TB Saracen Global Income & Growth Fund: Portfolio Activity – September 2018

Graham Campbell & David Keir give the latest updates in portfolio activity in TB Saracen Global Income & Growth Fund…

Two new holdings: Carnival Cruises and Valeo

We are frequently asked whether we meet company management prior to investment.  The reality is that we are unsure about the value of these meetings, as most information is already available, and management are rarely impartial in their assessment of outcomes.  However, in the two cases discussed below, the meetings were sufficiently interesting to spur us to further analysis.

Some of our best decisions have been when we invested in global leading companies that were out of favour.  Our two recent acquisitions – Carnival Cruises and Valeo – fit this bill, albeit for different reasons.

We held Carnival Cruises ($59) at the launch of the fund in June 2011 but sold the shares at the start of 2015 after a rise of 25% due to the valuation becoming stretched.  We continued to follow the company as we like the long-term trends and Carnival’s position in the marketplace.  We have continued to regularly meet management over the years.  Recently, one of those sessions was the trigger for a closer look at our Carnival model.

Since the start of the year, Carnival shares suffered as a very strong 2017 hurricane season led to postponement of bookings for Caribbean cruises in 2018.  The market became increasingly concerned over potential discounting to fill capacity.  In fact, management was relatively relaxed about the ongoing booking season and saw customers coming back without having to lower ticket prices.  In general, the story looked much better than it had in the recent past.

As is so often the case, the market de-rated the shares on the short-term outlook, ignoring that the long-term industry drivers are actually improving.  These include amongst others:

  • the main target group (US retirees) is still growing, has plenty of dispensable income and should benefit from tax cuts
  • cruises appeal to millennials and younger people as they are hassle free holidays with lots of experience
  • cruising is still a small part of the overall travel industry and taking market share
  • cruising is becoming more main stream with 33% of passengers who have taken a cruise in the past three years having a household income of less than $80k

Investors are also concerned about the increase in capacity over the next five years.  Carnival operates just over 100 ships with another 19 ordered through 2022.  This represents a 5.4% CAGR in capacity versus 5.6% for the industry.  Some investors are concerned that this will create a supply glut as it outstrips the industry demand growth rates of 4-5% p.a.  However, some ships are earmarked for the fledgling Chinese market where cruising is still in its infancy.  Stripping out the Chinese allocation, the capacity growth drops to an average of 3.4%, which is in line with forecast industry demand.  We believe Carnival has enough pricing power to fill additional space at full price.

Additionally, Carnival has various options to increase its margins.  Bigger and more efficient ships will offset the rise in fuel costs; more onboard spending will contribute positively to operating profit, as will high end tours and excursion to Carnival owned resorts.  We bought the shares at 14.2x 2018 PE and 9.8x 2022 PE with a yield of 2.8%, similar metrics to when we originally bought the shares.  By comparison, when we sold our holding previously in 2015 they were trading at 19.8x Y1 PE with a 2.1% yield.  Providing the company and industry outlook remains favourable and the valuation attractive, we are happy to back the shares again.

Our interest was drawn to Valeo (€40) in a different way.  It appeared on our weekly screen next to many other car companies and automotive suppliers.  The whole sector has been de-rated this year due to the increased trade war risks between China and the US, as well as the recent weakness in auto sales on a global basis.  But as so often, short term pain offers long term opportunity.

Valeo is number one or two in each of its four divisions on a global basis (comfort & driving assistance, powertrain systems, thermal systems and visibility systems).  In short, it is exposed to many of the growth technologies.  It supplies all the major OEMs and has a well-diversified customer and geographical portfolio.  However, the main reason – next to valuation – that attracted our interest is Valeo’s growth profile.  The company has consistently outperformed the wider automotive market in recent years.  The order book grew at a compound rate of 14%per annum from 2008-17 and increased to 17% in 2017.

The driver behind this is Valeo’s investment in R&D (6% of sales) and capex (10% of sales) in recent years.  This investment has helped cement Valeo’s position as one of the leading suppliers for electrical and autonomous vehicles over the next decade.  While R&D will stay at elevated levels near term, capex should peak in 2018. Source: Valeo

The company, peers and OEMs cut their guidance for 2018 due to lower auto sales in recent months, mainly in Europe and China.  This is partly due to the trade war rhetoric between China and the US and to the uncertainty over the introduction of the WLTP (worldwide harmonized light vehicle test procedure).  In the wake of the diesel scandal, new testing procedures were introduced globally in 2017.  As of September 2018, all new car registrations must apply with WLTP.  Many consumers are understandably still confused and have postponed purchases until they have more clarity.

Following a reassuring meeting with the company, we believe investors have generalised assumptions across the sector.  The fact that Valeo is one of the leaders in R&D for next generation cars, has had no cancellations for its mid and long-term contracts and continues to see strong order intake gives us comfort for the mid to long term.  We know the short term will be volatile, which is why we initiated a small position.  We will top-up on any weakness.  At 10x 2018 PE and 6.5x 2022 PE, we think there is a lot of pessimism included in the price.  The dividend yield of 3.2% is safe.

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 (graham@saracenfundmanagers.com)

Co-Managers, TB Saracen Global Income & Growth Fund

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