Looking abroad for opportunities in quality
With equity markets as they are, there is an almost constant debate around where to invest for sustainable growth. The appetite for quality companies on the JSE has pushed their share prices to very demanding multiples. This has led many local investors to look offshore. Even though international markets are not cheap either, the much wider choice they offer means that there are greater opportunities to find quality that can offer long-term growth.
Duncan Burden and William Ball, investment analysts at Sanlam Private Wealth’s UK business, identify three themes investors could be looking at when it comes to global stocks: companies exposed to structural growth, those that benefit from growing wealth in emerging markets and those that are undervalued and unloved.
The first category presents the biggest opportunity, with a number of large international companies likely to benefit from a sustained recovery in the global economy. They include MasterCard, Accenture, Diageo, McDonald’s and Coca-Cola.
“MasterCard is a well-positioned business exposed to a structural growth market, with electronic payments set to materially expand over the coming years,” Burden says. “The business enjoys the rare combination of a dominant position in a market with a clear path to growth.”
While MasterCard is the most expensive of his picks on a price-to-earnings basis, Burden points out that the company has grown cash f low from operations by 36% a year and net income by 28% since listing in 2006. Its cash generative business model and low capital requirements mean that this could well continue.
In the case of Accenture, the two analysts see a company with an established name and entrenched customer relationships.
“It has more than a 100 clients contributing greater than $100m each in annual revenue,” Burden explains. “So it has a well-entrenched industry position and solid long-term growth opportunities, enabling it to produce a return on equity around 55%, which we believe it can maintain for the foreseeable future.”
Diageo is one of the world’s leading producers of spirits, with an unrivalled portfolio that extends from entry-level to premium-level spirits. However, its recent performance has been muted.
“China’s crackdown on governmental gifting has presented headwinds,” Burden concedes. “However, with the valu-
ation sitting at a discount to its global peer group and more recently rumours of M& A in the beverages sector, we are comfortable that now is a good time to access this structural growth story.”
Sanlam Private Wealth’s UK business has been a long-term investor in McDonald’s and although they don’t expect the company to shoot the lights out, they do see an opportunity for it to deliver a sustained recovery in its US operation through improving margins.
“With solid free cash f low generation, a growing dividend and a return on equity north of 30%, we remain attracted to McDonald’s ability to deliver decent returns in the low double-digit range,” Burden says.
Coca-Cola is a particularly interesting pick because it is based not only on the company’s formidable market position, but its appreciation that it has to adjust to changing consumer appetites. The company is growing its portfolio of non-carbonated soft drinks as consumers start to move away from drinks with high sugar content.
“Coca-Cola’s worldwide still beverage volumes increased by 8% last quarter, with solid volume growth across multiple beverage categories, including juices, ready-to-drink teas, packaged water, sports drinks and energy drinks,” Burden explains. “And with a highly-reputed, shareholder-friendly management team delivering consistently high returns on capital, we remain confident buyers for the long term.”
The company that Sanlam Private Wealth feels is a good play to capture the growth in wealth in emerging markets is luxury goods producer Burberry. However, it’s not just the rising demand for its products in places like China and India that looks attractive, but also its ongoing business re-organisation.
“The insourcing of Burberry’s previously outsourced beauty business and the movement away from a licence model in Japan appears to be gaining traction, and should deliver growth and margin accretion over the medium term,” Burden suggests. “The valuation is also attractive on a relative basis.”
The two unloved stocks that the analysts believe deserve another look are Samsung Electronics and Oracle.
“Samsung will show almost f lat year- on-year 2014 earnings per share growth due to operating margin contraction in its handset business,” Burden says. “However, we look past this short-term deceleration to the book value per share, which will increase by over 20% this year due to the company’s attractive return on equity of 18%. The growth in book value this year translates into a price-to-book value of less than 1.2 times based on 2014 estimates.”
He believes that this is highly attractive for a business with stable growth prospects driven by product innovation in its mobile division and the ongoing strength of its semiconductor division.
In the case of Oracle, Burden believes that the market may be overstating some of the company’s challenges and it may be in oversold territory.
“We continue to believe that Oracle is nearing an inf lection point of a positive secular growth trend associated with its database line as well as its core licence sales growth,” he argues. “We suspect that traditional applications software will continue to struggle with secular pressures, but equally all but the worst of these fears appear to be discounted, with shares trading at the lowest valuation relative to the S&P 500 we have seen since before the tech boom. Considering the free cash f low yield of 7.6%, we see good long-term value in this name.”