Affordable luxury, attractive stocks

Trimark's Michael Hatcher cites expanding markets for smaller-ticket premium brands.

Sonita Horvitch 7 May, 2014 | 6:00PM
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 Michael Hatcher, head of global equities and director of research at Trimark Investments, says that a number of leading global companies that sell affordable luxury goods in emerging economies have strong growth prospects in those markets.

"Companies with well-established smaller-ticket global brands such as high-end scotch and premium beers have far more scope to expand in emerging economies than those offering big-ticket brands, such as high-end vehicles," he notes.

There is a growing middle class in these countries and the demand for what are perceived to be "affordable luxury items" is growing apace, he says.

This ties into Hatcher's approach to investing. Essentially a stock picker with a longer-term investment horizon, he targets companies that are prominent in the markets they serve, have sustainable competitive advantages and operate in a field where there are high barriers to entry. The companies must produce a high return on invested capital and strong cash flow.

"Global spirit producers and brewers have these characteristics," he says. "There are a small number of large players in these businesses and high barriers to entry."

In addition to these consumer-staples companies, another fruitful hunting ground for companies that have the virtues he is looking for is technology, says Hatcher. A niche that he has invested in is enterprise software that allows businesses to manage their entire operation. "This industry is a duopoly."

A value manager, Hatcher's approach is to first identify those companies that have the characteristics he is looking for "regardless of value." He then calculates the intrinsic value of these companies and compares this to the market's valuation of the company. "I have a watch list of companies that are attractive and I will consider investing in them, when the market price warrants this."

 
Michael Hatcher

At present, says Hatcher, it is tough to justify buying new names as market valuations are such that they do not offer a sufficient margin of safety, i.e. stocks that trade at a discount of some 30% to their estimated intrinsic value. "My approach is to hold on to existing names and if some of them do pull back to add to them modestly."

Of the big picture, Hatcher notes that so far Russia's involvement in Ukraine has not derailed global stock-market valuations. If the conflict escalates within that region, he says, there could well be a fallout on stock markets around the world. "This might well represent a buy opportunity, as the companies that we target have little at stake in that region."

At Trimark Investments, a division of Toronto-based Invesco Canada Ltd., Hatcher's wide-ranging responsibilities include Trimark Europlus (assets $331 million and 28 names at the end of March), Trimark Global Fundamental Equity (assets $1.4 billion and 70 names) and the flagship Trimark Fund (assets $3.4 billion and 38 names).

Consumer staples and information technology are among the largest sectors in these three funds. There are also some names that are common to all three funds.

An example in the consumer-staples sector is the leading premium-drinks company, London-based Diageo PLC, which has an American Depository Receipt (ADR) and trades on New York under the ticker DEO. "I have been adding modestly to this stock on weakness, but it is not inexpensive."

Diageo's brands include Johnnie Walker, the world's leading spirits seller by value and second largest by volume, and Smirnoff, the world's leading premium spirit by volume and ranked second by value. "Whisky is a major contributor to Diageo's operating profits; its other whiskey brands include Crown Royal and J&B." The company's other well-known drinks brands include Baileys liqueur, Captain Morgan rum and Guinness beer.

"Some 40% of Diageo's sales are in the emerging economies, and its products are an example of consumer products considered to be affordable luxury in these markets," says Hatcher. The stock trades at 17 times forward earnings-per-share estimates.

A long-standing holding of Hatcher's that is also a major player in the global drinks industry is Heineken Holding N.V., which is based in the Netherlands. This stock is held in Trimark Global Fundamental Equity and Trimark Europlus.

"Heineken is one of four leading global brewers in a highly competitive and mature market," says Hatcher. "This is not a high-growth business, but the companies are substantial cash-flow generators."

Heineken Holding's flagship product, Heineken beer, "is the world's largest premium beer and it has a good growth profile," he says. As part of its marketing and distribution strategy, "the company also has local and regional brands in both Europe and emerging markets." The latter accounts for some 45% of company sales, says Hatcher. The stock trades at 14 times 2015 earnings-per-share estimates.

An addition to all three funds in the last two years is the Belgium-based global brewer, Anheuser-Busch InBev S.A., which has an ADR and trades on New York under the ticker BUD. This company's global brands include Budweiser, Corona and Stella Artois.

"The company has a dominant market share in the United States and Brazil, along with its global presence." Some 50% of its revenue stems from emerging economies, says Hatcher. The stock trades at 18 times 2015 earnings-per-share (EPS) estimates.

Turning to technology, there are two major enterprise-software companies, which dominate this space, says Hatcher. They are: SAP AG, based in Germany, which has an ADR and trades on New York under the ticker SAP, and U.S.-based Oracle Corp. ORCL. SAP is held in all three funds, while Oracle is held only in Trimark Fund and Trimark Global Fundamental Equity.

Anheuser-Busch
InBev S.A.
Diageo PLC Oracle Corp. SAP AG
May 5 close $107.38 $123.83 $41.21 $78.50
52-week high/low $111.38-$83.94 $134.08-$111.87 $42.00-$29.86 $87.42-$69.71
Market cap $172.0 billion $78.0 billion $183.7 billion $93.9 billion
Total % return 1Y* 14.4 2.9 24.9 -2.6
Total % return 3Y* 23.8 17.9 6.8 9.0
Total % return 5Y* n/a 22.4 17.5 16.3
*As of May 5, 2014. All figures in U.S. dollars
Source: Morningstar

"SAP is a pure play on this enterprise software," says Hatcher. The backbone of the business "is the maintenance contract that follows on from the adoption of the software." These contracts provide stability, growth and predictability of cash flow and income, he says. "They are in the nature of an annuity." There is a cyclical aspect to the business relating to new sales of the software, "but the key driver is maintenance contracts." The stock trades at 15 times 2015 EPS estimates.

"Oracle competes head to head with SAP in this niche," says Hatcher. "But the U.S. -based company also has hardware offerings, so it is not a pure play on enterprise software." The stock trades at 12.5 times 2015 earnings estimates.

When it comes to recent trims or sells from the three portfolios, Hatcher says there has been little movement. One trim from the Trimark Europlus portfolio was major franking machine maker, Neopost SA. Based in France, Neopost is a global company with a strong market presence, he says. "I was concerned about the valuation on the stock and, fundamentally, the mail business is in structural decline."

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Sonita Horvitch

Sonita Horvitch  

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