Large-cap turnaround stories Unilever and Pearson are not enticing enough for top fund manager Alex Savvides, who has eschewed them for better prospects in Restaurant Group and SIG. 
The manager runs the four FE Crown-rated contrarian JOHCM UK Dynamic fund and said he is not struggling for new ideas in the current climate.
However, identifying which opportunities to take and which to walk away from is one of the key reasons his £580m fund has outperformed over the long-term.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
As the above shows, the fund has returned 100.9 per cent over the last five years, far ahead of the IA UK All Companies sector and FTSE All Share index.
Below, the FE Alpha Manager highlights the two companies he has invested in and two that he has walked away from, despite their interesting turnaround potential.
Restaurant Group
The first name that Savvides (pictured) has invested in is Restaurant Group – home to brands such as Frankie & Benny’s, Chiquito and Coast to Coast – which has been on a very poor run in recent years.
Performance of stock over 5yrs
Source: FE Analytics
The manager said the firm is being hit by perceptions over the UK consumer spending, as well as the fact that increased competition has hit some of its restaurants.
“But what people don’t know so well is that it is also a concessions business that runs concessions in UK airports – not just for their own brands but for lots of other brands as well,” he said.
“It is the largest concession provider at Gatwick and Heathrow and that is a very capital-light, high-return business that is doing quite well.”
As well as this, the company runs a set of pubs that account for around a third of the enterprise value of the business.
“They basically own all the freeholds of 60 pubs – most in the nice parts of the north in countryside settings – and they generate roughly a third of the value of the company.”
As well as this, the underperforming leisure business is going through a turnaround under a new management team and that is what he finds most interesting.
“It has been giving up like-for-like volume for about two or three years and that has been of their own making but also of an overserved market capacity-wise,” Savvides noted.
“What we’ve got with the new management team, which have been in place for about a year now, is a strategy to drive that volume through lower prices which is quite a simple strategy but does seem to be working so far.
The company is now a 2.5 per cent holding in the fund. “We made the first investment in the second half of last year (around 1 per cent) but we made an addition to it so it became a material portion of the fund in the last six months,” the manager said.
SIG
The other company the manager has bought into recently is insulation products provider Sheffield Insulation Group, now known as SIG.
“It is a business I have owned in the past but not since 2013 and I watched a bit of a car crash historically with the past management team taking capital allocation decisions with that company that haven’t really worked,” he said.
“They took their eye off the ball and Travis Perkins came in and started growing a business in competition with them through price and so there was a margin issue.”
However, like Restaurant Group above, the company underwent a management change and appears to be at the start of a recovery.
In 2016, the chairman removed the chief executive and finance director (FD) and put in an acting CEO whilst looking for a permanent appointment.
Savvides said: “The acting CEO put a trading statement out for the full-year results in January saying the results were in-line with expectations but that the way they were thinking about managing the business purely around cash, working capital, balance sheet management and giving individual depot managers the ability to compete more clearly with price initiatives.
“It was a complete break with the past,” he added.
Since then, the company has appointed a new CEO with the acting CEO stepping back to a non-executive position.
“The new CEO has been in place for three months and the FD has been there six months and what they are doing to restructure the business is coming through very clearly.
“In the last six months they have taken £100m out of a net debt number of £260m – that is brilliant balance sheet management.”
Performance of stock in 2017
Source: FE Analytics
Shares have responded, as the above shows, with the company up 74.61 per cent so far in 2017.
Unilever
On the other side of the coin, one company that Savvides has decided not to invest in is Dove and Marmite owner Unilever, despite the manager accepting that there will be benefits from proposed reforms.
Earlier this year, the company was the recipient of a surprise bid from US peer Kraft Heinz, though this lasted less than a week as shareholders and management unanimously decided to undertake proposed restructuring to stave off future takeover attempts.
“Okay these changes were forced upon them rather than wanting to do them themselves but we should that to one side because they are now going to undertake them,” the manager said.
However, he noted that these are likely to be much more expensive than is currently being priced in, with the company aiming to generate around 500 basis points of margin from restructuring its manufacturing base.
“It is tough to restructure Unilever otherwise they would have done it historically. It is very difficult with labour laws and labour relations to undertake cheap restructuring so it might be expensive,” he noted.
The main reason he did not invest in the company though was the current valuation of the company, with shares near record highs, as the below shows.
Performance of stock over 5yrs
Source: FE Analytics
The company has been a beneficiary of the ‘hunt for yield’ in recent years, with investors placing a premium on its dividend payments, sending the share price up 126.27 per cent over the last five years.
The manager noted: “We were coming from a base where Unilever was near or at an all-time high in share price terms at the point in time the decided to undertake this restructuring.
“When I am buying these restructuring situations I want to buy them at low points in the company’s life cycle where there is scepticism and fear over the future revenue growth, cashflow margin and outlook for these companies.”
He explained: “To put it simply, I want companies on low PEs with value characteristics when they undertake their restructuring so I get a double benefit – I get the re-rating benefit and I get the re-structuring benefit through your earnings.
“That doesn’t minimise the amount of value they can create but it doesn’t maximise the returns you can create from that restructuring at that point in time.”
Pearson
Another company Savvides has looked at closely this year but decided to walk away from is FTSE 100-listed education company Pearson.
The former Financial Times owner has had a torrid time in recent years, as the below chart shows, losing 35.79 per cent over the last five years.
Performance of stock over 5yrs
Source: FE Analytics
“It has lots of the attractions that we typically look for – a change in strategy, lots of cost cutting, dealing with its issues but ultimately to us we think having had a look at it that the issues are too deep, they are too structural,” Savvides said.
However he added that the company is undertaking a number of good strategies in an effort to manage the balance sheet and get back on track.
“They are selling assets to bring cash into the group and they’re selling other assets that don’t make a high return on capital, so over the next three years I think returns on capital will begin to stabilise and improve a bit,” the manager noted.
“But then it is all about the headwinds in the core higher education sector in the North America where the shift from print to digital is accelerating and Pearson, whilst responding now, has been slow historically to respond,” he added.
Despite the share price drop, Savvides said that the valuation investors are being asked to pay for the turnaround at current levels, combined with the risks still in the core US business makes it a bit more of a challenged situation than he is willing to invest in.
“It’s one where the more we have understood about the situation the more we have felt nervous and we walked out,” he said.