint venture with IBM (TradeLens). More customers have moved to long term contracts (70% of Maersk’s expected volume in 2022 vs 46% in 2019). By managing more of its customers’ logistics, Maersk is becoming an integrated part of supply chains rather than a commoditised link. As a solution provider, Maersk charges more, and the customer can prioritise items for delivery, understand where and when goods will be received and overall save money from its logistics chain, despite spending more with Maersk at the headline level.
The company has resisted buying many new ships, and the dozen vessels that it has ordered in recent times are dual fuel. This is an area on which we have engaged with management over recent years, and it is encouraging that these vessels can be powered by green methanol, a renewable fuel. We keep an eye on industry discipline and new orders, which were absent for a few years, but are now at a level that is replacing scrapped vessels. There has been a high single digit percentage of the global fleet held up queuing outside ports, waiting for a berth.[i] In our downside scenario, port efficiency improves, and that chunk of global shipping capacity is released leading to lower rates, which could be further exacerbated by inventory run downs from industries that may have over-ordered when things were disrupted. These are some of the topics of debate within the team.
This also leads us on to valuation, and what we think is baked into the current share price. Maersk earned $8bn in EBITDA in the last quarter of 2021, an annualised rate of $32bn.[ii] With a market cap of $63bn and a strong balance sheet that is net cash, we think the shares are definitely at the value end of the market spectrum. The company’s guidance for 2022 assumes current shipping rates normalise back down in the second half of the year. Maersk would then generate free cash flow equivalent to a quarter of its market cap. Rates are likely to fall in the medium term, but we believe that this will be to a level that generates returns on capital that are above the historic average. A decline in rates is baked into the price – and the company is returning cash to shareholders through an 11% dividend yield and buying back 4% of the company this year.
At the other extreme of the valuation spectrum, MercadoLibre’s fundamentals continue to perform well. MercadoLibre is the leader in e-commerce in Latin America, with strong positions in major markets such as Brazil, Argentina and Mexico. Over the last few years, the company has invested substantially in its logistics network and in developing its payment and fintech offering. Mercadolibre’s strategy is to invest in growth and target negligible short-term profitability – in a manner very similar to Amazon in its early years. The success of its fulfilment network has been demonstrated in the reach of its fast delivery promise. Over half of shipments were received the same or next day in their last reported quarter. This is a huge competitive advantage given the countries that it operates in, such as Brazil, Argentina and Mexico, have relatively weak delivery infrastructure. What’s great to see is that recently the company has started monetising its fulfilment and logistics operations, shifting from it being a cost base towards a profit centre. This bodes well for long run profitability and competitive advantage.
The low level of e-commerce penetration in the region (in the single digits) creates scope for many years of rapid growth in this segment of their business. E-commerce is the core on which the business was founded, but MercadoLibre’s payments business is large (over $20bn of payments per quarter) and fast growing (almost 60% FXneutral annual growth last quarter). It is also the facilitator of their credit business, which uses the information and data that it gleans from customers and vendors on its platform to offer a variety of loans. The cost of loan origination is low, allowing small loan sizes (e.g. to customers who have run out of mobile credit for the month). The non-traditional data sources that are used allow Mercado Credito to offer loans to vendors that would otherwise find it difficult and expensive to develop the required relationship with a traditional bank. This should have the long-term impact of bringing more companies into the formal economy and thus improving labour conditions, social security protections etc. Over the last year the balance of loans at Mercado Credito has quadrupled to over a billion dollars. This is an early stage, but exciting business.
The increasing breadth of MercadoLibre’s offering is enabling the company to offer more to customers in their loyalty tiers. The more frequently purchases are made, and the more MercadoPago is used for payment, the higher the tier level a customer can access. The highest tiers give free shipping at lower order values and bundle in free streaming services such as Disney+ and Star+. The shares have sold off substantially in the recent market rotation away from growth stocks, with a 50% drawdown from their peak. Over the last five years, the stock has had drawdowns of over 30% on six occasions. It is a volatile stock. As long term, patient holders we see the improving fundamentals within the company’s operating model, work out our long-term upside and downside scenarios view this as a long term opportunity to add to our position. The founder, Marcos Galperin, has built a business not just to sell in an economic upcycle but to thrive across the economic cycles that have often been extreme in the Latam region. We are minded to continue to back him with our patience.
Fiserv is a great example of a steady compounder that has also de-rated substantially since the beginning of 2021, while experiencing modest upgrades to earnings estimates. Fiserv is one of the world’s leading payment service providers. This is a subscription-like business that grows steadily. Growth has been augmented in two clear ways. Firstly, acquisitions and a careful approach to stripping out cost synergies, and secondly through their rapidly growing Clover brand. Clover is a digital first payments platform, similar to Square and Stripe, that has scale (over $200bn annualised gross payment value) and is growing rapidly (50% in the last quarter). Pulling this all together, we believe that Fiserv is a cash generative business that should generate a sustainable 15%+ per annum earnings per share growth. In our base-case model, we are paying approximately 15x earnings this year and by 2024 the company should generate nearly a 10% free cash flow yield. We think the company is cheap for a level of growth that exceeds that of the market over the long term.
Zimmer is another company that we think offers the type of attractive skew to the upside of potential returns that we look for. Zimmer offers replacement hips and knees and continues to innovate with their Rosa robot (now 10% of procedures) and smart implants. As these are adopted the revenue and margin profile of the business should improve. The big issue for Zimmer is Covid-19 and its impact on elective procedures in hospitals. Cancellations from patients testing positive, and a lack of availability of beds and, more recently, staff (isolating nurses/doctors), has held back the company’s growth profile. The company appears to be retaining its market share, and we believe that a backlog should be forming as patients’ hips and knees will still need replacing (interviews with doctors are supportive of this). The consistency of the delays to the recovery have led management to doubt whether it will happen and if there is any pent-up demand. After a tough December and January (worse than 2021), they are extrapolating this weakness into the future. Sell-side analysts are doing likewise, and the multiple that is being placed on those low expectations of revenue growth and margins suggests that the buyside is too. When expectations are low, a company has disappointed and there are catalysts for improvement (e.g. the opening up of the economy post-Covid) then there is great potential for positive surprises within our three-to-five-year time horizon. We have been adding to our position.
The examples above illustrate the breadth of names within the portfolio including value names such as Maersk, rapid growth in Emerging Markets with MercadoLibre, an unloved steady compounder with Fiserv and a Covid-recovery play with Zimmer. We believe each of these is offering attractive upside within our three-to-five-year time horizon, and importantly this upside is likely to come in a range of different ways – it is not dependent on just one type of stock performing well. In the short term, some share prices are being dislocated from fundamentals by the pressure of asset flows. For us as long-term, patient investors, these dislocations can provide fantastic opportunities to build positions in companies we like at lower share prices
Key Risks
