Our investment in stocks focuses in three pilars:
01- The Business
When you buy shares of Moat companies, you’re buying a stream of cash flow that is protected from competition for many years. So the Moats increase the value of the companies. If you are right about a Moat, your odds of permanent capital impairment are lower. Companies with moats also have greater resilience, because firms that can fall back on a structural competitive advantage are more likely to recover from temporary troubles. Finally, our cycle of competence are firms with competitive advantages, regardless of what business they are in.
Victrex plc / A British Specialty Chemicals Company and global leader in engineering PEEK thermoplastics
PEEK’s unique competitive advantage works in Victrex’s favour, as the company currently controls 65% of the global market share leaving the remaining percentage to be split among smaller players. It is precisely PEEK’s critical employment as a specialty material across a broad range industries and use cases that creates a wide enough moat or advantage for Victrex in the shape of high switching costs. Victrex’s clients would find it hard to replace PEEK with a substitute of lesser quality that would not compromise or risk the quality of their own products.
02 – Accounting Red Flags
In a late cycle environment with global macro-risk rising, revenue growth slowing and downward pressure on margins, the conditions are ripe for aggressive accounting manipulations as management feel pressure to boost earnings. We strongly believe that the balance sheet and cash flow statements are forward indicators of potential income statement problems and that management teams may mask deteriorating business fundamentals through various accounting maneuvers.
Mitie Group / Mitie is a facilities management, consultancy and project management company in UK.
The red flag was related to Goodwill impairment in the 1st half of 2016.
In October 2012, Mitie bought Enara and assigned 85% of the transaction price to Goodwill. This increased the weight of Goodwill + intangibles (infinite useful life) as % market capitalization to more than 60% and that concerned me. Goodwill was GBP 464m and 22% of it was related to the healthcare division. In 2015, this business unit was operating at a loss but Senior Management announced that it had good prospects for the future leading Mc-Gregor, the CEO, to openly state, – “We’re not concerned about impairment“.
However, only one year later, the CEO was forced to recognise that “Given the further deterioration of the financial performance of the healthcare business, we have concluded that a sustainable long term plan for the group’s domiciliary healthcare business cannot be delivered under Mitie’s operating model. The group has undertaken an impairment review of the goodwill and intangible assets, accordingly a write off of £107.1m of goodwill.
03 – Aligned interest with company management
Managers have only a limited amount of ability to affect the competitive advantages of his companies but they are responsible of the capital allocation decision. The study of management, vía conference calls and face-to-face meetings are one of the main elements of our daily job.
O’Reilly / One of the biggest ‘Auto Parts’ retailers in USA
O’Reilly is a good example of sound capital management proven by their track record of paying a small percentage of their earnings in dividends and their well-timed share repurchasing programmes only when a cheap share price is perceived by Senior Management. Gregory Henslee, CEO since 2005 and with more than 30 years’ experience in the company, authorized a share repurchase at the start of September 2017 worth up to $ 1 billion added to the previous amount, resulting in a total share repurchase approval of $ 9.75 billion, or 53% of its market cap, setting a new inflexion point in its share price. In September 2017, the P/E ratio was close to 15x.
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