At Evenlode, we like to fish in a pool of competitively advantaged companies with asset-light, high return economics. This is a ‘get rich slowly’ approach, with compound growth in both dividends and per share free cash flow – in combination with the incremental recycling of capital into more attractively valued stocks – driving total returns over time.
Since the end of February, many of these cash compounders have lagged as other areas of the UK market have performed strongly, such as more asset-intensive financial and commodity stocks. Portfolio fundamentals, though, continue to make steady progress, and the outlook for long-term growth remains attractive.
For 2024, the forecast for the portfolio’s average organic revenue growth is 5% and average operating profit growth is expected to grow at a high single-digit rate. Free cash flow growth is also healthy – the fund’s free cash flow yield is 5.1% for this year and forecast to be 5.7% for next year, providing ample headroom for the 2.9% dividend yield.
Compass: Market leadership and structural growth
Compass is the global market leader in the food-service industry and supplies a wide range of business sectors, from healthcare to offices, defence and industry.
Over time, Compass has been a stalwart compounder within the Evenlode Income fund. This track record was interrupted by Covid, as the world suddenly locked down. The company has subsequently emerged in good shape, and recent results are a reminder of the qualities of Compass’ business model and its long-term growth potential.
Organic revenue grew 11% and operating profit grew 19% in the latest quarter. As the complexities of food-service delivery have grown over recent years, Compass’ expertise at managing these intricacies – along with digital know-how, procurement scale and financial strength – has been driving considerable new customer growth.
Structural opportunities from first-time outsourcing remain significant, with about half of the global food catering market still in-house.
Informa: Powerful networks of human connection
Like Compass, Informa – the global market leader in trade exhibitions – was also disrupted by Covid as social distancing and travel restrictions shut the industry down for several months. Informa has now also re-emerged in good health.
In an increasingly digital world, it has been interesting to observe how physical trade events have continued to thrive and prosper. The more members of a business community spend the year communicating virtually, the more importance they place on the annual opportunity to all get together in person.
Recent results demonstrated healthy growth trends, with the company expecting high single-digit revenue growth and double-digit profit growth for the year.
Howden Joinery: Investing through the downturn
Howden Joinery Group, the UK's leading supplier of kitchens, managed to grow organic revenue over its latest four months, despite a very tough market in which cost-of-living pressures have continued to weigh on consumer spending.
Howden’s management has been resolute in its strategy of reinvestment, expanding their depot network in the UK and Ireland, and more recently in France. The company plans to refurbish more than 80 of its UK depots and to open 30 new ones during the year.
As of January this year, bedrooms have also now become available in all UK depots, reflecting management’s commitment to invest and expand Howden’s offering over time. When the tide turns, and the market improves, Howden will be in a strong position to benefit.
Diageo: Recovering from a Covid hangover
After Reckitt, Diageo has been the most significant negative performer within the portfolio over the past 12 months, falling nearly 20%. The company is experiencing a hangover from a post-Covid surge in sales. Consumer demand is easing, whilst wholesalers and retailers simultaneously run down their inventory, accentuating the slowdown for Diageo’s sales.
Full year results, when they are announced in July, will therefore be uncharacteristically weak, with current expectations for profit to fall by about 8%. This trend is reflected across the global spirits industry, with similar companies such as Pernod Ricard, Remy Cointreau and Brown Forman (which we follow but are not held in the fund) experiencing similar trends to Diageo. As consumer demand has cooled, destocking trends have created a bullwhip effect in Diageo’s supply chain as wholesalers and retailers run down their inventories.
Taking a step back from this current dynamic, we continue to view Diageo as a well-invested global market leader with good growth prospects and an impossible-to-replicate brand portfolio and global footprint. From a valuation perspective, the company’s price/earnings ratio has fallen from over 25x to 18x.
Unilever: Renewed focus
Current sentiment towards Diageo is reminiscent of sentiment towards Unilever in the first quarter of 2022 (i.e. severely depressed). At that time, nothing was going right for Unilever and management’s execution and strategic clarity left room for improvement.
Though the subsequent two years have not been plain sailing, new management has made some sensible strategic decisions, Covid volatility is now beginning to wash through the system, and operating performance is on an improving trend. Even the share price has begun to show glimmers of life, with a total return of more than 40% since the recent nadir in March 2022.
In the latest quarter, Unilever reported 5% year-on-year growth, with volumes up 2%, building on last year’s high single-digit organic growth rate.
The company is taking a more focused approach and accelerating its investments in innovation and marketing spend behind its 30 power brands, such as Dove and Vaseline. These power brands generate more than 75% of Unilever’s sales and enjoy strong market leadership, scale and more attractive economics than the company’s other brands. In the latest quarter, the power brand portfolio continued to outperform with organic revenue growth of 6%, of which two-thirds was driven by volume.
Experian: Data analytics and client embeddedness
Meanwhile, the results from our portfolio’s high-margin, asset-light digital companies have remained strong, and the rapid build out of data analytics capabilities has been a recurrent theme, as companies such as RELX, Microsoft, London Stock Exchange Group and Sage invest heavily in expanding their capabilities in this area.
Experian, for instance, reported organic revenue and profit growth of 6% and 8% respectively at its recent full year results. The company benefits from high switching costs and brand strength – it would be very difficult for a competitor to build up a comparable depth of data – and management continues to invest heavily in the business to drive growth.
Experian’s growth prospects look attractive; as financial inclusion expands globally, the requirements of fraud and risk management become more demanding and Experian’s services become increasingly embedded in customer workflows over time. In recently published results, management set a new target of achieving high-single digit organic growth over the medium term, and an aspiration for low-double-digit growth over the longer term.
Hugh Yarrow, portfolio manager of the Evenlode Income fund. The views expressed above should not be taken as investment advice.