One of the biggest challenges for investors is that we judge companies by their track records. However, the world is always changing, and a company’s value lies in its future success.
I see a common thread running through many of our holdings – they are in sectors in transition.
Amid rising interest in environmental, social and governance (ESG), there has been much focus in recent years on the need to transition to a low-carbon world. We hold National Grid and SSE, which will have a vital part to play in the development of electricity infrastructure.
An electric vehicle can use as much electricity as a house. If we all owned one and ran it down fully each day the pressure on the grid would be the same as doubling the number of homes in Britain – and there are 27 million of them!
Of course, we do not all drive a couple of hundred miles a day. But there are nearly 32 million cars in Britain, so it gives you an inkling of the scale of development that will be required in the coming years as we switch so much of our energy infrastructure from fossil fuels to renewables.
National Grid and SSE are two businesses with huge growth opportunities ahead of them. We also own BP, which has a crucial role to play if the UK government is to reach its target for decarbonisation. BP expects to invest over 40% of its capital expenditure on transition growth businesses by 2025.
Other sectors in transition
Transition may be at the heart of the energy industry, but it is apparent in a lot of other sectors, too. When investing in companies in transition it is important to look at the scale of the future opportunity, to look back to the record of management in introducing change so far and to monitor their progress against plans and promises diligently.
Transition can be expensive. That means we look for companies capable of generating strong profits and whose management has demonstrated the will to use resources smartly and borrow prudently.
One such business is clothing and homeware retailer Next. Like quite a few companies we hold, it has a long history of coping with transition – it began life as Hepworth, a men’s tailor, in 1864.
Next is in a treacherous sector where companies often implode and disappear – and with more regularity than ever in recent years as consumers have shifted their shopping online. It has remained strongly cash generative whilst undergoing its business transformation and has a healthy balance sheet. This year it expects to generate £220m of surplus cash. So why has it survived when other clothing retailers have struggled?
Next has a strong management team that consistently does two things very well: it keeps an eye on the future and allocates capital sensibly. Its genius was to recognise the need to move beyond store retail early on.
It bought mail order company Grattan in 1986 and launched the Next directory in 1988 and an online directory in 1999. It has built an effective online retail channel with efficient distribution and has now begun offering that infrastructure to other retailers, like Gap and Victoria’s Secret. The range of products available through its website today is remarkable.
As well as investing smartly, Next buys back shares – but only when it believes it can achieve an 8% equivalent rate of return on them. So it is always looking to benefit investors.
Bunzl is another company that has evolved considerably since its inception. It was founded in 1854 in Bratislava as a paper manufacturing business and floated on the UK stock exchange just over a century later, in 1957. Today it is a distribution and services company, operating in 31 countries.
You will have experienced Bunzl in action without even knowing it. It procures and distributes the everyday products needed for many businesses to function. If you own a coffee shop, for example, you probably want to source your coffee and consumables yourself.
But you may not want to spend hours sourcing the takeaway cups, lids, paper napkins and other products needed. Bunzl sources, packs and delivers these items for you, ensuring reliable delivery and a reasonable price.
One of the advantages of Bunzl’s scale is that it can audit the supply chain to ensure products comply with ethical and sustainability standards – something that is becoming increasingly important.
It has tapped into different industries around the globe while maintaining the local element of its service. The company grows through intelligent acquisition of other businesses, each of which might focus on a particular industry in a specific area. It has enormous scope for growth, leveraging off its logistics expertise and scale.
Transition to survive
Companies in certain industries are faced with a need to re-evaluate their purpose if they are to keep up with evolving consumer attitudes. British American Tobacco (BAT) was established in 1902, at a time when consumers were unaware of the health risks posed by smoking.
Though there is still a market for traditional cigarettes today, BAT is pulling its focus away from combustibles and developing scientifically substantiated, less risky alternatives with reduced health impacts. BAT expects to generate £5bn from its “new category” businesses by 2025. Meanwhile, it is on track to return £2bn to shareholders in 2022.
As investors, we think it pays to look at which direction the wind is blowing in each industry, how companies are working to ensure their relevance in the future and whether they have the wherewithal, the skill and the will to make the necessary transitions.
Ciaran Mallon is co-manager Invesco Select Trust UK equity portfolio. The views expressed above should not be taken as investment advice.