Regular readers will know that we do not often trade. Activity results from changes in the gap between what we think a business is worth and what the market thinks it is worth. Our research is based on how much distributable cash flow a company can produce under a range of likely future scenarios. In this article, we cover two new purchases, two sales and one significant top-up of an existing position. The new purchases are Buzzi and the National Bank of Greece, the sales were of Danone and Handelsbanken and the top up is Philip Morris International (PMI).
We have spent considerable time looking at cement and aggregate businesses. The view we have formed is that there is a huge opportunity as legislation increases the pressure on them to reduce carbon dioxide emissions and increase circularity.
In Europe, some believe that the number of plants will decrease by between 30% and 50% as they are too old, too small or too remote to sufficiently decarbonise. With planning permission almost impossible for new builds, this is likely to lead to a much tighter market, which in return leads to less cyclicality, and higher prices.
We have owned Heidelberg Materials for some time. The shares have performed well but are still on a consensus FY1 P/E ratio of 8.8X*. We have now added another family-owned business in Buzzi, which is on consensus FY1 P/E of 8.6x*. Although listed in Italy, most of its profits come from the Americas. It has substantial net cash, is buying back shares and has some valuable, and potentially earnings enhancing, options to consolidate joint ventures in Brazil and Mexico. Fundamentals are improving, with demand increasing for new housing and infrastructure projects. We expect the changes to market dynamics to eventually be reflected in share valuations in the sector.
One of the main reasons we own banks has been their increased profitability as net interest margins (NIM) increased along with Central Banks increasing interest rates from close to zero. While base rates have probably now peaked, rate cuts have been delayed yet credit quality has remained good. Lending growth, however, has generally remained low. This has been especially acute in Sweden, where Handelsbanken, which remains one of the strongest banks in the world, has also faced funding pressure. With already competitive costs and the market reacting favourably to an announcement on distributing excess capital, there was less potential than for other banks.
Net interest income is a function of the NIM and lending volumes. We have searched for banks that have clear buffers above regulatory capital, a record of risk management and cost control, but are also able to grow lending volumes. This was behind our purchase of Banorte in Mexico last year. This year we came across National Bank of Greece (NBG).
It is a shame that despite filling the headlines more than a decade ago, there has been little to no international coverage of the remarkable turnaround that Greece as a country has achieved. NBG has rebuilt its balance sheet to have significant surplus capital (CET Tier 1 of 15.2% against a requirement of 10.5%) a leading digital offering, conservative provisioning and a firm control of costs. Like we found in Ireland with AIB, the banking sector has changed substantially. Most foreign players have withdrawn and the smaller banks have consolidated. NBG’s loan to deposit ratio is only 60% allowing for cheap funding. While lending growth is expected to remain subdued with Handelsbanken, it is accelerating in Greece as the economy recovers**.
When it comes to consumer staples, we haven’t seen much value in the sector for some time now. Over the last few years, we had only two holdings in this space – Danone and PMI. We bought Danone in March 2020 at the start of Covid lockdowns. The shares were trading on 1Y FWD PE of 12*x. Our thesis was based on a restructuring of the business, expansion into growth areas like plant based dairy and medical nutrition and multiple expansion. All this has played out. Danone is now trading on consensus 1Y FWD PE of 16.5x* after new management have substantially changed innovation, go to market and most importantly the culture of the business. In fact, Danone has seen one of the strongest re-ratings in the consumer staples space since the start of Covid. It was time for us to move on.
We did so by increasing our holding in PMI. We have held the shares since July 2018 when they traded on 1Y FWD PE of just 8x* after a 30% decline in the previous 12 months. Today, the rating has doubled to 16x*. So why are we selling Danone at 16.5x yet buying PMI at 16x? It comes down to the growth potential, cash generation and ROIC. With the acquisition of Swedish Match, PMI has established itself as the clear leader in smoke free tobacco and continues to gain market share. We see a good chance for high-single digit revenue growth, expanding margins and a growing dividend, along with the return of share buybacks. A starting yield of 5.3% and a growing dividend adds to a very attractive total shareholder return. We believe the share price fails to reflect this. PMI has a strong balance sheet, is highly cash generative, has invested heavily in R&D over the last 10 years and will be in a position to initiate a share buy back programme within the next 24 months. Although we are not fans of consumer staples we are impressed by the transformation of PMI and its prospects in a sub sector that is growing more strongly than the overall consumer staples industry. There’s always an exception to the rule.
*Source: Bloomberg
**Source: European Commission
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