- 3 new holdings – Corning, Mondelez and Philip Morris
- Funded by 3 sales on valuation grounds – Diageo, Microsoft and Hugo Boss
At Saracen, we take a long-term view and try to avoid trading wherever possible. We added no new positions in the first 6 months of 2018. However, we have been active during July, adding three new holdings in businesses that we have followed for years and where the recent share price movements have provided an attractive entry point; namely Corning, Mondelez and Philip Morris. We have funded these purchases through selling three long-standing holdings which have all performed incredibly strongly and no longer fit our strict valuation criteria; namely Diageo, Microsoft and Hugo Boss. Our sales are in no way a reflection on the quality of these business, but we no longer believe that they are attractive investments on valuation grounds.
Corning ($27.00) is a multinational company, listed in the US, that manufactures specialty glass, ceramics, and related materials and technologies including advanced optics, primarily for industrial and scientific applications. The business has many factors that we look for; it’s a global leader, has high barriers to entry, good margins and invests heavily in Capex and R&D. The balance sheet is strong, and we find the 16X Year 1 PER and dividend yield of 2.6% attractive entry points. Corning continues to innovate and is currently adding capacity for new products. As a result, production will lead to higher sales revenues and margin improvement from both mix and scale. We expect the dividend to grow at 10% per annum over our 5-year forecast period.
Mondelez ($42.61) spun out of Kraft in 2013 and represents mostly the snacking businesses, which is biscuits, chocolate and gum/candy. All of these divisions are global with a group split of 26% North America, 38% Europe, 22% AMEA and 14% LatAm. The snacking industry is growing high single digits in emerging markets and low single digits in developed markets, partly due to lifestyle changes and more on-the-go eating. The historic sales performance is highly correlated to GDP growth. Unlike many other consumer businesses, it has low private label penetration. Mondelez is driving growth with innovation, like chocobakery (combine Milka and Oreo), mindful snacking (smaller portion sizes) and improved ingredients (non GMO, wholegrain, gluten free, low sugar, high protein).
The new CEO, Van de Put is currently conducting a strategic review of the company and will deliver a new 5-year plan in September. We expect more focus on top line growth, a change to its “direct to store distribution” in North America which would be helpful for margins and potentially the sale or strategic review of the gum business.
The shares have de-rated in recent months and now trade on an attractive 16X Year 1 PER. The dividend yield is slightly on the low side at 2.3%, however, we expect 11% growth per annum over our 5-year forecast period with 18% in 2018.
Philip Morris International ($81.66) was spun out of its US tobacco parent, Altria, in 2008. The demerger was intended to provide shareholders access to faster growing markets outside of the USA. Indeed, around 60% of PMI’s revenues are generated in developing economies where the emerging middle classes are attracted to its premium brands. It has seven of the world’s fifteen leading cigarette brands including Marlboro. Today, PMI is the largest global player with 25% market share (BATS 19%, JT 15%). However, PMI is differentiated by its superior growth profile resulting from its geographic mix. The long term fx neutral growth targets are 4-6% top line, 6-8% operating profit and 8-10% EPS.
The shares have de-rated this year from 23X to 15X year 1 PER, over concerns regarding the growth rates in their “heat not burn” products in Japan. This represents a 7-year PER low. The shares now yield 5.5% after management has increased the dividend by 6.5%. Whilst we are not great enthusiasts of investing in the tobacco sector, we are pragmatists with our primary focus on valuation. Accordingly, we believe the recent share price fall of over 25% provides an excellent entry point for the fund.
While we are loathe to sell great businesses such as Diageo and Microsoft, we must maintain the valuation discipline that our research demands. Both holdings had been in the fund since launch in June 2011.
We bought Diageo at £12.10 when the shares were trading on 13X Year 1 PER and yielded 3.6%. Today the shares have re-rated to 22X Year 1 PER and yield 2.3%. The shares were sold at £27.71 which represents a total return of 182% over the 7-year holding period. Whilst we continue to like the company and indeed its products, we are concerned about the share valuation against our estimated growth prospects. In addition, we would like to highlight some sell side comments trying to justify the current share price. We read this comment from an analyst – “The stock is hardly cheap at over 20x PE, but we believe that investors should increasingly benchmark it against European Luxury Goods companies rather than some of its Staples’ peers that are more at risk from ‘disruption’. On that basis its valuation looks more reasonable”. We have never been fans of valuing companies relative to other expensive ones.
We have written extensively in recent blogs and the quarterly commentary about over-valuation in the technology sector. Our investors have benefitted from this trend, through the holding in Microsoft. We bought Microsoft shares at $26 at the launch of the fund when they were valued at only 9X Year 1 PER and offered a yield below 3%. The shares have re-rated significantly over the last 7 years and now trade on 26X Year 1 PER and only yield 1.7%.
We sold our holding at $106 which represents a total return (including dividends and FX movements) of 424% on the initial purchase price.
In addition, we sold our position in Hugo Boss at €78 following very strong share price performance – the shares are up more than 60% from their lows in 2016. The shares now trade on 21X Year 1 PER and no longer represent value.
Feel free to contact us if you have any questions regarding the recent activity in the fund.
Many thanks for your continued support
David Keir (David@saracenfundmanagers.com)
Graham Campbell (firstname.lastname@example.org)
Co-Managers, TB Saracen Global Income & Growth Fund
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