Top-down investing, which involves identifying growth markets of the future, can offer some sort of hedge compared with a bottom-up strategy – if the trend driving this growth is strong enough, you do not necessarily need to pick the winning business in the sector to generate a decent return.
However, Unicorn Asset Management’s Simon Moon pointed out the opposite is also true. The manager said he likes “good operators in sleepy industries”, adding there are many companies out there that deliver strong returns on invested capital “and are throwing off large amounts of cash”, yet are being overlooked by the market because they are in a sector that has fallen out of favour.
The manager of the Unicorn UK Income fund said this is why it is so important to take the time to visit companies.
“People think it’s just a tick in the box,” he explained “But meeting the management team is so important as a smaller company investor because it is so integral to the success or failure of that business. You know, even if the end market turns south over a brief period of time, or maybe for a slightly protracted period of time, a good management team will be able to be disruptive and grow market share. And that’s hugely important.”
Here Moon and co-manager Fraser Mackersie name three stocks they are backing even though they operate in sectors that the market perceives to be structurally challenged.
Card Factory
The high street has seen a growing number of casualties since the turn of the century, as consumers turn away from physical stores and make more purchases online.
However, Moon said Card Factory, which has about 850 high street stores, is bucking this trend.
“The difference with its business model is it is almost fully vertically integrated, so it designs, manufactures, distributes and sells cards, which gives it sector-leading margins of 20.5 per cent, which a lot of retailers frankly would be very envious of.
“And it’s one of the few retailers on the high street that has actually grown like-for-like sales [up 1.5 per cent in the six months to the end of July] – not exactly gangbusters. But you know it is certainly not feeling the pressure that a lot of them are.”
There had been concerns that the greetings card market would be disrupted by changing demographics, with people either ordering personalised cards online or using social media to wish people ‘happy birthday’, for example. However, Mackersie said this threat has been overstated.
“Personalised cards are still quite a small proportion of the market, it has plateaued. And while they are personalised, they are not personal,” he explained.
“People do still send cards, for all sorts of different occasions now. And we think we’re backing the best in the UK in that space.”
He admitted that the company has had a “torrid ride share-price wise” – the stock has almost halved in value over the past few years – but pointed out it is continuing to open about one store a week, targeting a total of 1,200, while there are also opportunities to increase its online offering and like for like sales.
Performance of stock since IPO
Source: FE Analytics
“It’s very cash-generative as a business, it’s got a good record of paying special dividends,” he added. “And in that market, we see it as the long-term winner.”
ITV
In an article published on FE Trustnet late last year, Temple Bar Investment Trust’s Alastair Mundy claimed there was an “embarrassment of riches” among the stocks being discarded by growth managers, but warned against investing in those stuck in structural decline, pointing to ITV as an example.
“I gave a presentation to a bunch of sixth formers earlier in the year and I just happened to mention ITV,” said Mundy, “and they looked at me as if I’d been in prison for 25 years. ‘What is this ITV of which he talks?’”
However, Moon said there is so much more to this business than what the viewer sees on television at home.
“With our small-cap hats on, we think the market’s undervaluing that as well,” he explained.
“It is taking too much of a dim view of net advertising revenue, which is in a tough environment and is under pressure.
“But we think it has got this huge content provision and production side which really isn’t given enough value by the market in our opinion. And in fact we think that the market has changed around it as well.”
While many analysts point to the threat to terrestrial television channels from the likes of Netflix, Now TV and Amazon Prime, Moon said that what all of these streaming providers need is content, which they are willing to pay for. He pointed to the estimated $500m Netflix paid for the rights to show Seinfeld over five years.
“I’m not saying it’s got a Seinfeld in its back pocket, but it has got many good TV shows and it also has a very good studio function as well that’s producing them,” he added.
Mackersie also pointed out that ITV and the BBC’s online streaming service, Britbox, already has 650,000 subscribers in North America. It will launch in the UK later this year.
“It has a huge back catalogue of quality content, it is producing, creating and investing in content every year, as is the BBC, and together they are signing up other third-party suppliers,” he said.
“Time will tell on that one, but I think it is the sensible thing to do.”
Data from FE Analytics shows ITV has made 288.06 per cent over the past decade, but is down more than 40 per cent from its 2015 peak.
Performance of stock over 10yrs
Source: FE Analytics
Cineworld
Another sector that is perceived to be under threat from online streaming is cinema. However, the managers said that the number of tickets sold at the box office in the US has remained more or less steady over the past 40 years, while takings have steadily increased.
Source: Unicorn
They added that the reason they own Cineworld goes back to their enthusiasm for “good operators in sleepy industries”.
“Exhibitors cannot control the film quality, but they can control the experience of going to see the film,” said Moon. “And Cineworld puts a lot of emphasis on that. It was one of the first in the UK to invest fully in fully digitised projectors."
Mackersie added: “Cineworld wants to be the best place to watch a movie, and I think that sums it up. It’s just got some sensible things around the edges. It launched an unlimited card in the UK, which has been very successful.”
Aside from box-office takings, which set a new record last year, Cineworld also enjoys healthy margins on food sales, which make up about a third of revenues.
“It’s a pretty good side of the business and I think people just accept that when they go to the cinema,” Moon added. “They know they’re probably paying over the odds, but they like to do it.”
He finished by highlighting the progress of Cineworld since it was added to the portfolio, saying: “It is important to point out this wasn’t even the second biggest cinema chain in the UK when we first invested in it almost 10 years ago. It’s now the second biggest in the world after two large acquisitions.”
Cineworld has made 389.12 per cent since its IPO in April 2007.