January 21, 2025 • 40 mins
In the latter half of 2024, the healthcare sector underperformed the rest of the European market due to uncertainty related to potential policies of the new Trump administration and mixed news on pharmaceutical companies. In this episode of Inside Active, host David Cohne, mutual fund and active management analyst with Bloomberg Intelligence, along with co-host Laurent Douillet, senior equity strategist for Bloomberg Intelligence, spoke with Colin McQueen, vice president of T. Rowe Price Group and a portfolio manager of the International Value Equity Fund (TRIGX) about the significance of free cash flow generation. They also discussed the need to look at downside valuations and downside risk, why restructuring provides opportunities and why the headwinds facing value companies could be abating.
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Episode Transcript
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Speaker 1 (00:15):
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges and philosophies and security selection. I'm David Cohne,
I lead mutual fund and active research at Bloomberg Intelligence.
Today my co host is Laurent Dulier, senior equity strategist
at Bloomberg Intelligence. Laurent, thank you for joining me today.
Speaker 2 (00:39):
Thanks for inviting me, so I wanted.
Speaker 1 (00:42):
To ask you about your note today. In Europe, the
healthcare sector has underperformed the rest of the market since
the summer and its valuation has come back below its
long term average. What do you think the market is
concerned about and what could reverse that trend?
Speaker 2 (00:58):
Yeah, I think there are two main reason for this.
The first one is definitely the uncertainty surrounding the health
policies of the Trump administration. The President elect during his
campaign not commented that drugmakers have engaged in deception, misinformation
and disinformation. So I think it suggests that potentially is
(01:21):
going to take a tough stance against some pharmaceutical companies,
and the ones that I wrow is the most are
definitely the European ones, because many European companies or pharmer
companies have a very large export to the US market.
And the second reason I think for the underperformance of
(01:43):
the sector is that we had a mixed newsflow on
farmer companies over the past few months. First, we're seeing
increasing competition in the anti obesity drug market and we
have in Europe a champion with novel Artisk, but the
company had some supply issues and it lost market share
to Helivily LII in the US, and I think it
(02:05):
has a negative impact on its valuation. But also during
the quarterly reporting season in October, we had mixed newsflow
from nov Artists and Glaxo Smiths clin regarding their twenty
twenty five outlooks. So I think it added a bit
more clouds on the prospect of this sector in Europe.
(02:27):
To your question about what could reverse the trend, I
think at this stage regarding the health policy in the US,
there is a lot of speculation about what Donald Trump
will do or not, so I think here we need
to wait and see what are going to be his
initial measures and see how drastic he is going to
be regarding the competition in the anti obosited drug market.
(02:52):
Our industry analysts in Europe do believe that the injectable
drugs of Helilyli and Novo Nordisk will remain the dominant
solution over the coming years up towards the end of
vis decades. So potentially the competitive threat may not be
as big as expected. So I think when the market
(03:14):
realize that those two companies potentially are going to remain
the dominant players, market may be less negative on those two.
Speaker 1 (03:26):
Great. Well, let's bring in our guests who may have
thought on his own about this. I'd like to welcome
Colin McQueen, who is vice president TI Price Group Interior
Price International Limited and a portfolio manager in the equity division,
including the International Value Equity fund ticker TRIGX. Colin, thanks
for joining us, Hi.
Speaker 3 (03:45):
Thanks very much, good to be here.
Speaker 2 (03:47):
Maybe I will start the conversation by a question on
value companies, because in Europe often value companies are seeing
as being cheap for fundamental reasons, and I would like
to know as a value investors, what is your secret
source in a sense to avoid investing in those value
(04:10):
trap because there are usually the one which it's severally
as a performance of.
Speaker 3 (04:16):
A fund thank you, Ron. I think there's a couple
of aspects to that that are worth touching on in
terms of sort of I guess the stocks being perceived
as value traps. Values really just coming off probably one
of its worst periods in history, the decade after the GFC.
You have to go back to the nineteen thirties to
find a worse period for value, So, you know, in
(04:37):
that sense, I think the market has become very skeptical
about valuation as a driver of out performance. I do
think though, that some of the headwinds that are faced
value companies in that period are abating, if not even
potentially reversing. And we've seen, perhaps kind of the other
(04:57):
side of the pandemic and the Ukraine War, some changes
in terms of outlook that I think kind of level
the playing field a little bit. More specifically, those for
me would be the change in interest rates. You know,
we've had a decade of very negative interest rates continuously falling,
(05:17):
ending with I guess a third of the world's bond
markets negative yielding at one stage negative interest rates, particularly
in Europe. That's negative for value companies, both technically in
terms of the discount rate movement, but also it's been
a massive headwind for financial companies, which tend to be
overrepresented in the value universe, and really I guess banks
(05:41):
particularly just don't work at negative interest rates. So the
reset we've seen in interest rates has been a material positive,
particularly I would say for European banks. I mean, on
our estimates, we've sort of moved the average ROWE from
about eight to twelve, which is a very material change.
The second thing I think is we're getting a broadening
(06:03):
of some of the sources of growth in the economy.
We spent a lot of period after the GFC with
really a lot of growth being driven by the build
out of Internet platforms, driven by companies with intangible assets.
We've seen a very sort of concentrated pattern of demand growth.
(06:24):
Looking the other side of the pandemic, I think we're
seeing a broadening to that, and particularly in the industrial area.
So we're seeing a big wave of expenditure from on
energy transition and obviously the build out of aidentity data
centers is turbo charging that materially. We're also seeing quite
a change in terms of where supply chains are built. Both,
(06:47):
I guess, from a geopolitical perspective, sort of near suring
or friendshuring. But also I think as we saw in
the pandemic problems at places with extended supply chains, we've
seen places where infrastructure just didn't work as well as
we might have hoped when it was stress tested. So
we're seeing quite a broadening of the areas of expenditure,
(07:11):
not to mention also at least the reversal of the
Defense Peace divid end. So I think the outlook for
growth and demand for a lot of companies making kind
of tangible goods capital equipment has improved, and that obviously
drags through a lot of materials demand with that. So
we've seen an aggregate if we look at sort of
(07:31):
international value companies as a cohort, earning's growth in the
decade after the GFC was a pretty miserable zero point
five percent per annum, which compared to about eight percent
of the S and P five hundred on our numbers,
so a massive gap. It's not surprising potentially that these
companies didn't really perform very well. If we take that
(07:54):
from the start of the pandemic, we've seen growth accelerate
up to about four just over four percent per annum
with the US again remaining at eight. So we're not
delivering the growth in international value stocks of the S
and P five hundred yet, but the gap has materially closed,
whilst at the same time the valuation dispersion has widened
yet further. It's now, you know, versus the US, the
(08:17):
widest it's been on history. So I think there's a
there's an opportunity in terms of value stocks Internationally, we're
seeing improving prospects, a better outlook, and yet the valuations
remain very much in the doldrums. You'd asked also specifically
on how how I think about sort of avoiding value
(08:37):
traps in the portfolio reading that out, and really there's
kind of two aspects to that for me. One is
maybe as well, we'll sort of get into a little
bit later. For me, a lot of what we're trying
to achieve in the portfolio is to buy undervalued free
cash flow generation from companies. So we want to buy
(08:58):
good companies when they're out of favor, trading cheaply and
when we can. Basically, we think of the underlying value
of the business as driven by its free cash generation.
So if we're having free cash generative companies, if we're
early in buying them. Assuming we're right on the free
cash generation, the opportunity will tend to get bigger rather
(09:18):
than smaller over time. So that's probably I guess the
primary sort of defense point. The second one is whenever
we buy initiate positions in companies, we kind of do
a downside valuation exercise to ask ourselves what is this
business worth if we're wrong? And ideally we're looking for
situations where we don't have a lot of absolute downside.
(09:41):
You can't always always get that happy combo. But again,
I'm sort of equally pleased where our research has done
its job on the value protection side. So we may
miss a bit of opportunity costs, but we don't lose
money on a stock.
Speaker 1 (09:57):
That's great. Why don't we take a step back back,
and you know, I'd love to hear about how you
got your start and investing.
Speaker 3 (10:06):
Yep, sure, I guess I was relatively lucky. I joined
the industry in nineteen eighty nine fresh from an economics
master's degree, which I guess persuaded me to move to
a career in investment management rather than being an economist
at that stage, partly as I think driven by I
started to develop an increasing interest in industries and how
(10:28):
companies worked, and investment management sort of lets you get
up close and personal with that. So I was fortunate
to land a job straight in the industry from university.
I think also fortunate in that respect that I joined
a UK based deep value shop at that time, which
(10:50):
me gave a very good grounding in terms of how
to look at out of favor companies, what to look
for in Stockton market didn't like, but also taught the
emotional discipline around that. I think everyone's a contrarian investor
on paper, but it's a lot harder to do when
you're buying aerospace stocks in the middle of COVID. So
(11:12):
I think, although obviously you adapt processes and methodologies over time,
I think that sort of core DNA of being comfortable
with going against the market being uncomfortable has kind of
stayed with me throughout that piece. I think also I
was fortunate at that time for somebody who spent an
(11:33):
entire career in value investing in I started my career,
or at least the first half of it, in the
period where value investing worked as it had done traditionally
in the textbooks. So in fact, almost to the extent
that you wondered why anybody did anything else, and then
probably spent the last fifteen years after the GFC getting
the answer to that question. So I think a lot
(11:54):
of investors have sort of spent their career really in
this very unusual market condition we've seen since the GFC.
So I regard myself as fortunate in having seen both
sides of the coin there.
Speaker 1 (12:09):
So if we focus into the international Value Equity fund,
you mentioned what you're looking for in terms of valuations,
can you expand a little bit of you know, how
the process works of you know where you start when
you're selecting positions for the portfolio.
Speaker 3 (12:27):
Yes, absolutely, so Again for me, the aim is, as
I mentioned, to companies when they're out of favor and
trading material discounts to their underlying value. That can be sparked.
It's usually sparked by concerns in some form or another.
That can be concerns are aut an industry, as I mentioned,
anything to do with travel in COVID was trading flat
(12:49):
on its back for a while. It can be to
do with geographic news and certainly some of the political
headlines we've been seeing over recent weeks can offer you
opportunities that at some pretty contrarian investments, or it can
simply be an individual company having a bump in the
road in terms of product roadmap or something going wrong.
So try to focus in on areas of the market
(13:12):
that are out of favor, that have underperformed, where we're
seeing sort of negative sentiment emerging, and going to sort
of kick the tires and understand what drives the future
free cash flow. So to think about what will drive
free cash generation over a cycle, to understand the sort
of product competitiveness, the cost competitiveness, how well that profitability
(13:35):
then trade fleets into cash flow and looking to be
disciplined to pay kind of a maximum of eighty five
cents in the dollar. There's periods where things are much
much cheaper than that, but you know, again we have
a sort of strict discipline that we won't pay above
that level. So that kind of is the bread and
butter of what we're looking for as a firm. We
(13:58):
also pay a lot of attention to restructuring potential. Again,
one of the things you often find without a favor companies,
often they haven't been performing as well as they might
have done, so we spend a lot of time thinking
about how a company can get better, what can be
changed operationally, whether in some cases we're finding from a
(14:19):
portfolio perspective there's a good business hiding behind a bad one.
And I guess, really where we get the home runs
in the portfolios where both sides of that kick in,
where we get the undervalued free cashflow stream and also
we get the improvement process of the restructuring, adding materially
(14:39):
to the underlying value of the company. The process of
doing that really is helped materially by the strength of
the research platform that I have to draw on. I
could say, in having been an investment management for thirty
odd years, I could say, hand on heart, probably the
tiro price we should this platform is the best resource
(15:02):
I've had to work with. So we have one hundred
and seventy research analysts around the world with deep knowledge
of their companies and industries. So I spend the majority
of my time working with those guys discussing through what
a company could look like in the medium term, what
are the downside risks, and really trying to get to
(15:23):
the answers where we're getting that combination of an attractive
reward with relatively minimal downside. I think just two things
maybe to add on that. In terms of the portfolio side,
we try to deliberately take quite a wide net to
the sort of companies we're looking for. I think over
(15:44):
the course of my career, I've worked at a number
of different value firms, and we find the value tent
is actually much broader than it's often labeled to be.
So you know, at one end, you can have the
kind of deep value approaches, you know, buying steel companies
at the on the cycle, the other end of the spectrum,
we're looking at sort of war On Buffett buying Coca Cola,
(16:05):
much more sort of high quality compounding companies. We find
a lot of firms tend to gravitate to one or
other side of that spectrum. We've kind of developed the
processes and the tools to operate really across the piece,
so that gives us a lot of shots on goal.
It also gives us, from a portfolio perspective, a lot
(16:28):
of opportunities to improve the risk reward and again that's
something we've paid quite a lot of attention to. On
the portfolio side. Again, I've found over the course of
my career that value investing often and contrarian investing doesn't
work linearly. You tend to get returns in spurts and cycles.
(16:48):
So partly from bottom up, but also developed a sort
of risk dashboard to try and figure out when when
we want to be taking maximum risk and when we
want to be keeping a bit more powdered r. I
kind of think that almost as the similar to the
process of counting cards at a blackjack table. We want
to know when the when the playing field is set
(17:10):
up really for us to make big returns, or when
we want to be a bit more cautious and wait
for the better opportunities.
Speaker 1 (17:18):
So you mentioned, you know, finding opportunities during COVID, and
then also you mentioned a risk model, and so would
you say the portfolio was kind of a mix of
both top down and bottom up research.
Speaker 3 (17:33):
It's principally driven by bottom up research. So the starting
point is kind of really company by company, what are
the opportunity sets? How undervalued is this business in terms
of what we think free cash generation can do. We
incorporate elements I guess of top down primarily as a
sense check, so you know, we want to understand if
(17:56):
we're buying a company that has a cyclical strain. Ideally
we're not buying it at the top of the cycle,
would rather be buying it at the bottom. So kind
of some understanding around where we are in terms of
economic cycles business cycles is helpful, but it's nothing I
would I wouldn't claim the crystal ball that we add
(18:17):
a lot of value that way. It's more defensive to
make sure we're not not kind of making a mistake.
And similarly, in portfolio terms, we spend a lot of
time on scenario analysis around the portfolio. So what happens
if economies start to weaken more than we expected, what
happens if there's bursts of growth, what happens if the
(18:38):
dollar actually finally eventually starts to weaken at some stage. Again,
we want to make sure that we're getting a diversification
of drivers within the portfolio. So what's really doing the
heavy lifting is kind of the research insights and basically
buying that free cash flow at eighty five cents in
the dollar.
Speaker 1 (18:57):
So you know, in addition to cash flow in and
some of the other things you mentioned, there are other
financial characteristics you look at when you're evaluating balance sheets
and income statements.
Speaker 3 (19:10):
I mean in terms of balance sheets, obviously we're looking
for also looking at excess assets that are potentially could
be better deployed. So that kind of is on the
offense side, what additional value could be unlocked from a
company's balance sheet. It's fair to say, though, for me,
when we think talk about balance sheets, the starting point
(19:33):
is pretty much almost the cash flow statement. I think
that tells you the most about how a company behaves
over time. So tracking its cash generation performance is kind
of a big driver. And clearly if we have companies
that are self funding and generating free cash flow over time,
that tends to sort of overshadow the balance sheet condition
(19:57):
for a lot of periods. It's important though Obviously we're
going to have companies that we know will draw in
debt at times, and you want to make sure the
balance sheet is kind of strong enough to withstand that.
So we look at probably relatively conventional metrics around net
debt to ebit are clusters of debro financing, etc. I
(20:21):
think the other thing we've found probably over recent years,
it's important in sort of understanding finances also to think
about preemption rights, and we found that's actually added quite
a lot of value particularly during COVID in companies like
Rolls Royce or Outstorm, where you know, the long short
community often likes to cluster around companies that they think
(20:43):
are going to need a refinancing. If you're running a
lawn short portfolio, that's a win you You can tend
to close the short relatively well. It has led to
some cases, however, where the kind of total enterprise value
of the company gets really mispriced and we're we can
have confidence that we can participate as shareholders in that refinancing.
(21:06):
We've been willing to be proactive and buy ahead of
unexpected rights issues from companies, and again those have turned
out to be home runs for the portfolio in many cases.
Speaker 2 (21:18):
Looking at value opportunities on a geographic basis, I would
like to have your view on Japan because many investors
things that the country is undergoing structural shift with a
move from deflation to reflation. Corporate governance is being much
more shareholder friendly than it used to be in the past.
(21:40):
So market has done quite well over the past two
to three years. Where do you think we are in
this cycle.
Speaker 3 (21:47):
Yes, certainly the market has done well, and I think
also within Japan, the sort of value cohort of stocks
have done well as we've seen some of those changes unlocking.
I think all of those things are happening. So we
are seeing restructuring in Japan. We're seeing an accelerating release
of cross shareholdings. We're seeing companies being a bit more
(22:12):
deliberate about capital allocation, a bit more shareholder return driven
in some of those policies. Having said that, I think,
as you said, the market has become more consensual about
these things. There was a lot of debate around that
a couple of years ago. It now seems to be
very much received wisdom. So we're finding you have to
(22:32):
pick your spots a bit more carefully in Japan now.
So we're looking for opportunities, I guess actively for restructuring.
It's one of the sort of tenets of the portfolio,
but we're perhaps finding we're rotating a little bit away
from some of the industrial and export sectors. And again
some of those companies, things like Katachu held in the
(22:53):
portfolio for ten years, it's been a great restructuring story.
But we're seeing, I guess, a a consensus around restructuring
for some of these companies. But also there's been quite
a benefit from the weekend for a lot of exporters,
which again we don't want to sort of bake in
(23:13):
as permanent. And we're also seeing perhaps quite a change
in terms of the competitive levels for some Japanese companies
versus Chinese competitors, and certainly where where China has been
a big end market, we're seeing quite an increase in
sort of domestic competition, so rotating a little bit away
(23:33):
from some of the export industries, and we've been finding
more opportunities on the domestic side. Companies like seven to
eleven have been a big additions to the portfolio this year.
This is like Cow where we're seeing prices rise for
the first time in twenty odd years. And we're also
finding we're moving a little bit down the capitalization spectrum,
(23:53):
so more opportunity in the mid cap and Japan, but
netnet for fund has now moved underweight Japan. In contrast,
we've probably been adding over the last eighteen months or
so to positions in Korea quite heavily. I think it
feels to me like Korea is at an earlier stage
(24:14):
to Japan in terms of its value up program. But
there's a certainly we're finding from companies a drive to
sort of better define capital allocation. We probably need some
tax changes more to see asset release. But again there's
a sort of relatively lowly valued set of companies that
(24:34):
start to be starting to change. So Korea is an
area of spending increasing time. Obviously, the political events of
the last few days don't help the case in the
short run.
Speaker 2 (24:45):
There coming back very quickly. On Japan. Do you think
that if the boj increase rates over the next twelve
to eighteen months, does it create a good opportunity for
Japanese financials.
Speaker 3 (24:58):
Or not it does. I guess some of that good
news is already baked into the share prices. I mean,
we've seen Japanese financials move from half book value to
one time's book value, so that's starting to put a
normalization of return on equity on the table. Obviously, the
(25:20):
Japanese banks are extremely long of deposits, so we would
anticipate that they keep a good benefit from from rate rises.
I think it's fair to say there are rate rises
already baked into the share price, so it's not an
area we've been chasing, and we can see continued benefits.
But yeah, again there's a portion of that in the
(25:43):
share prices already. Conversely, the other side, actually, we've been
taking the opportunity to add a bit more to real
estate holdings in Japan which have been dragged down by
that sort of movement in the BOJ rates. So it's
kind of interesting that you can buy basically companies like
Mitsubishi Estate that are sitting on some of the absolutely
(26:06):
top quality prime real estate in Tokyo at half net
asset value and with a management team that's starting to think,
I think more holistically around its capital allocation and portfolio management.
Speaker 2 (26:20):
To come back on your comment in Japan moving toward
a smaller gap, is it also something that you would do,
for example, in Europe because European media and small gap
are on the perform large gap quite significantly in twenty
twenty four, So do you think they could present good
value opportunities for your fund.
Speaker 3 (26:42):
Yes, I certainly find we've been moving that way. Again,
it's more bottom up driven than some sort of realisas
to say we need to buy smaller MidCap companies in Europe,
but they have been lagging. You know, we're seeing relative
valuations come down, So yeah, we're starting to see opportunities
of a number of areas. We've found clusters in the
(27:03):
UK that have been really interesting. Again, I suppose we
think of some companies that sit in sort of mid
cap space but are market leaders in their area. Companies
like Pearson that have been underperforming for a number of
years as the sort of the higher education textbook market
has weakened. But you know, you know, we're seeing the
other parts of the business pick up the pick up
(27:25):
the slack and start to generate good growth. So we're
seeing a number in the UK. It's fair to say
we're seeing a number of industrials again. Businesses like Diamler
Truck in Germany look really interesting, you know, market leading
truck business in North America and in Europe, having spun
off out of Diimler, it's trading at under half the
(27:47):
valuation in terms of what we're paying for sales compared
to Volvo, and around a third of pack are So
we think there's a lot of potential for Dimeler or
restructure to returns on the profitability over time. So we're
finding a number of opportunities springing up in Europe bottom up.
(28:09):
I think somewhat unusually we're finding them also in financial areas,
both across some of the banks, so in BCP and
Portugal has been a great holding for us, but also
in areas like George which has to get overlooked by
sort of small MidCap investors. You know, in Holland, we've
seen five leading insurers consolid eight down to three. There's
(28:34):
a lot of cost cutting potential there over time, potentially
better pricing, and yet we're sort of we're paying eight
and a half times earnings and getting seven and a
half dividend yield out of some of those companies. With
that that good cost cutting runway still to come.
Speaker 2 (28:50):
Moving another gear, I mean underlyzing your fund. It seems
that you have a large position meansions of pharmaceutical and
l scare space, which is usually seen more as gross
than value. So do you think for you investing in
lscare is more finding quality cuponders at a reasonable price.
(29:14):
And if it is the case in which pace would
you look at equipment, pharma more service providers? Which one
would you favor?
Speaker 3 (29:24):
I guess we're finding opportunities in both. As you say,
I think healthcare is one of those sectors that's traditionally
been thought of as growth rather than value. If we
kind of go back to the Ben Graham textbooks, I
mean they're traditionally written really around companies that are based
around tangible assets, hard capital. But increasingly in the economy
(29:47):
more growth, a bigger proportion of the economy is being
driven by companies that are based around intellectual property, intellectual capital,
and obviously healthcare sits in that zone. I think the
sort of the tools you need to look at that
can vary a little bit, they can be quite different.
The patterns of cash flow over time tend to be
(30:09):
less economically sensitive. It's more around understanding the portfolio drivers
and getting into the weeds on the individual stocks. So
again we look through a lens of free cash generation.
In an ideal world, we're finding companies that have a
good runway of a number of years of predictable free
(30:30):
cash generation with all the optionality for future pipeline research development,
essentially for nothing. I think it's fair to say we're
seeing some opportunities like that today on the pharmaceutical side
against sort of companies like Sanafee. We sit with an
(30:50):
eight and a half free cash flow yield, no patent
expieres or no material ones until the early twenty thirties.
That's a sort of relatively cash flow stream, and again
we're not winning anything for research. Similar equations around some
companies like AstraZeneca not quite as cheap as Santa Fee,
but the pipeline is much stronger, the business is much
(31:15):
more diversified, So I think some of those we just
see good value in terms of what we're paying for
cash generation, you know, in terms of the equipment side.
Phillips has been quite a big holding for the portfolio,
where again they've had their trails over the respiratory products,
but underlying it, we have a company with good market
(31:37):
positions that that again we're paying pretty reasonable valuations for,
So we kind of think of it as a good
hunting ground. In a portfolio sense, we're probably tilting a
little bit towards overweight cyclical companies. We're finding more opportunities there,
so we're leaning a little bit more into something like
healthcare that has that that sort of count balance in
(32:00):
terms of the portfolio shape. I think it's fair to
say also it's an area of the market that I
guess I approach a TIRO price with quite a good
degree of confidence. We have kind of twelve dedicated healthcare analysts.
So I have the luxury as a portfolio manager of
going through the company's portfolios with people that really understand
(32:23):
the science and the competing drugs and products. So I
think it's an area where we do excel in from
a research perspective.
Speaker 1 (32:33):
So we've talked about what you're looking for companies, But
what would trigger a cell do you? I mean, do
you look at target prices or is it more of
you know, the fundamentals of a company changing.
Speaker 3 (32:46):
We do look at I guess target prices. I mean
we throw to its sort of intrinsic value. So what
as a company, what do we think the free cash
generation is worth? And so sort of fair value for
us would be when the free cash generation and delivers
you effectively a nine percent IR, we'll kind of consider
a neutral price. If we've reached that level, we'll reassess
(33:09):
the investment case. Obviously, if we're growing over time, if
we're seeing restructuring, there's usually a sort of upt trajectory
to the numbers, So we don't want to throw the
baby out with the bath water. But if we don't
see a case to revise the intrinsic value estimate, then
the stock gets sold. We refer to those as the
good levers internally, and they tend to be about sixty
(33:32):
percent of the sales from the fund. The other side
of that, the bad levers are obviously ones where we've
had to come to the painful refibation that what we
were looking to happen in terms of cash generation, restructuring
or change just isn't developing as we would like it. Hopefully,
(33:53):
again our downside analysis gives us some protection, but again
those are the time for ones to decide, but it
tends to be about forty percent of stocks just have
to go back to the original thesis and say what
we're looking for isn't happening and we should move on.
The other thing I guess I would add up to
(34:14):
that is we have a lot of emphasis on restructuring
in the portfolio, and I guess I've found over the
course of my career, when you get big companies that
haven't been as well managed as they might have been,
the process of improvement can tend to be a multi
year process. So again, where we're seeing companies sort of
(34:35):
changing their spots in terms of catal alacation, changes to portfolio,
new management really improving things. We'll want to give them
a good sort of space to run. We don't want
to be too hasty in moving out of that I
tended to find. You know, with companies like Rolls Royce
with Atacia mentioned where you end up after sort of
(34:56):
five years of earning the stock, it can very frequently
be much better in terms of company performance than you
ever might have jumped along the way. So we give
those sort of stocks the room to run within the portfolio.
Speaker 2 (35:10):
One follow up question during one of the remarks, you
said that potentially Korea is a good investment opportunity on
the value side. Do you have any strong views on
China because his market has been i would say left
four dead in terms of valuation and market trends, or
(35:30):
any other market potentially in emerging market which could look
as interesting for you.
Speaker 3 (35:37):
Yeah. I think the portfolio strategy is primarily developed market strategy,
so we're sort of benchmark to develop markets outside the US,
so we have scope to buy emerging markets, and there's
currently about eight percent of the portfolio in emerging markets.
So we do that in an off benchmark sense where
(36:00):
we see opportunity. Again, the research platform kind of covers
a lot of those areas in good depth. We tend
to say probably about half of the exposures within the
portfolio would be in areas like Korea or Taiwan, where
you know, we're kind of on a spectrum between emerging
and developed. So you know, often we could regard the
(36:24):
competitiveness of a Samsung Electronics or something as being equivalent
to owning it's its peers in the in the developed markets.
Outside of that, it tends to be more opportunistic approach,
so looking for really materially undervalued companies or where where
sentiment has become very negative. China obviously keeps coming up
(36:48):
on the radar. It's probably fair to say for a
contrarian investor, China has kept tapping us on the shoulder
several times over the last few years. We do have
some exposure there. I think it's it's pretty cheap, a
lot of cheap stocks, But principally, I guess we've kind
of taken China exposure through multinationals. So when we've seen
(37:12):
kind of panic sell offs in China and Hong Kong,
we've been added quite a bit. To say, Aias we
have probably one of the highest quality stocks in its
sector in terms of insurance exposure, and a big runway
of underpenetration for insurance markets really across Asia. Around half
(37:33):
the portfolio exposed to China, so we've been doing it
quite heavily, perhaps through multinationals, but we do have some
China exposure in the portfolio. I think it's cheap enough
that you want to have some exposure. I wouldn't be
in the camp to say just avoid China at all costs.
Speaker 1 (37:51):
So I've one question before we let you go. It's
actually a more reflective question. What advice would you give
your younger self just starting in the industry.
Speaker 3 (38:01):
I think, reflecting on that, I would the advice I
would would give to someone starting today is to think
about how you manage your relationship with deusflow actually in
financial markets, and certainly you know, for over the period
of my career, the amount of daily newsflow, opinion pieces,
(38:22):
facts that are sort of dropped into our desks every
day via email, via services like Bloomberg Financial Television, it
can be quite overwhelming. You know, there's there's usually three
different explanations for why the market is going up, down,
or sideways on any given day. A lot of effort
to explaining short term share price movements. So I guess
(38:47):
I would would advise people to try and sort of
disconnect it a little bit from that that sort of
pose of information and just try to think about what
that makes a company valuable over time, So kind of
what drives the product growth, what drives the cost competitiveness,
(39:08):
the capital allocation, Those things I guess tend to change
more slowly out of time. I think you can get
more of an edge actually sort of being prepared to
dig into the weeds and think about what is a
company worth If I, you know, metaphorically put the chess
to get in a drawer for five years. I think
(39:29):
that's a sort of much better way to be approaching investment.
And I would encourage people to sort of try and
just step back from the noise flower and think about
what matters on a longer term basis.
Speaker 1 (39:40):
That's great advice. Well, thank you Colin for joining us today.
Speaker 3 (39:44):
Great, thank you, it's been a pleasure. Thank you for
having me and Lauren.
Speaker 1 (39:47):
Thank you for serving as my co host.
Speaker 2 (39:50):
I thank you.
Speaker 1 (39:51):
Until our next episode. This is David Cohn with Inside Active.
Speaker 3 (40:01):
The two Stars of the Old Town has as
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges and philosophies and security selection. I'm David Cohne,
I lead mutual fund and active research at Bloomberg Intelligence.
Today my co host is Laurent Dulier, senior equity strategist
at Bloomberg Intelligence. Laurent, thank you for joining me today.
Speaker 2 (00:39):
Thanks for inviting me, so I wanted.
Speaker 1 (00:42):
To ask you about your note today. In Europe, the
healthcare sector has underperformed the rest of the market since
the summer and its valuation has come back below its
long term average. What do you think the market is
concerned about and what could reverse that trend?
Speaker 2 (00:58):
Yeah, I think there are two main reason for this.
The first one is definitely the uncertainty surrounding the health
policies of the Trump administration. The President elect during his
campaign not commented that drugmakers have engaged in deception, misinformation
and disinformation. So I think it suggests that potentially is
(01:21):
going to take a tough stance against some pharmaceutical companies,
and the ones that I wrow is the most are
definitely the European ones, because many European companies or pharmer
companies have a very large export to the US market.
And the second reason I think for the underperformance of
(01:43):
the sector is that we had a mixed newsflow on
farmer companies over the past few months. First, we're seeing
increasing competition in the anti obesity drug market and we
have in Europe a champion with novel Artisk, but the
company had some supply issues and it lost market share
to Helivily LII in the US, and I think it
(02:05):
has a negative impact on its valuation. But also during
the quarterly reporting season in October, we had mixed newsflow
from nov Artists and Glaxo Smiths clin regarding their twenty
twenty five outlooks. So I think it added a bit
more clouds on the prospect of this sector in Europe.
(02:27):
To your question about what could reverse the trend, I
think at this stage regarding the health policy in the US,
there is a lot of speculation about what Donald Trump
will do or not, so I think here we need
to wait and see what are going to be his
initial measures and see how drastic he is going to
be regarding the competition in the anti obosited drug market.
(02:52):
Our industry analysts in Europe do believe that the injectable
drugs of Helilyli and Novo Nordisk will remain the dominant
solution over the coming years up towards the end of
vis decades. So potentially the competitive threat may not be
as big as expected. So I think when the market
(03:14):
realize that those two companies potentially are going to remain
the dominant players, market may be less negative on those two.
Speaker 1 (03:26):
Great. Well, let's bring in our guests who may have
thought on his own about this. I'd like to welcome
Colin McQueen, who is vice president TI Price Group Interior
Price International Limited and a portfolio manager in the equity division,
including the International Value Equity fund ticker TRIGX. Colin, thanks
for joining us, Hi.
Speaker 3 (03:45):
Thanks very much, good to be here.
Speaker 2 (03:47):
Maybe I will start the conversation by a question on
value companies, because in Europe often value companies are seeing
as being cheap for fundamental reasons, and I would like
to know as a value investors, what is your secret
source in a sense to avoid investing in those value
(04:10):
trap because there are usually the one which it's severally
as a performance of.
Speaker 3 (04:16):
A fund thank you, Ron. I think there's a couple
of aspects to that that are worth touching on in
terms of sort of I guess the stocks being perceived
as value traps. Values really just coming off probably one
of its worst periods in history, the decade after the GFC.
You have to go back to the nineteen thirties to
find a worse period for value, So, you know, in
(04:37):
that sense, I think the market has become very skeptical
about valuation as a driver of out performance. I do
think though, that some of the headwinds that are faced
value companies in that period are abating, if not even
potentially reversing. And we've seen, perhaps kind of the other
(04:57):
side of the pandemic and the Ukraine War, some changes
in terms of outlook that I think kind of level
the playing field a little bit. More specifically, those for
me would be the change in interest rates. You know,
we've had a decade of very negative interest rates continuously falling,
(05:17):
ending with I guess a third of the world's bond
markets negative yielding at one stage negative interest rates, particularly
in Europe. That's negative for value companies, both technically in
terms of the discount rate movement, but also it's been
a massive headwind for financial companies, which tend to be
overrepresented in the value universe, and really I guess banks
(05:41):
particularly just don't work at negative interest rates. So the
reset we've seen in interest rates has been a material positive,
particularly I would say for European banks. I mean, on
our estimates, we've sort of moved the average ROWE from
about eight to twelve, which is a very material change.
The second thing I think is we're getting a broadening
(06:03):
of some of the sources of growth in the economy.
We spent a lot of period after the GFC with
really a lot of growth being driven by the build
out of Internet platforms, driven by companies with intangible assets.
We've seen a very sort of concentrated pattern of demand growth.
(06:24):
Looking the other side of the pandemic, I think we're
seeing a broadening to that, and particularly in the industrial area.
So we're seeing a big wave of expenditure from on
energy transition and obviously the build out of aidentity data
centers is turbo charging that materially. We're also seeing quite
a change in terms of where supply chains are built. Both,
(06:47):
I guess, from a geopolitical perspective, sort of near suring
or friendshuring. But also I think as we saw in
the pandemic problems at places with extended supply chains, we've
seen places where infrastructure just didn't work as well as
we might have hoped when it was stress tested. So
we're seeing quite a broadening of the areas of expenditure,
(07:11):
not to mention also at least the reversal of the
Defense Peace divid end. So I think the outlook for
growth and demand for a lot of companies making kind
of tangible goods capital equipment has improved, and that obviously
drags through a lot of materials demand with that. So
we've seen an aggregate if we look at sort of
(07:31):
international value companies as a cohort, earning's growth in the
decade after the GFC was a pretty miserable zero point
five percent per annum, which compared to about eight percent
of the S and P five hundred on our numbers,
so a massive gap. It's not surprising potentially that these
companies didn't really perform very well. If we take that
(07:54):
from the start of the pandemic, we've seen growth accelerate
up to about four just over four percent per annum
with the US again remaining at eight. So we're not
delivering the growth in international value stocks of the S
and P five hundred yet, but the gap has materially closed,
whilst at the same time the valuation dispersion has widened
yet further. It's now, you know, versus the US, the
(08:17):
widest it's been on history. So I think there's a
there's an opportunity in terms of value stocks Internationally, we're
seeing improving prospects, a better outlook, and yet the valuations
remain very much in the doldrums. You'd asked also specifically
on how how I think about sort of avoiding value
(08:37):
traps in the portfolio reading that out, and really there's
kind of two aspects to that for me. One is
maybe as well, we'll sort of get into a little
bit later. For me, a lot of what we're trying
to achieve in the portfolio is to buy undervalued free
cash flow generation from companies. So we want to buy
(08:58):
good companies when they're out of favor, trading cheaply and
when we can. Basically, we think of the underlying value
of the business as driven by its free cash generation.
So if we're having free cash generative companies, if we're
early in buying them. Assuming we're right on the free
cash generation, the opportunity will tend to get bigger rather
(09:18):
than smaller over time. So that's probably I guess the
primary sort of defense point. The second one is whenever
we buy initiate positions in companies, we kind of do
a downside valuation exercise to ask ourselves what is this
business worth if we're wrong? And ideally we're looking for
situations where we don't have a lot of absolute downside.
(09:41):
You can't always always get that happy combo. But again,
I'm sort of equally pleased where our research has done
its job on the value protection side. So we may
miss a bit of opportunity costs, but we don't lose
money on a stock.
Speaker 1 (09:57):
That's great. Why don't we take a step back back,
and you know, I'd love to hear about how you
got your start and investing.
Speaker 3 (10:06):
Yep, sure, I guess I was relatively lucky. I joined
the industry in nineteen eighty nine fresh from an economics
master's degree, which I guess persuaded me to move to
a career in investment management rather than being an economist
at that stage, partly as I think driven by I
started to develop an increasing interest in industries and how
(10:28):
companies worked, and investment management sort of lets you get
up close and personal with that. So I was fortunate
to land a job straight in the industry from university.
I think also fortunate in that respect that I joined
a UK based deep value shop at that time, which
(10:50):
me gave a very good grounding in terms of how
to look at out of favor companies, what to look
for in Stockton market didn't like, but also taught the
emotional discipline around that. I think everyone's a contrarian investor
on paper, but it's a lot harder to do when
you're buying aerospace stocks in the middle of COVID. So
(11:12):
I think, although obviously you adapt processes and methodologies over time,
I think that sort of core DNA of being comfortable
with going against the market being uncomfortable has kind of
stayed with me throughout that piece. I think also I
was fortunate at that time for somebody who spent an
(11:33):
entire career in value investing in I started my career,
or at least the first half of it, in the
period where value investing worked as it had done traditionally
in the textbooks. So in fact, almost to the extent
that you wondered why anybody did anything else, and then
probably spent the last fifteen years after the GFC getting
the answer to that question. So I think a lot
(11:54):
of investors have sort of spent their career really in
this very unusual market condition we've seen since the GFC.
So I regard myself as fortunate in having seen both
sides of the coin there.
Speaker 1 (12:09):
So if we focus into the international Value Equity fund,
you mentioned what you're looking for in terms of valuations,
can you expand a little bit of you know, how
the process works of you know where you start when
you're selecting positions for the portfolio.
Speaker 3 (12:27):
Yes, absolutely, so Again for me, the aim is, as
I mentioned, to companies when they're out of favor and
trading material discounts to their underlying value. That can be sparked.
It's usually sparked by concerns in some form or another.
That can be concerns are aut an industry, as I mentioned,
anything to do with travel in COVID was trading flat
(12:49):
on its back for a while. It can be to
do with geographic news and certainly some of the political
headlines we've been seeing over recent weeks can offer you
opportunities that at some pretty contrarian investments, or it can
simply be an individual company having a bump in the
road in terms of product roadmap or something going wrong.
So try to focus in on areas of the market
(13:12):
that are out of favor, that have underperformed, where we're
seeing sort of negative sentiment emerging, and going to sort
of kick the tires and understand what drives the future
free cash flow. So to think about what will drive
free cash generation over a cycle, to understand the sort
of product competitiveness, the cost competitiveness, how well that profitability
(13:35):
then trade fleets into cash flow and looking to be
disciplined to pay kind of a maximum of eighty five
cents in the dollar. There's periods where things are much
much cheaper than that, but you know, again we have
a sort of strict discipline that we won't pay above
that level. So that kind of is the bread and
butter of what we're looking for as a firm. We
(13:58):
also pay a lot of attention to restructuring potential. Again,
one of the things you often find without a favor companies,
often they haven't been performing as well as they might
have done, so we spend a lot of time thinking
about how a company can get better, what can be
changed operationally, whether in some cases we're finding from a
(14:19):
portfolio perspective there's a good business hiding behind a bad one.
And I guess, really where we get the home runs
in the portfolios where both sides of that kick in,
where we get the undervalued free cashflow stream and also
we get the improvement process of the restructuring, adding materially
(14:39):
to the underlying value of the company. The process of
doing that really is helped materially by the strength of
the research platform that I have to draw on. I
could say, in having been an investment management for thirty
odd years, I could say, hand on heart, probably the
tiro price we should this platform is the best resource
(15:02):
I've had to work with. So we have one hundred
and seventy research analysts around the world with deep knowledge
of their companies and industries. So I spend the majority
of my time working with those guys discussing through what
a company could look like in the medium term, what
are the downside risks, and really trying to get to
(15:23):
the answers where we're getting that combination of an attractive
reward with relatively minimal downside. I think just two things
maybe to add on that. In terms of the portfolio side,
we try to deliberately take quite a wide net to
the sort of companies we're looking for. I think over
(15:44):
the course of my career, I've worked at a number
of different value firms, and we find the value tent
is actually much broader than it's often labeled to be.
So you know, at one end, you can have the
kind of deep value approaches, you know, buying steel companies
at the on the cycle, the other end of the spectrum,
we're looking at sort of war On Buffett buying Coca Cola,
(16:05):
much more sort of high quality compounding companies. We find
a lot of firms tend to gravitate to one or
other side of that spectrum. We've kind of developed the
processes and the tools to operate really across the piece,
so that gives us a lot of shots on goal.
It also gives us, from a portfolio perspective, a lot
(16:28):
of opportunities to improve the risk reward and again that's
something we've paid quite a lot of attention to. On
the portfolio side. Again, I've found over the course of
my career that value investing often and contrarian investing doesn't
work linearly. You tend to get returns in spurts and cycles.
(16:48):
So partly from bottom up, but also developed a sort
of risk dashboard to try and figure out when when
we want to be taking maximum risk and when we
want to be keeping a bit more powdered r. I
kind of think that almost as the similar to the
process of counting cards at a blackjack table. We want
to know when the when the playing field is set
(17:10):
up really for us to make big returns, or when
we want to be a bit more cautious and wait
for the better opportunities.
Speaker 1 (17:18):
So you mentioned, you know, finding opportunities during COVID, and
then also you mentioned a risk model, and so would
you say the portfolio was kind of a mix of
both top down and bottom up research.
Speaker 3 (17:33):
It's principally driven by bottom up research. So the starting
point is kind of really company by company, what are
the opportunity sets? How undervalued is this business in terms
of what we think free cash generation can do. We
incorporate elements I guess of top down primarily as a
sense check, so you know, we want to understand if
(17:56):
we're buying a company that has a cyclical strain. Ideally
we're not buying it at the top of the cycle,
would rather be buying it at the bottom. So kind
of some understanding around where we are in terms of
economic cycles business cycles is helpful, but it's nothing I
would I wouldn't claim the crystal ball that we add
(18:17):
a lot of value that way. It's more defensive to
make sure we're not not kind of making a mistake.
And similarly, in portfolio terms, we spend a lot of
time on scenario analysis around the portfolio. So what happens
if economies start to weaken more than we expected, what
happens if there's bursts of growth, what happens if the
(18:38):
dollar actually finally eventually starts to weaken at some stage. Again,
we want to make sure that we're getting a diversification
of drivers within the portfolio. So what's really doing the
heavy lifting is kind of the research insights and basically
buying that free cash flow at eighty five cents in
the dollar.
Speaker 1 (18:57):
So you know, in addition to cash flow in and
some of the other things you mentioned, there are other
financial characteristics you look at when you're evaluating balance sheets
and income statements.
Speaker 3 (19:10):
I mean in terms of balance sheets, obviously we're looking
for also looking at excess assets that are potentially could
be better deployed. So that kind of is on the
offense side, what additional value could be unlocked from a
company's balance sheet. It's fair to say, though, for me,
when we think talk about balance sheets, the starting point
(19:33):
is pretty much almost the cash flow statement. I think
that tells you the most about how a company behaves
over time. So tracking its cash generation performance is kind
of a big driver. And clearly if we have companies
that are self funding and generating free cash flow over time,
that tends to sort of overshadow the balance sheet condition
(19:57):
for a lot of periods. It's important though Obviously we're
going to have companies that we know will draw in
debt at times, and you want to make sure the
balance sheet is kind of strong enough to withstand that.
So we look at probably relatively conventional metrics around net
debt to ebit are clusters of debro financing, etc. I
(20:21):
think the other thing we've found probably over recent years,
it's important in sort of understanding finances also to think
about preemption rights, and we found that's actually added quite
a lot of value particularly during COVID in companies like
Rolls Royce or Outstorm, where you know, the long short
community often likes to cluster around companies that they think
(20:43):
are going to need a refinancing. If you're running a
lawn short portfolio, that's a win you You can tend
to close the short relatively well. It has led to
some cases, however, where the kind of total enterprise value
of the company gets really mispriced and we're we can
have confidence that we can participate as shareholders in that refinancing.
(21:06):
We've been willing to be proactive and buy ahead of
unexpected rights issues from companies, and again those have turned
out to be home runs for the portfolio in many cases.
Speaker 2 (21:18):
Looking at value opportunities on a geographic basis, I would
like to have your view on Japan because many investors
things that the country is undergoing structural shift with a
move from deflation to reflation. Corporate governance is being much
more shareholder friendly than it used to be in the past.
(21:40):
So market has done quite well over the past two
to three years. Where do you think we are in
this cycle.
Speaker 3 (21:47):
Yes, certainly the market has done well, and I think
also within Japan, the sort of value cohort of stocks
have done well as we've seen some of those changes unlocking.
I think all of those things are happening. So we
are seeing restructuring in Japan. We're seeing an accelerating release
of cross shareholdings. We're seeing companies being a bit more
(22:12):
deliberate about capital allocation, a bit more shareholder return driven
in some of those policies. Having said that, I think,
as you said, the market has become more consensual about
these things. There was a lot of debate around that
a couple of years ago. It now seems to be
very much received wisdom. So we're finding you have to
(22:32):
pick your spots a bit more carefully in Japan now.
So we're looking for opportunities, I guess actively for restructuring.
It's one of the sort of tenets of the portfolio,
but we're perhaps finding we're rotating a little bit away
from some of the industrial and export sectors. And again
some of those companies, things like Katachu held in the
(22:53):
portfolio for ten years, it's been a great restructuring story.
But we're seeing, I guess, a a consensus around restructuring
for some of these companies. But also there's been quite
a benefit from the weekend for a lot of exporters,
which again we don't want to sort of bake in
(23:13):
as permanent. And we're also seeing perhaps quite a change
in terms of the competitive levels for some Japanese companies
versus Chinese competitors, and certainly where where China has been
a big end market, we're seeing quite an increase in
sort of domestic competition, so rotating a little bit away
(23:33):
from some of the export industries, and we've been finding
more opportunities on the domestic side. Companies like seven to
eleven have been a big additions to the portfolio this year.
This is like Cow where we're seeing prices rise for
the first time in twenty odd years. And we're also
finding we're moving a little bit down the capitalization spectrum,
(23:53):
so more opportunity in the mid cap and Japan, but
netnet for fund has now moved underweight Japan. In contrast,
we've probably been adding over the last eighteen months or
so to positions in Korea quite heavily. I think it
feels to me like Korea is at an earlier stage
(24:14):
to Japan in terms of its value up program. But
there's a certainly we're finding from companies a drive to
sort of better define capital allocation. We probably need some
tax changes more to see asset release. But again there's
a sort of relatively lowly valued set of companies that
(24:34):
start to be starting to change. So Korea is an
area of spending increasing time. Obviously, the political events of
the last few days don't help the case in the
short run.
Speaker 2 (24:45):
There coming back very quickly. On Japan. Do you think
that if the boj increase rates over the next twelve
to eighteen months, does it create a good opportunity for
Japanese financials.
Speaker 3 (24:58):
Or not it does. I guess some of that good
news is already baked into the share prices. I mean,
we've seen Japanese financials move from half book value to
one time's book value, so that's starting to put a
normalization of return on equity on the table. Obviously, the
(25:20):
Japanese banks are extremely long of deposits, so we would
anticipate that they keep a good benefit from from rate rises.
I think it's fair to say there are rate rises
already baked into the share price, so it's not an
area we've been chasing, and we can see continued benefits.
But yeah, again there's a portion of that in the
(25:43):
share prices already. Conversely, the other side, actually, we've been
taking the opportunity to add a bit more to real
estate holdings in Japan which have been dragged down by
that sort of movement in the BOJ rates. So it's
kind of interesting that you can buy basically companies like
Mitsubishi Estate that are sitting on some of the absolutely
(26:06):
top quality prime real estate in Tokyo at half net
asset value and with a management team that's starting to think,
I think more holistically around its capital allocation and portfolio management.
Speaker 2 (26:20):
To come back on your comment in Japan moving toward
a smaller gap, is it also something that you would do,
for example, in Europe because European media and small gap
are on the perform large gap quite significantly in twenty
twenty four, So do you think they could present good
value opportunities for your fund.
Speaker 3 (26:42):
Yes, I certainly find we've been moving that way. Again,
it's more bottom up driven than some sort of realisas
to say we need to buy smaller MidCap companies in Europe,
but they have been lagging. You know, we're seeing relative
valuations come down, So yeah, we're starting to see opportunities
of a number of areas. We've found clusters in the
(27:03):
UK that have been really interesting. Again, I suppose we
think of some companies that sit in sort of mid
cap space but are market leaders in their area. Companies
like Pearson that have been underperforming for a number of
years as the sort of the higher education textbook market
has weakened. But you know, you know, we're seeing the
other parts of the business pick up the pick up
(27:25):
the slack and start to generate good growth. So we're
seeing a number in the UK. It's fair to say
we're seeing a number of industrials again. Businesses like Diamler
Truck in Germany look really interesting, you know, market leading
truck business in North America and in Europe, having spun
off out of Diimler, it's trading at under half the
(27:47):
valuation in terms of what we're paying for sales compared
to Volvo, and around a third of pack are So
we think there's a lot of potential for Dimeler or
restructure to returns on the profitability over time. So we're
finding a number of opportunities springing up in Europe bottom up.
(28:09):
I think somewhat unusually we're finding them also in financial areas,
both across some of the banks, so in BCP and
Portugal has been a great holding for us, but also
in areas like George which has to get overlooked by
sort of small MidCap investors. You know, in Holland, we've
seen five leading insurers consolid eight down to three. There's
(28:34):
a lot of cost cutting potential there over time, potentially
better pricing, and yet we're sort of we're paying eight
and a half times earnings and getting seven and a
half dividend yield out of some of those companies. With
that that good cost cutting runway still to come.
Speaker 2 (28:50):
Moving another gear, I mean underlyzing your fund. It seems
that you have a large position meansions of pharmaceutical and
l scare space, which is usually seen more as gross
than value. So do you think for you investing in
lscare is more finding quality cuponders at a reasonable price.
(29:14):
And if it is the case in which pace would
you look at equipment, pharma more service providers? Which one
would you favor?
Speaker 3 (29:24):
I guess we're finding opportunities in both. As you say,
I think healthcare is one of those sectors that's traditionally
been thought of as growth rather than value. If we
kind of go back to the Ben Graham textbooks, I
mean they're traditionally written really around companies that are based
around tangible assets, hard capital. But increasingly in the economy
(29:47):
more growth, a bigger proportion of the economy is being
driven by companies that are based around intellectual property, intellectual capital,
and obviously healthcare sits in that zone. I think the
sort of the tools you need to look at that
can vary a little bit, they can be quite different.
The patterns of cash flow over time tend to be
(30:09):
less economically sensitive. It's more around understanding the portfolio drivers
and getting into the weeds on the individual stocks. So
again we look through a lens of free cash generation.
In an ideal world, we're finding companies that have a
good runway of a number of years of predictable free
(30:30):
cash generation with all the optionality for future pipeline research development,
essentially for nothing. I think it's fair to say we're
seeing some opportunities like that today on the pharmaceutical side
against sort of companies like Sanafee. We sit with an
(30:50):
eight and a half free cash flow yield, no patent
expieres or no material ones until the early twenty thirties.
That's a sort of relatively cash flow stream, and again
we're not winning anything for research. Similar equations around some
companies like AstraZeneca not quite as cheap as Santa Fee,
but the pipeline is much stronger, the business is much
(31:15):
more diversified, So I think some of those we just
see good value in terms of what we're paying for
cash generation, you know, in terms of the equipment side.
Phillips has been quite a big holding for the portfolio,
where again they've had their trails over the respiratory products,
but underlying it, we have a company with good market
(31:37):
positions that that again we're paying pretty reasonable valuations for,
So we kind of think of it as a good
hunting ground. In a portfolio sense, we're probably tilting a
little bit towards overweight cyclical companies. We're finding more opportunities there,
so we're leaning a little bit more into something like
healthcare that has that that sort of count balance in
(32:00):
terms of the portfolio shape. I think it's fair to
say also it's an area of the market that I
guess I approach a TIRO price with quite a good
degree of confidence. We have kind of twelve dedicated healthcare analysts.
So I have the luxury as a portfolio manager of
going through the company's portfolios with people that really understand
(32:23):
the science and the competing drugs and products. So I
think it's an area where we do excel in from
a research perspective.
Speaker 1 (32:33):
So we've talked about what you're looking for companies, But
what would trigger a cell do you? I mean, do
you look at target prices or is it more of
you know, the fundamentals of a company changing.
Speaker 3 (32:46):
We do look at I guess target prices. I mean
we throw to its sort of intrinsic value. So what
as a company, what do we think the free cash
generation is worth? And so sort of fair value for
us would be when the free cash generation and delivers
you effectively a nine percent IR, we'll kind of consider
a neutral price. If we've reached that level, we'll reassess
(33:09):
the investment case. Obviously, if we're growing over time, if
we're seeing restructuring, there's usually a sort of upt trajectory
to the numbers, So we don't want to throw the
baby out with the bath water. But if we don't
see a case to revise the intrinsic value estimate, then
the stock gets sold. We refer to those as the
good levers internally, and they tend to be about sixty
(33:32):
percent of the sales from the fund. The other side
of that, the bad levers are obviously ones where we've
had to come to the painful refibation that what we
were looking to happen in terms of cash generation, restructuring
or change just isn't developing as we would like it. Hopefully,
(33:53):
again our downside analysis gives us some protection, but again
those are the time for ones to decide, but it
tends to be about forty percent of stocks just have
to go back to the original thesis and say what
we're looking for isn't happening and we should move on.
The other thing I guess I would add up to
(34:14):
that is we have a lot of emphasis on restructuring
in the portfolio, and I guess I've found over the
course of my career, when you get big companies that
haven't been as well managed as they might have been,
the process of improvement can tend to be a multi
year process. So again, where we're seeing companies sort of
(34:35):
changing their spots in terms of catal alacation, changes to portfolio,
new management really improving things. We'll want to give them
a good sort of space to run. We don't want
to be too hasty in moving out of that I
tended to find. You know, with companies like Rolls Royce
with Atacia mentioned where you end up after sort of
(34:56):
five years of earning the stock, it can very frequently
be much better in terms of company performance than you
ever might have jumped along the way. So we give
those sort of stocks the room to run within the portfolio.
Speaker 2 (35:10):
One follow up question during one of the remarks, you
said that potentially Korea is a good investment opportunity on
the value side. Do you have any strong views on
China because his market has been i would say left
four dead in terms of valuation and market trends, or
(35:30):
any other market potentially in emerging market which could look
as interesting for you.
Speaker 3 (35:37):
Yeah. I think the portfolio strategy is primarily developed market strategy,
so we're sort of benchmark to develop markets outside the US,
so we have scope to buy emerging markets, and there's
currently about eight percent of the portfolio in emerging markets.
So we do that in an off benchmark sense where
(36:00):
we see opportunity. Again, the research platform kind of covers
a lot of those areas in good depth. We tend
to say probably about half of the exposures within the
portfolio would be in areas like Korea or Taiwan, where
you know, we're kind of on a spectrum between emerging
and developed. So you know, often we could regard the
(36:24):
competitiveness of a Samsung Electronics or something as being equivalent
to owning it's its peers in the in the developed markets.
Outside of that, it tends to be more opportunistic approach,
so looking for really materially undervalued companies or where where
sentiment has become very negative. China obviously keeps coming up
(36:48):
on the radar. It's probably fair to say for a
contrarian investor, China has kept tapping us on the shoulder
several times over the last few years. We do have
some exposure there. I think it's it's pretty cheap, a
lot of cheap stocks, But principally, I guess we've kind
of taken China exposure through multinationals. So when we've seen
(37:12):
kind of panic sell offs in China and Hong Kong,
we've been added quite a bit. To say, Aias we
have probably one of the highest quality stocks in its
sector in terms of insurance exposure, and a big runway
of underpenetration for insurance markets really across Asia. Around half
(37:33):
the portfolio exposed to China, so we've been doing it
quite heavily, perhaps through multinationals, but we do have some
China exposure in the portfolio. I think it's cheap enough
that you want to have some exposure. I wouldn't be
in the camp to say just avoid China at all costs.
Speaker 1 (37:51):
So I've one question before we let you go. It's
actually a more reflective question. What advice would you give
your younger self just starting in the industry.
Speaker 3 (38:01):
I think, reflecting on that, I would the advice I
would would give to someone starting today is to think
about how you manage your relationship with deusflow actually in
financial markets, and certainly you know, for over the period
of my career, the amount of daily newsflow, opinion pieces,
(38:22):
facts that are sort of dropped into our desks every
day via email, via services like Bloomberg Financial Television, it
can be quite overwhelming. You know, there's there's usually three
different explanations for why the market is going up, down,
or sideways on any given day. A lot of effort
to explaining short term share price movements. So I guess
(38:47):
I would would advise people to try and sort of
disconnect it a little bit from that that sort of
pose of information and just try to think about what
that makes a company valuable over time, So kind of
what drives the product growth, what drives the cost competitiveness,
(39:08):
the capital allocation, Those things I guess tend to change
more slowly out of time. I think you can get
more of an edge actually sort of being prepared to
dig into the weeds and think about what is a
company worth If I, you know, metaphorically put the chess
to get in a drawer for five years. I think
(39:29):
that's a sort of much better way to be approaching investment.
And I would encourage people to sort of try and
just step back from the noise flower and think about
what matters on a longer term basis.
Speaker 1 (39:40):
That's great advice. Well, thank you Colin for joining us today.
Speaker 3 (39:44):
Great, thank you, it's been a pleasure. Thank you for
having me and Lauren.
Speaker 1 (39:47):
Thank you for serving as my co host.
Speaker 2 (39:50):
I thank you.
Speaker 1 (39:51):
Until our next episode. This is David Cohn with Inside Active.
Speaker 3 (40:01):
The two Stars of the Old Town has as
Host
Gina Martin Adams
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