British market leaders who will stay streets ahead of the competition
A professional investor tells us where he would put his money. This week: Gary Channon, fund manager of Aurora Investment Trust, highlights three favourites
Imagine a company that earns a 15% return on the capital it uses to generate profits – a real 15% in cash after tax and all necessary capital expenditures, and 15% on the capital retained for growth. If you can buy it near the level of its capital, and hold it for the very long term, then your returns will also be approximately 15%.
Understanding a business well enough to make such judgements requires many years of work, and firms like these rarely trade at such levels. So you need to do the work and be willing to wait so that you are ready when, very occasionally, they are available at such prices.
For that, you need investors who support that approach, because sometimes the process is like watching paint dry, and at others it is gut-churningly scary. Welcome to Aurora.
Three top blue chips
Three businesses hidden away in the FTSE 100 that meet these criteria are Barratt Developments (LSE: BDEV), Lloyds Banking Group (LSE: LLOY) and Frasers Group (LSE: FRAS). The first two are market leaders in sectors of the UK economy with very robust barriers to entry, deterring potential competitors.
Housebuilding and retail banking are firstly very local (in other words there are virtually no scale benefits for international players); secondly, they are industries where no new major competitor has emerged in more than 50 years, despite all the changes in commerce.
The two firms are also both in industries that the competition regulator has looked at several times. It has established that they both make excess returns on capital, but it has not been able to change the situation. For the housebuilders it is the planning system that is to blame, while for banks the problem has been regulation and customers’ inertia.
Both those businesses are available for less than their capital, don’t need to retain much capital for growth and will be returning the rest to shareholders in dividends or share buybacks. Buying back shares for them is like reinvesting in their business at 15% rates of return – it leads to good outcomes.
Frasers Group couldn’t have a more difficult terrain to navigate. The retail sector is brutally competitive, it is hard to build economic moats (enduring competitive advantages), customers are fickle and there is a lot of disruptive innovation. In that arena, Mike Ashley and his team at Frasers Group have built a top operator where, when you look through the noise, you see a capital-allocation machine that makes the same levels of returns as the other two.
Judgement, not luck
The business has been built without any outside capital – it has all been internally generated. That level of return, in that arena, over that period, is not luck. It suggests a machine that has an edge, and we have spent a lot of time trying to understand what that is and how to monitor its persistence.
When a fund manager delivers a consistently high return over decades, you don’t deconstruct it through the individual stock picks. Instead, you look at the process and philosophy that generated those returns to gauge whether it is sustainable.
That’s the best way to think about Frasers Group. You are handing your money to the Warren Buffett of retail. Mike Ashley owns 73% of Frasers, draws no salary, and the firm pays no dividend. You won’t find a more shareholder-aligned executive in the FTSE 100.
“Mike Ashley, founder of Sports Direct, is the Warren Buffett of retail”