Since the market crash in March 2020 due to the pandemic, equity markets have gone on to achieve successive record highs. But, these have been off the foundations of shifts into and out of defensive and then cyclical recovery sectors based on changing investor confidence in the global economic outlook.
We prefer to invest in businesses that look attractive on both a fundamental and valuation basis. Identifying these opportunities requires rigorous research and a deep understanding of risk-reward trade-offs. Deciding to then invest in them takes considerable experience and a willingness to dive in when others may be fearful of doing so, instead remaining in the comfort of cash until uncertainty passes.
Based on our decades of experience in investing in global markets, below are some exciting long-term investment opportunities that we identified following the sharp bear market crash last year. They are primarily recovery stocks that we believe will benefit from the structural tailwinds of economies emerging from the pandemic and the compelling valuations at the time we invested. They are led by excellent management teams who ultimately determine the business’s long-term success, instead of hard-to-predict macro factors that companies cannot control.
Airbus is probably the ultimate Covid-19 recovery stock. It navigated the harsh operating environment of Covid-19 tremendously well, reducing costs and maintaining profitability on an adjusted earnings before interest and taxes (adjusted EBIT) basis. It also maintained a net cash balance while its main peer, Boeing, took on a large amount of debt.
Although air-traffic figures have only been recovering gradually, airline management took the opportunity to refresh fleets during the crisis, retiring older models and continuing with newer aircraft deliveries which now offer significant efficiency and environmental improvements. The trend towards smaller-sized aircraft such as the Airbus A320neo family, the largest profit contributor for the business by far, further accelerated due to the airlines’ need for capable but flexible capacity over the coming years.
As such, we expect Airbus to generate higher margins than we anticipated even before the crisis. These already started to come through in the second quarter. The company is also now positioned to generate high levels of free cash flow, which we expect, in turn, to be returned to shareholders.
In the travel segment, we also have high conviction in Trip.com, the dominant online travel agency in China. Recently, we took advantage of an opportunity to top up our holding when the share price sold off by more than 20% due to new travel restrictions imposed in various Chinese regions as a result of a small Covid-19 outbreak. We believe this issue was transient and doesn’t materially affect the business’s long-term value, which emanates from its leading position in the broader travel sector in China.
The structural outlook for the online travel industry is very favourable. A growing Chinese middle class is catching up with developed world peers in travel habits, starting from a low base. Despite lower online penetration of travel bookings as a whole, online travel agencies are more preferred as a reservation avenue in China than in the West. This bodes well for their market share position in the long term.
The valuation of the business is also highly attractive. If you assume a mid-teens margin in 2023, which is eminently possible, then you are buying this company on a 15 times earnings multiple.
Brewers and spirits makers are also very much reliant on a Covid-19 recovery and we particularly like Heineken, Anheuser-Busch InBev (ABI) and Diageo. During the lockdown periods, consumption moved from on-premises to off-premises, which had a detrimental impact on margins. Coming out of lockdowns, we are likely to see this reverse. Profitability will also continue to be boosted by the product mix shifting to premium and alcohol-free categories.
Heineken has a strong brand and has engaged in a significant cost-cutting programme across the business, targeted especially on the European, large-fixed-cost business. Heineken Holding trades on 19 times next year’s earnings, with a dividend yield of almost 2%.
ABI’s exposure to emerging markets has been a long-term headwind due to the weak performance of currencies in those markets. However, this theme could have run its course and the emerging market exposure could be turning into a tailwind in the coming years. Equity holders should also benefit from a transfer of enterprise value away from creditors as the business deleverages from high levels of Net Debt-to-EBITDA (4.8 times).
Meanwhile, Diageo has shown off its strength as a business during this challenging period. When others were running scared, it reinvested in brand and marketing, and that investment is now paying off. Covid-19 is unlikely to affect the company’s long-term growth, with 85% of its sales base representing products that are either holding or increasing market share. Like with brewers, Diageo’s margins are going to benefit further from the move from off- to on-trade.
Well-run luxury companies with sought-after brands have tremendous pricing power, resulting in high gross-profit margins, handsome operating margins and high returns on equity. This makes them the kind of businesses we want to own.
LVMH owns an unrivalled, diversified portfolio of brands, covering fashion and leather, wines and spirits, perfumes and cosmetics, watches and jewellery. Given the heritage and provenance behind many of their brands (with the majority being more than 100 years old), it would be impossible for a competitor to replicate what LVMH has built.
This business is a solid compounder. It has a formidable track record of earnings growth, generates high returns on capital and converts almost all of its earnings to cash. In our mind, it is one of the best businesses in the world.
Capri is another example of such a business. Listed in the US, Capri owns Versace, Jimmy Choo and Michael Kors, an entry-level luxury business. The opportunity lies in the turnaround of Versace and Jimmy Choo, which are currently generating below normal profits. The company currently generates margins in the region of 10%, which we believe can increase to 15% over time. The business is undervalued, trading at only 12 times our forecasted earnings.
These investment opportunities are exceptionally varied and driven by different market dynamics and prospects. We are confident that they will deliver on our expectations over a reasonable time horizon, even in a still stressed macro environment. These companies have proven their mettle during Covid-19 and we are very excited by the potential that they offer investors. DM/BM
To find out more about accessing opportunities such as these through our range of offshore funds, visit coronation.com.
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