The optimistic outlook for global equities

James Marlay: When we last spoke, it was a really crazy time and it has been a busy year. Headlines are dominating the news flow around the pandemic, the US election, stimulus in the market, and just even more recently, news on a potential vaccine. It is a lot of noise for people to get consumed in. What have people been overlooking? What are people missing?

Catriona Burns: The case for optimism as we look forward. There has been an enormous amount of noise. There has been some doom and gloom associated with the pandemic. A lot of people have had a tough year but as we look forward we are very optimistic. We know a lot more about the coronavirus. The US election is now passed and the outcome and set up looks quite positive for equities. In terms of stimulus, we have governments that are very supportive, central banks that are incredibly supportive, and so we are quite positive in terms of the outlook. We think that you can lose that in terms of all the noise that we have had over the last year.

James Marlay: If you shift that to the portfolio, how have you moved things around to capture some of that optimistic view that you have?

Catriona Burns: Initially, we focussed on liquidity and bought a number of the larger cap names that had really been sold off. As we have gone through the reopening of economies, and a lot of the share prices of some of those large cap stocks have done exceptionally well, we have been agile and have taken advantage of disconnects in valuation.

We have found a lot more opportunities in the small and mid-cap end of the market. From a geographic perspective, we had a very heavy weighting in the US, and we still love a lot of the businesses that we own in the US, but where we are finding more incremental ideas is actually out of Europe. We find that a lot of the valuations there are not as extreme as the US, but we can still find businesses that are growing fantastically, that have very high quality management teams and are potentially earlier on in terms of some of those structural trends that are occurring through the rest of the world.

Nick Healy: In a year like this, it has brought home the importance of the ability to have that flexible view on the world and to be able to step back and to look where the opportunities exist, whether it is small to mid caps, or whether it is in Europe. It is continuing to stick that process and find great businesses. We are just looking for those great businesses at very attractive prices.

James Marlay: When we caught up in May, you talked about a couple of themes that you were looking to put into the portfolio: e-commerce, digital payments, which we know have been strong, and you also introduced the concept of “thrifty stores” which was an interesting one for the time. Are they still in the portfolio and how have they played out?

Catriona Burns: In times of uncertainty, people tend to tighten their belts. We have had that thematic that we liked and we played that thematic through a number of names around the world. For example, in the US, we owned the largest dollar stores operator Dollar General (NYSE: DG), in Japan a discount retailer called Kobe Bussan (TYO: 3038), and in Europe a discount store operator called B&M Value Retail (LON: BME).

What we have seen is that the consumer has tightened their belt. A lot of those stores remained open even through lockdowns, so they were massive beneficiaries of other shops not being open. We have reduced some of the positions in those stocks just because they have done well, but we do think there is still uncertainty in the world. We are more optimistic on the outlook, but we still like the thematic. What we liked about those individual business was that they had store rollouts themselves, they had really high quality management teams, and their valuations were really compelling. So we still like them.

Nick Healy: We very much believe in digital payments having longevity to the theme. We are currently seeing a generational shift in how payments occur with the shift from cash and cheque towards digital and application programming interface (API) driven payment processes. It has been ten plus years of a shift to digital payments, but cash remains an $18 trillion opportunity globally. And even over that timeframe, the amount of cash transactions has actually grown. There are a lot of reasons on our behalf to think that the digital payments thematic has a lot of runway left to go. We play that space through names like Fiserv (NASDAQ: FISV) and Fidelity National Information Services (NYSE: FIS) amongst others within the portfolio.

James Marlay: With these structural themes, it seems like everyone is on the trade. But where is the value?

Nick Healy: Most companies in the space, if they trade on a price to earnings (P/E) at all it is north of 100 times, which is not where we like to hunt traditionally. So what we have done is we have found companies that trade on 20 times 22 times P/E.

James Marlay: And then on e-commerce do you see the tailwinds continue to support that opportunity?

Catriona Burns: We have seen an acceleration in a trend that was already there. Companies playing in the home and furnishings area in Germany, such as Home24 (ETR: H24) and Westwing (ETR: WEW) are two names trading on fractions of the peers globally and yet with an enormous runway ahead. The German market in home and furnishings is at that 8% to 10% penetration level, and was 6% or 7% pre-coronavirus. Yet UK and US are well north of 20%. Wayfair (NYSE: W) is the peer in the US and has a market capitalisation of $24 billion, these are at the EUR400 to EUR500 market capitalisation level and yet are growing at the same level. They have a net cash balance sheet, management teams that are well incentivised, well aligned, and margins that are actually already better than their US peer.

James Marlay: And so outside of those three thematics what are some of the other ideas that are in the portfolio?

Catriona Burns: One would be the Cloud. It is well discussed and well known but through the coronavirus we have all been forced to migrate. With travel at the moment, we are doing all our international company meetings via Zoom and Microsoft Teams. And yet we are very early days in terms of transitioning onto the Cloud. If you look across the world, 50% percent of dollars are still spent on premise. There is a significant longevity in that transition and there has been some pull forward. The Microsoft CEO, talking earlier in the coronavirus, said about two years demand was being pulled forward into two months. But that weight of dollars is still significant in terms of on premise versus off premise. So we are excited about opportunities there still.

James Marlay: And Nick, is there anything else that you have been doing some work on?

Nick Healy: Healthcare is a trend that has a lot of longevity to it. Demographics are also a significant tailwind here. In the US at least by 2030 the old will outnumber the young. One in five people will be over the age of 65. It is a truism in healthcare that you spend more as you age, so there are a couple of strong tailwinds behind the healthcare thematic.

We play healthcare through a number of names in the fund but in particular Avantor (NYSE: AVTR) and Thermo Fisher (NYSE: TMO) are great support companies to those companies doing the pharmaceutical research and development. They are not exposed to FDA approvals. They will not be a disappointment if a drug does not pass the phase three trial. But they are set to benefit from these really strong long term tailwinds that are in healthcare.

James Marlay: Where are you seeing compelling data? Talk me through a story that you are really passionate about.

Nick Healy: One I would love to talk through is Avantor, who are a life sciences and tools company. They have done very well and they are in the mid-cap category at this point. Certainly not large cap like some of their peers in that space.  What they do is they both produce and distribute consumables and equipment to the pharmaceutical, the industrial, and the government and academic end markets. There are three things in particular that we think makes it a great name to hold right now. The first is that 50% of the company is driven by Biopharma as an end market, and Biopharma is doing phenomenally well right now. The funding levels are at record highs, future proofing the next few years. There are innovations being achieved in oncology, orphan drugs and even with the vaccines for the coronavirus, and Avantor is a big player there as well.

James Marlay: How have you changed the way that the overall portfolio looks from a geographic and a market cap position?

Catriona Burns: In places like Europe, for example, we can find a number of names that we think are really interesting. In particular, down the market capitalisation, we are seeing lots of interesting companies in the small mid-cap end of the market. If you look at the valuations versus historic norms, they are about average to where they have traded over time, whereas in that large cap, growth end of the market they are well above historic norms. We are finding lots of interesting exciting opportunities there.

James Marlay: How are the two of you thinking about opportunities that come from a reopening of economies?

Catriona Burns: We have found a number of businesses that we think are really interesting from an opening up perspective. In Germany, we own an outdoor media business called Ströer (ETR: SAX) which does digital billboards. It has 60% market share in outdoor billboards across Germany. It has a really high quality management team that is highly aligned. The two founders own 40% of the stock and one of them is still the current CEO.

They did some deals years ago that we think have created some very interesting assets where value will be realised over time. That is an example of a stock where the revenues and the earnings have been hit through the coronavirus as advertising was stopped, but it is a business with a fantastic industry position. It will survive and has a management team highly aligned to you. We think it is very well placed as we reopen.

Earlier on, as we came out of the pandemic, we thought domestic travel relative to international travel was obviously going to rebound more quickly. We looked at names, for example, in France we owned a position in the largest caravan RV player in Europe called Trigano (EPA: TRI). So we thought that was an interesting company because it was a leading player in the European market. Clearly people still are itching to travel but they cannot go far. It has a net cash balance sheet and we rate the management team, and again a founding family with a lot of stock. We played that earlier on. Now we are more into those deeper hit, line of fire stocks that are probably going to have the most potential to rerate here. For us, that is just a portion of the portfolio. At the same time we have a lot of these longer dated thematic stocks that we think can benefit looking out five ten years.

James Marlay: Final question. For shareholders, we asked you for a bit of a message for them at the end of our May Vault update. Have you got a message for shareholders at the moment?

Catriona Burns: It has obviously been a really hard year and a lot can get mixed with all the media announcements. There can be a lot of doom and gloom presented around the risks and the downsides of coronavirus, but I think if we take a step back, we are relatively optimistic about the coming period.

We are not struggling to find new ideas and companies that we want to invest in. We value your support, very grateful for it, and are relatively optimistic about the period ahead.