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Investment Strategy
Sunday, August 1, 2010
Time for a free lunch

This last decade has been exceptional when one considers the performance of the JSE relative to global markets. In fact the JSE has outperformed the MSCI World Index by a whopping 260% in US$ terms. “Will the next ten years hold the same fortune for domestic investors?” asks Greg Hopkins of PSG Alphen Asset Management.

“Mean reversion, as history has shown, is a powerful force and betting against prevailing thinking often yields handsome returns. Global investing also provides a large set of opportunities that are often not available in one's backyard.”
For South Africans, investing abroad is often perceived as venturing into less familiar and more risky waters. 'Stick with what you know' we are often told, and in this ever-uncertain world this rings true. Observes Hopkins, “The Sage of Omaha, Warren Buffett, reminds us to invest within our circle of competence, though one might be surprised how big one's circle of competence really is. There are a group of global leader, household-name stocks, which we believe are comparatively easy to understand. Companies like Tesco, Unilever, Dell and Johnson and Johnson to name a few.”
Some commentators, such as Jeremy Grantham at GMO, have recently referred to these stocks as the 'one free lunch' out there in this uncertain world. They are also sometimes referred to as 'win-win' stocks. They tend to outperform their lower quality peers through time and, as they are currently trading at similar - or even lower multiples than their peers, one gets for free the armour plating they provide in times of global distress. Hence the free lunch.
“We believe that adopting a simple philosophy will reap dividends in the global arena. Our philosophy is to invest in quality stocks with long track records, simple to understand businesses, and companies with a moat that provides protection against the marauding competition.
“These types of companies generally have high returns on capital and often the ability to invest large amounts of capital in their business at high rates of return. Through time, these companies tend to open an unassailable lead on their competition as they continually reinforce their moats and maintain their defences against competition,” explains Hopkins.
Some larger capitalisation developed market stocks can provide a relatively cheap entry into emerging market growth. For example, a company like Unilever has over 50% of its revenues in the emerging markets, a market position that has been built up over more than a hundred years. In fact, Unilever was first incorporated in South Africa in 1904. How many businesses are still around in South Africa from the early 1900s in their present form? According to Unilever, two billion people use their products on a daily basis. Imagine trying to replicate a business that sells to one in two global households through a global distribution channel that was formed in the times of the British South Africa company? It has quite a head start. Unilever's emerging market business has been growing at around 10% per annum over the last 20 years and has never had a year of negative growth.
Consider the company Diageo. “You might not have heard of them, but we are sure you will have heard of Johnnie Walker whiskey, Smirnoff vodka, Guinness stout and Bailey's Irish cream. Diageo is the world's leading premium spirit company and Smirnoff is the world's leading premium spirit. Johnnie Walker is also the world's number one selling scotch whiskey. In terms of track records, Diageo's parent company, Arthur Guinness Son & Company, was incorporated in 1886. The Guinness brand has been around for over 250 years and has enjoyed an amazing 10% compound growth per annum since 1850, a record that we imagine would be difficult to try to beat. In terms of moats, ask yourself the question - on a trip to Cambodia would you drink the local whiskey (Ox Gold), the local Cola (Khmer Cola) or the local beer (Angkor)? We answered that last November - 'no, no, yes'.
“Diageo is listed in the UK, though it has 30% of its revenues from emerging markets. It's interesting to note that major spirits companies have a 40% market share in South Africa (of which Diageo has an approximate 80% share) but just 1% in Russia and China, the two largest spirits markets in the world. Imagine the growth possibilities, Imagine too being able to buy this company at a very attractive price. Well you don't need to imagine it - you can.”
Finally, consider Tesco, the UK grocer. It was founded in 1919, making it over 90 years old, with the last ten years being its best - not bad for an 80 year old. It is the number one retailer in the UK with a market share, according to TNS Worldpanel, of over 30% - almost double its nearest rival Asda (which is owned by Walmart). Over the last 15 years, we believe Tesco has opened up an unassailable lead over the competition - in retailing, size begets success in a virtuous circle - as the bigger one is, the lower cost one can become, the more shoppers one attracts, the bigger one becomes, etc... Not many people are aware that Tesco has 60% of its retailing floor space outside the UK, with most of that being in emerging markets.
What's more, that 60% of floor space is currently contributing only 30% towards group revenues. Korea is a good example: the country has a population of 48 million people, not dissimilar to that of the UK at 60 million, and where the company has built a market share of 30% in less than ten years. In fact CEO, Terry Leahy recently commented that the company has achieved in Korea in a decade what took 60 years in the UK. Korean revenues are still only 10% of revenues in the UK, which gives an idea of the potential in the market as the country's wealth continues to grow.
If we compare Tesco to local darling Shoprite, we can see that this globally diversified world-leader can currently be acquired at a p:e lower than that of the domestic company and at a higher dividend yield. Tasty Tesco.
“The stocks mentioned above and others of their ilk have largely been left behind over the past year as investors have scrambled into those sectors that are expected to benefit from a perceived immediate improvement in global growth,” notes Hopkins. “Whilst we have little clear visibility over the next ten years - there is much uncertainty and a large range of potential outcomes. We do, however, believe it is worth backing those companies that will likely continue to generate steady growth and which present a 'free lunch' for the patient investor.” From The Alphen Angle, by PSG Alphen Asset Management.

Copyright © Insurance Times and Investments® Vol:23.8 1st August, 2010
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