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Nikko AM Global Share Fund: Solid Strategy, Experienced Team and Remarkable Process

Approach

The investment process is based around searching for stocks that have “future quality.” To achieve the investment objective, the analyst’s undertakes bottom-up fundamental research seeking quality of franchise (competitive advantages), quality of balance sheet (low debt), quality of management (strong stewardship), and quality of future valuation (sustainable but growing cash flow). The first step is developing stock ideas; the analyst’s makes use of third-party research, personal insights, company meetings, site visits, conferences, and input from other Nikko AM investment teams. Ultimately, the investment universe is restricted to companies with market caps above USD 1 billion and daily traded liquidity of more than USD 10 million. The next step is thorough fundamental bottom-up research on the firm’s business model, management and balance sheet. Detailed financial models, based on long-term cash flow forecasting, are built to establish a future quality valuation. The individual portfolio managers summarise the company research in a standard template and present stock ideas formally at a weekly meeting, where open critique is undertaken by the analysts. The investment philosophy is high-conviction, with the analysts adopting a largely index-agnostic strategy, which slightly favours growth and results in an active share of 90%-95%. Ultimately, stock selection plays a key role in the process.

Portfolio

The portfolio construction methodology is disciplined and repeatable, using a proprietary ranking tool to grade stocks in terms of expected alpha and risk. The resulting portfolio contains the analyst’s highest conviction 40-50 stock ideas. The investment process typically leads the team to construct a portfolio with a higher weighting in defensive sectors, including healthcare and consumer staples, and typically a lower weighting in cyclicals, namely, consumer discretionary and financials. However, these allocations depend on stock opportunities and economic conditions. At 31 Oct 2021, the portfolio had an active underweighting in defensive sectors, with healthcare heavily favoured and an active overweighting in cyclical sectors, with industrials and consumer discretionary stocks favoured. Regional allocation typically tends to be similar to the index. However, at 31 Oct 2021, the portfolio was only overweight in two regions: the United States and Hong Kong/Singapore. A comprehensive risk-management process is implemented to ensure no unintended sector, geographic, or commodity risk is included in the portfolio. The portfolio is also monitored from an environmental, social, and governance risk perspective. Risk-management guidelines include that no more than 10% of net assets may be invested in any one stock.

People

The investment team includes five highly experienced portfolio managers (William Low, James Kinghorn, Iain Fulton, Greig Bryson, and Johnny Russell) who operate as global generalists but with sector-specific responsibilities. In addition, two portfolio analysts, who mainly undertake thematic or project research joined the team in 2019. Low leads the team; he joined Nikko AM in mid-2014 as a portfolio manager with overall responsibility for the global-equity team (the team moved across from Scottish Widows Investment Partnership where they previous managed global equity strategies together). He has more than 30 years’ experience in the investment/finance industry, previously working for BlackRock and Dunedin Fund Managers as a portfolio manager and investment manager. Kinghorn and the other team members joined Nikko AM in mid-2014; Kinghorn had been at SWIP since 2011. Fulton joined after previously working at SWIP as head of research since 2005. Bryson joined after working at SWIP since 2007. Russell joined Nikko AM after working at SWIP since 2002. The team has access to the extensive global resources of Nikko AM, which boasts more than 100 portfolio managers and 50 analysts.

Performance 

In mid-2015, the existing Nikko AM global-equity fund was restructured from a multimanager approach to its current structure of direct investment in stocks in the MSCI ACWI, under the guidance of the incumbent five portfolio managers. This team arrived at Nikko AM in 2014, having previously worked at Scottish Widows Investment Partnership. Since the strategy and personnel changes, this fund has outperformed its Morningstar Category index (MSCI World Ex Australia NR Index) and most peers in the five years to 30 Nov 2021, on a trailing returns basis. Individual calendar-year results have been strong from 2015 through 2020, with standout 2018 and 2020 years, and 2016 the lone blot against the team. In 2017, outperformance was relatively slender, 

and positive contributors included Sony and Tencent. The strategy had a stronger 2018 with positive attribution from LivaNova. Returns were again solid against the index and peers during 2019, with Chinese sporting goods company Li Ning Company and US software giant Microsoft among the top contributors. Both the index and peers were thumped in 2020 by the team, which managed a softer drawdown during the first-quarter correction and adding alpha each of the remaining quarters. In the 11 months to 30 Nov 2021, the strategy have struggled, as style headwinds had an impact on performance, despite solid attribution from SVB Financial Group and Bio-Techne Corporation.

About Fund:

Nikko AM Global Share is a strategy with sturdy foundations, thanks to its highly experienced team of portfolio managers and well-structured investment process. The Edinburgh-based investment team functions in a very cooperative, transparent, and mutually respectful manner, adopting a flat operating structure, with individual portfolio managers having specific sector responsibility on a global basis. The resulting portfolio of typically around 40-50 stocks is slightly growth-orientated and high conviction, with around 35% of FUM in the top 10 stocks. The strategy benchmarks to the MSCI All Country World Index, giving it rein to venture into emerging markets, but this allocation is rarely more than 10% of assets.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Funds Funds

AMP Capital Corporate Bond Fund Outdoing the Bloomberg AusBond Bank Bill Index and The Average Credit Fund

Process:

AMP Capital Corporate Bond provides exposure to a wide range of credit securities within Australian, global, investment-grade, corporate bond, and high yield. The benchmark changed from the Bloomberg AusBond Credit 0+Yr Index to the Bloomberg AusBond Bank Bill Index in February 2016, reflecting the fund’s capital preservation and income emphasis since 2012. Monthly distributions are announced and reviewed biannually, which helps income-focused investors manage their expectations. Credit analysis is done on two accounts; first, a quantitative and qualitative assessment of the broader industry sector, and second, issuerand security-specific analysis. 

The analysis is conducted in line with a “score card” methodology that incorporates fundamentals, technicals, and valuations. The primary weighting is to the valuation and fundamental factors as the team believes this is the primary determinant of a positive outcome for investors over the longer term. The duration view is led by the macro team and is established through a similar score card system, which again considers fundamental, sentiment, and technical factors, with the analyst view of valuation playing a key part. The credit strategy panel, comprising senior investment staff, set the overall credit strategy, risk budget, and sector allocations. However, the ultimate duration and credit exposures are determined by comanagers Sonia Baillie and Nathan Boon.

Portfolio:

The vehicle chiefly comprises Australian credit, though it does hold around 5% each in US and UK names. The strategy can hold up to 10% in high yield and 15% in unrated bonds but is usually well below these limits. The portfolio is largely BBB and A rated corporate bonds, with the BBB names providing a slightly larger proportion of the fund’s asset value at nearly 44% to October 2021. Following the coronavirus-driven dislocation, the team took opportunistic exposures in long duration REITs and industrials, some of which have seen partial profit taking with significant spread tightening throughout 2021. 2019 saw the fund rotate back into corporate bonds following the late-2018 sell-off. 

The team believes credit fundamentals are improving and technicals supportive, but valuations indicate little expectation of further spread compression. It wants to maintain income by holding credit, albeit at a reducing amount to late-2021, also using credit derivatives to insulate from wider spreads. The fund’s duration limits were adjusted from plus or minus 1.5 years versus the old credit benchmark, to absolute terms of zero to 4.5 years in October 2014. The fund has been positioned within a duration range of 0.2-0.8 years since the start of 2017 (0.6 years in October 2021), meaning the sensitivity to rising interest rates is low. FUM has steadily declined over the past few years and currently sits at AUD 855 million as of October 2021.

People:

Sonia Baillie (head of credit) has led this portfolio since October 2017, joined by Nathan Boon (head of credit portfolio management) in March 2018. This group, however, is currently transitioning into the Macquarie fixed-income team as part of AMP Capital’s sale to that organisation; completion is expected by mid-2022, creating some uncertainty. The duo gets significant input from head of macro Ilan Dekell, and a team of analysts spread between Sydney and Chicago. Head of credit research Steven Hur was previously a key member until he left the group in December 2021. The fixed-income team is headed by Grant Hassell, who has more than 30 years of experience, though he is the sole member of this quartet not joining the Macquarie investment team in the same capacity. 

Hassell contributes to overall discussions through team meetings and investment committees, acting as the sounding board for the various heads to bring ideas together into a portfolio. While there has been staff turnover among the credit analyst and credit portfolio managers–former managers Jeff Brunton and David Carruthers left in 2014 and 2016, respectively–most key staffers have long tenure. For example, while Baillie was appointed portfolio manager only in 2017, she has been with the team since 2010, has held other senior roles, and worked in the firm’s Asian fixed-income business. Furthermore, AMP Capital has taken steps to improve staff incentives and address staff turnover.

Performance:

Over the long run, this fund has outdone the Bloomberg AusBond Bank Bill Index and the average credit fund. That’s not necessarily compelling, given the fund has been running substantially more credit and/or duration risk than those yardsticks. Since AMP Capital slashed the fund’s duration, rival credit funds are a more reasonable benchmark looking ahead; the fund’s historically high duration means we also compare the fund’s history against the Bloomberg AusBond Credit Index, where this strategy has underperformed. The fund’s track record has benefited from higher-than-average credit risk, as well as significant interest-rate risk, that has paid off as rates declined to historically low levels. returns, yet three- and five-year returns fail to beat the average category peer. Given declining global interest rates, the fund reduced its distribution in mid-2017 to 0.275% per month, and then 0.25% per month at the beginning of 2018. This continued through 2021 when distributions dropped to 0.175% by year-end, the shop expects it to remain at these compressed levels, barring unforeseen circumstances. The rate peaked at 0.55% per month in 2012, highlighting that while these distribution indications can be helpful in the short run, they should not be relied on for long-term income expectations.

About Funds:

Though a new home will bring positives to AMP Capital Corporate Bond, it also introduces uncertainties for this diversified credit strategy. AMP Capital’s Global Equities and Fixed Interest business is in the midst of a sale to Macquarie Asset Management, which is expected to complete by mid-2022. Head of global fixed income Grant Hassell is leading the integration. The strategy has benchmarked to the Bloomberg Ausbond Bank Bill Index since early-2016, reflecting the income goals with capital stability. This move followed a history of changes, which under Macquarie’s guidance going forward could see further revisions in approach.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Funds Funds Research Sectors

AMP Capital Corporate Bond Fund Outdoing the Bloomberg AusBond Bank Bill Index and The Average Credit Fund

Process:

AMP Capital Corporate Bond provides exposure to a wide range of credit securities within Australian, global, investment-grade, corporate bond, and high yield. The benchmark changed from the Bloomberg AusBond Credit 0+Yr Index to the Bloomberg AusBond Bank Bill Index in February 2016, reflecting the fund’s capital preservation and income emphasis since 2012. Monthly distributions are announced and reviewed biannually, which helps income-focused investors manage their expectations. Credit analysis is done on two accounts; first, a quantitative and qualitative assessment of the broader industry sector, and second, issuerand security-specific analysis. 

The analysis is conducted in line with a “score card” methodology that incorporates fundamentals, technicals, and valuations. The primary weighting is to the valuation and fundamental factors as the team believes this is the primary determinant of a positive outcome for investors over the longer term. The duration view is led by the macro team and is established through a similar score card system, which again considers fundamental, sentiment, and technical factors, with the analyst view of valuation playing a key part. The credit strategy panel, comprising senior investment staff, set the overall credit strategy, risk budget, and sector allocations. However, the ultimate duration and credit exposures are determined by comanagers Sonia Baillie and Nathan Boon.

Portfolio:

The vehicle chiefly comprises Australian credit, though it does hold around 5% each in US and UK names. The strategy can hold up to 10% in high yield and 15% in unrated bonds but is usually well below these limits. The portfolio is largely BBB and A rated corporate bonds, with the BBB names providing a slightly larger proportion of the fund’s asset value at nearly 44% to October 2021. Following the coronavirus-driven dislocation, the team took opportunistic exposures in long duration REITs and industrials, some of which have seen partial profit taking with significant spread tightening throughout 2021. 2019 saw the fund rotate back into corporate bonds following the late-2018 sell-off. 

The team believes credit fundamentals are improving and technicals supportive, but valuations indicate little expectation of further spread compression. It wants to maintain income by holding credit, albeit at a reducing amount to late-2021, also using credit derivatives to insulate from wider spreads. The fund’s duration limits were adjusted from plus or minus 1.5 years versus the old credit benchmark, to absolute terms of zero to 4.5 years in October 2014. The fund has been positioned within a duration range of 0.2-0.8 years since the start of 2017 (0.6 years in October 2021), meaning the sensitivity to rising interest rates is low. FUM has steadily declined over the past few years and currently sits at AUD 855 million as of October 2021.

People:

Sonia Baillie (head of credit) has led this portfolio since October 2017, joined by Nathan Boon (head of credit portfolio management) in March 2018. This group, however, is currently transitioning into the Macquarie fixed-income team as part of AMP Capital’s sale to that organisation; completion is expected by mid-2022, creating some uncertainty. The duo gets significant input from head of macro Ilan Dekell, and a team of analysts spread between Sydney and Chicago. Head of credit research Steven Hur was previously a key member until he left the group in December 2021. The fixed-income team is headed by Grant Hassell, who has more than 30 years of experience, though he is the sole member of this quartet not joining the Macquarie investment team in the same capacity. 

Hassell contributes to overall discussions through team meetings and investment committees, acting as the sounding board for the various heads to bring ideas together into a portfolio. While there has been staff turnover among the credit analyst and credit portfolio managers–former managers Jeff Brunton and David Carruthers left in 2014 and 2016, respectively–most key staffers have long tenure. For example, while Baillie was appointed portfolio manager only in 2017, she has been with the team since 2010, has held other senior roles, and worked in the firm’s Asian fixed-income business. Furthermore, AMP Capital has taken steps to improve staff incentives and address staff turnover.

Performance:

Over the long run, this fund has outdone the Bloomberg AusBond Bank Bill Index and the average credit fund. That’s not necessarily compelling, given the fund has been running substantially more credit and/or duration risk than those yardsticks. Since AMP Capital slashed the fund’s duration, rival credit funds are a more reasonable benchmark looking ahead; the fund’s historically high duration means we also compare the fund’s history against the Bloomberg AusBond Credit Index, where this strategy has underperformed. The fund’s track record has benefited from higher-than-average credit risk, as well as significant interest-rate risk, that has paid off as rates declined to historically low levels. returns, yet three- and five-year returns fail to beat the average category peer. Given declining global interest rates, the fund reduced its distribution in mid-2017 to 0.275% per month, and then 0.25% per month at the beginning of 2018. This continued through 2021 when distributions dropped to 0.175% by year-end, the shop expects it to remain at these compressed levels, barring unforeseen circumstances. The rate peaked at 0.55% per month in 2012, highlighting that while these distribution indications can be helpful in the short run, they should not be relied on for long-term income expectations.

About Funds:

Though a new home will bring positives to AMP Capital Corporate Bond, it also introduces uncertainties for this diversified credit strategy. AMP Capital’s Global Equities and Fixed Interest business is in the midst of a sale to Macquarie Asset Management, which is expected to complete by mid-2022. Head of global fixed income Grant Hassell is leading the integration. The strategy has benchmarked to the Bloomberg Ausbond Bank Bill Index since early-2016, reflecting the income goals with capital stability. This move followed a history of changes, which under Macquarie’s guidance going forward could see further revisions in approach.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Funds Funds

BlackRock Advantage International Fund K: Fund which aims to outperform the MSCI EAFE Index

BlackRock Advantage International Fund K seeks long-term capital appreciation, with a focus on risk management.Powered by innovation and technology driven investment process having exposures to international portfolio at a low cost.

Approach

The strategy aims to outperform the MSCI EAFE Index by combining bottom-up and top-down factors into a stock-selection model that uses roughly 40-60 signals that fall into three broad buckets: fundamentals, sentiment, and macro themes. Fundamental signals include factors such as management quality, valuation, and profitability; sentiment signals include analyst-, investor-, and broker-sentiment indicators; and macro signals include factors specific to industries, countries, and investment styles. The model weights the signals roughly evenly between the three buckets.

The team keeps a tight lid on the 375- to 715-stock portfolio’s tracking error (the volatility of its relative performance) by keeping its sector and industry weights within 4 percentage points of the index’s, generally. It mitigates stock-specific risk by typically keeping individual positions within 1-1.5 percentage points of the benchmark’s.

The systematic approach has a short time horizon of six to 12 months, which can lead to portfolio churn and higher trading costs. The strategy’s annual portfolio turnover has ranged from 106% to 247% during the past four years, much higher than the average foreign large-blend category peer’s 43%-51%.

Portfolio

In contrast to other foreign large-blend funds, the managers here allocate the strategy’s assets across positions that stick, deviated most at around 0.9 percentage points larger than the index’s share, as of November 2021. While the portfolio mostly invests in benchmark constituents, 5%-15% of assets are in stocks unique to the portfolio. Indeed, close to the MSCI EAFE Index’s weights. Its 1.1% stake in the world’s third-largest tobacco company, Japan Tobacco 10.1% of assets were invested across roughly 150 offbenchmark stocks such as Rexel SA RXL, Rightmove PLC RMV, and Électricité de France EDF.

The strategy typically has a bit more exposure to mid-cap stocks than does the index. As of November, the portfolio’s allocation to mid-caps stood at 15% versus the index’s 10%. As a result, the portfolio’s $41 billion average market cap was slightly below the index’s $47 billion.

Performance

The fund has earned mixed results since BlackRock’s Systematic Active Equity team took over in mid-2017. From July 1, 2017, through Dec. 31, 2021, the Institutional shares posted a 7.3% annualized return, which beat the foreign large-blend category’s 7.1% but trailed the MSCI EAFE Index’s 7.5%. Its risk-adjusted results don’t look much better. 

The fund has fared worse than the index during severe market drawdowns but has outperformed the benchmark during prolonged rallies. The strategy’s calendar 2021 results were solid: The fund’s 13.0% gain beat the average peer’s 9.8% return as well as the index’s 11.3%. The portfolio benefited from good stock selections in the financial services and industrials sectors, namely Nordea Bank and Recruit Holdings, respectively.

Top 10 Holdings

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About the fund

BlackRock Advantage International’s experienced and well-resourced research team plies a suitable quantitative approach and earns the strategy’s share classes Morningstar Analyst Ratings of Bronze or Neutral, depending on fees.

The team’s quant-driven approach has a lot of moving parts. It analyzes 40-60 signals that fall into three broad buckets–fundamentals, sentiment, and macro themes–that collectively consider both bottom-up and top-down factors. The strategy aims to outperform the MSCI EAFE Index by combining bottom-up and top-down factors into a stock-selection model that uses roughly 40-60 signals that fall into three broad buckets: fundamentals, sentiment, and macro themes. Fundamental signals include factors such as management quality, valuation, and profitability; sentiment signals include analyst-, investor-, and broker-sentiment indicators; and macro signals include factors specific to industries, countries, and investment styles. The model weights the signals roughly evenly between the three buckets. The team keeps a tight lid on the 375- to 715-stock portfolio’s tracking error (the volatility of its relative performance) by keeping its sector and industry weights within 4 percentage points of the index’s, generally. It mitigates stock-specific risk by typically keeping individual positions within 1-1.5 percentage points of the benchmark’s.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Funds Funds

Robeco QI Global Conservative Equities I: A strong option for investors looking for downside protection

Process:

The strategy’s robust foundation, high repeatability, discipline, and consistent execution remain attractive features. The team’s relentless efforts to implement new elements to the process, these also make the approach more complex and have led to a slight change of portfolio characteristics, which is appreciated. This rules-based, quantitative process is built on extensive academic research demonstrating that investing in low-risk stocks leads to better risk-adjusted returns. After an initial liquidity filter, Robeco’s quant model ranks the 4,500-stock universe on a multidimensional risk factor (volatility, beta, and distress metrics), combined with value, quality, sentiment and momentum factors. In recent years, the team has introduced several enhancements to refine the model, including short-term momentum-driven signals that can adjust a stock’s ranking up or down by maximum 10 percentage points. This should prioritize buy decisions for stocks that rank high in the model and score well on short term signals, and vice versa. Since 2020 the team also allows liquid mega-caps to have a higher weight in the portfolio. Top-quintile stocks are typically included in an optimisation algorithm that considers liquidity, market cap, and 10-percentage-point country and sector limits relative to the MSCI World Index. A 200-300 stock portfolio is constructed with better ESG and carbon footprints than the index, while rebalancing takes place monthly, generating modest annual turnover of about 25%. Stocks are sold when ranking in the bottom 40% of the model. 

Portfolio:

The defensive nature of the strategy currently translates into a higher allocation to low-beta and high yielding stocks in the consumer staples and communication services sectors, while industrials, energy and technology stocks are a large underweight. The valuation factors embedded in the model have steered the fund clear from MSCI ACWI index heavyweights Amazon.com AMZN, Tesla TSLA, and NVIDIA NVDA, while Microsoft MSFT and Apple AAPL were underweighted. Valuations make the fund lean towards European stocks while the U.S. stock market was an 8.8% underweight versus the index per November 2021. The model does like U.S. consumer defensives though, with larger positions for Proctor & Gamble PG, Walmart WMT, and Target TGT. The quant approach gives management wide latitude to invest across the market-cap spectrum, and the diversified 200- to 300-stock portfolio has long exhibited a small/mid-cap bias compared with the index.

People:

The team running this strategy is large, experienced, and stable. As such, it earns an Above Average People rating. This fund follows an entirely quant-based approach, an area where Robeco has extensive experience and expertise, and where it has invested heavily in human resources over the years. Robeco’s quant team runs various strategies: core quant equity, factor investing, and conservative equity, but there is significant interaction between them. The conservative equity team that runs this fund is led by Pim van Vliet, whose academic work has laid the foundation of the fund’s philosophy.

Performance:

This defensive strategy has generally offered good volatility reduction during turbulent markets. Robeco QI Global Conservative Equities’ C € share class absorbed 67% of the losses of the MSCI ACWI Index since inception. However, its results versus the MSCI ACWI Minimum Volatility Index have been less consistent. Disappointingly, it did not live up to its expectations in the corona-dominated markets of 2020, though the strategy’s failure can be explained by market dynamics in relation to the fund’s strategy. The portfolio lagged during the subsequent recovery that again benefited tech and ecommerce stocks, and while the value rally in the final quarter did help, cyclical value stocks that are not favoured here rallied the most.

(Source: Morningstar)

Price:

Analysts find it difficult to analyse expenses since it comes directly from the returns. Analysts expect that it would be able to deliver positive alpha relative to its category benchmark index.


(Source: Morningstar)                                                                       (Source: Morningstar)

About Funds:

Robeco’s quant-based conservative equities range is managed by a stable and experienced six-member team led by Pim van Vliet. They are supported by a group of 10 quantitative researchers led by David Blitz and a similarly sized group of data scientists. This credentialed team is vital to the fund’s success as it constantly refines the models used in the funds. It is also reassuring that Robeco’s broader quantitative team has successfully groomed quantitative researchers in its talent pool, allowing them to add people with complementary skills to the teams. The strategy’s academic foundation, repeatability, discipline, and consistent execution give us confidence. The rules-based, quantitative process is built on empirical research demonstrating that investing in low-risk stocks leads to better risk-adjusted returns. It goes beyond traditional low-volatility investing, combining a multidimensional risk factor with value, quality, sentiment, and momentum factors. Top-quintile-ranked stocks are included in the portfolio after running an optimisation algorithm.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

New Oriental Education: Restructuring Impact Remains Unclear

Business Strategy and Outlook:

New Oriental Education, or EDU, is a large-scale leading provider of private tutoring in China. EDU offers a diversified portfolio of educational programs, services, and products to students in different areas. Not only does EDU offer K-12 after-school tutoring, but EDU also offers other test preparations for both overseas and domestic examinations. In non-academic fields, EDU offers adult English and other languages, and it also provides services in vocational training, such as corporate training, marketing, accounting, human resources, IT and PRC Bar. EDU has been able to raise its fees via new students or new programs to cover rising costs, driving an improving margin as utilization and operational efficiency continues to improve.

A key tenant of EDU’s strategy is to improve operational efficiency in the near term. EDU is guiding 20%-25% year-over-year growth per year for its learning center capacity for the next three years and we believe that offline classes should gradually open as the impact of the coronavirus gradually fades. Also, EDU will continue to close down underperforming centers, which also implies improving operating efficiency. EDU is aiming to raise its student retention rate to 65% from 63% in fiscal 2021.

Financial Strength:

The company’s financial status has been healthy over the past years, with a clean balance sheet and steady cash inflows. EDU has been generating net cash since 2011 with steady cash flow. However, uncertainty is expected to be ahead before the end of 2021, when businesses are required to restructure–with the estimation of 62% of their business being required to be spun off.

Bulls Say:

  • Well-established reputation and dominant position in China. 
  • Successful expansion with strong student enrolment in China should drive growth. 
  • Likely to benefits in the longer term as one of the first movers in online education known as Koolearn.com.

Company Profile:

EDU, founded in 1993, is the largest well-established one-stop shopping private educational services provider in China. EDU has had over 52.8 million student enrollments, including about 8.4 million enrollments in fiscal 2019. As of third-quarter fiscal 2020, EDU had a network of 1,416 learning centers, including 99 schools, 12 bookstores and access to a national network of online and offline bookstores through 160 third-party distributors and over 38,400 highly qualified teachers in 86 cities. EDU offers a diversified portfolio of educational programs, services and products to students in different age groups, including K-12 after-school tutoring for major academic subjects, overseas and domestic test preparations, nonacademic languages and services in vocational training, and so on.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

Robust balance sheet and ample liquidity support Pilgrim’s Pride Corp endure market volatility

Business Strategy and Outlook

Although Pilgrim’s Pride is the second-largest poultry producer in the countries in which it operates, we don’t believe it has carved out an edge. About 70% of Pilgrim’s products are undifferentiated and therefore have difficulty commanding price premiums and higher returns. Further, its profit margins can be quite volatile, as several factors outside the firm’s control affect costs (weather, flock disease, global trade). Prices of feed ingredients can be quite volatile, surging in 2008 and leading to Pilgrim’s bankruptcy. Since then, the industry has moved to new pricing strategies, which are helping protect the processors from revenue/cost mismatches. However, despite Pilgrim’s size, we don’t believe this affords it a scale cost advantage, underpinning our no-moat rating. 

In August, JBS, which owns 80% of Pilgrim’s, proposed to buy the remaining 20% for $26.50 per share. The board is reviewing the deal, and if approved, it will be put to a shareholder vote (excluding JBS). The offer appears light, at a 20% discount to our $34 fair value estimate and at 6.5 times adjusted EBITDA, compared with the 9.1 times for which Sanderson Farms was acquired one week prior to the offer. 

As 50% of Pilgrim’s sales stem from food service, the pandemic impaired sales and margins in 2020; organic sales were down 2.4%, and adjusted operating margins fell 240 basis points to 3.7%. But trends are recovering as vaccines become more widely available, and we expect no lasting effects. We are optimistic on the long-term global demand for chicken, as developed market consumers have been shifting consumption of red meat toward poultry, and in emerging markets, a growing middle class is driving higher per capita consumption of protein. Pilgrim’s should benefit from strong demand in China, as the country eliminated its ban on U.S. chicken in late 2019. Further, China has a shortage of protein after a 2019 outbreak of African swine fever resulted in a 40% reduction in the country’s hog population. The disease is still not fully contained, so this supply shortage should support global protein prices once the pandemic subsides and should result in strong export demand.

Financial Strength

Pilgrim’s strong balance sheet (net debt/adjusted EBITDA at a very manageable 2.2 times as of September 2021) and sufficient liquidity ($1.5 billion cash on hand and available cash through its credit facilities) should help the firm withstand market volatility. Pilgrim’s has no debt maturities until 2023, does not pay a dividend, and has sufficient liquidity and debt capacity to fund $400 million in annual capital expenditures. Even beyond the pandemic, the business is inherently cyclical with many factors outside management’s control, but we applaud changes that have improved the predictability of earnings. Chicken pricing contracts now link costs and prices. In addition, Pilgrim’s now maintains diversified exposure to fresh chicken across large, tray pack, and small bird segments, which helps stabilize margins. The firm also maintains geographical diversification, with 62% of 2020 revenue from the U.S., 27% from Europe, and 11% from Mexico. The firm has stated its optimal net debt/adjusted EBITDA range is 2-3 times, which we think is manageable, but we wouldn’t want it to move above that range on a sustained basis, given the unpredictable nature of profits despite improvements. We think it’s likely that over the next few years Pilgrim’s will make acquisitions that we have not modelled, we don’t think leverage will exceed its 2-3 times target over an extended horizon. However, given the unpredictable size, timing, and characteristics, we have opted instead to model excess cash flow being allocated to special dividends beginning in 2026, as the company prefers this approach instead of regular dividends and share repurchases are constrained by limited float. We model dividends beginning at $2.17 per share in 2026 and gradually increasing to $2.86 per share throughout our explicit forecast.

Bulls Say’s

  • The global protein shortage resulting from China’s African swine fever outbreak should support global protein prices, which should stabilize and enhance Pilgrim’s profit margins. 
  • Pilgrim’s has an opportunity to unlock value through structurally boosting the profits of its European operations by applying best practices from the U.S. and Mexico and using its key customer strategy to change the producer/customer dynamic. 
  • In November 2019, China eliminated its ban on imports of U.S. poultry, which should help boost Pilgrim’s exports.

Company Profile 

Pilgrim’s Pride is the second-largest poultry producer in the U.S. (62% of 2020 sales), Europe (27%), and Mexico (11%). The 2019 purchase of Tulip, the U.K.’s largest hog producer, marks the firm’s entrance into the pork market, which represented 11% of 2020 sales. Pilgrim’s sells its protein to chain restaurants, food processors, and retail chains under brand names Pilgrim’s, Country Pride, Gold’n Plump, and Just Bare. Channel exposure is split evenly between retail and food service, with most of the food-service revenue coming from quick-service restaurants. JBS owns 80% of Pilgrim’s outstanding shares.

(Source: MorningStar)

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Key Catalyst For Trip.com: International Business A Hand In Recovery

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Business Strategy and Outlook

Narrow-moat Trip.com competes in China’s crowded online travel agent (OTA) industry by leveraging the largest selection of both domestic and international hotels in China on its platform and relying on user stickiness as a one-stop shop for travel ticketing, accommodations, and packaged tours. The platform is now also generating revenue from advertisement in which it hopes to take 3-5% of the ad market, but nearly all its revenue streams are travel-related, and COVID-19 lockdowns in China has cratered demand due to the inability to travel or unwillingness to quarantine. 

It is anticipated 2022 to be another challenging year for the travel industry as it is valued Trip.com’s revenue to recover to only 65% of 2019 levels. The company believes it can reach long-term non-GAAP operating margins of 20-30% on the back of its international, outbound, and high-star hotel businesses given their higher monetization rates, but the lack of demand has impacted these businesses, and total international revenue has declined to less than 5% of the mix and caused operating margin to be negative. Prior to the pandemic in 2019, international revenue was 25% of the mix and non-GAAP operating margins were 19%. It is alleged that reaching its long-term margin will rely heavily on the recovery, but the pandemic has been a significant headwind and has delayed its progress. It is supposed that outbound international travel should eventually recover but visibility is still limited, and further COVID-related setbacks could add to the uncertainty and possibility that the company could fall short of its long-term outlook. 

The other key business that will drive margins is its high-star domestic hotels which generates the highest take-rate on its platform at 9-10%. Trip.com charges low rates for its budget hotels to attract new users and directs them to its high-star hotels for future bookings as its traffic acquisition strategy, where it hopes to retain users through its wide selection of hotel, ticketing, and packaged tour options. Currently, this business has already recovered to 62% of 2019 levels, and thus it is alleged that the imminent key catalyst for Trip.com will be its international business.

Financial Strength

Trip.com operates as an asset-lite company and tends to not commit heavy resources to capital expenditures other than acquisitions for its operations. As of third-quarter 2021, net debt was almost 0 as Trip.com had nearly identical CNY 57.414 billion of debt against CNY 57.411 of cash and investments. Short-term liquidity is also safe with a quick ratio of over 1 time which should reflect some margin of safety and is representative of Trip.com’s financial strength. Trip.com has CNY 45 billion of short-term debt due, and should COVID-19 headwinds continue, it is seen the company issue debt in order to cover short-term expenses to navigate through COVID-19 but given history of low net debt and 15%-20% EBITDA margin, it is not expected to be an issue. The online travel business is not capital-intensive and has historically generated positive free cash flows. The exceptions to Trip.com was mostly due to acquisitions and capitalized operating expenses. In 2014, negative free cash flow for Trip.com was mainly due to its large investment in fixed assets of CNY 4.8 billion, mostly due to its new office building of CNY 3 billion. In 2016, negative free cash flow was mainly due to the merger with Qunar, and Trip.com returned to free cash flow positive from 2017 to 2019. It is projected cash flow to be negative in 2021 due to COVID-19 but should be positive in 2022 even as revenue recover to only 65% of 2019 levels as given in our base-case scenario.

 Bulls Say’s

  • The company can eventually reach its 20%-30% long-term operating margin target as COVID-19 subsides.
  • International and outbound business will eventually recover and drive margins upwards. Margin expansion will be dictated by its higher-margin businesses, including international air and hotels. 
  • The industry will see less competition in the future than before due to current headwinds faced, and thus lesser disruptions to its long-term business plan.

Company Profile 

Trip.com is the largest online travel agent in China and is positioned to benefit from the country’s rising demand for higher-margin outbound travel as passport penetration is only 12% in China. The company generated about 78% of sales from accommodation reservations and transportation ticketing in 2020. The rest of revenue comes from package tours and corporate travel. Prior to the pandemic in 2019, the company generated 25% of revenue from international business, which is important to its margin expansion. Most of sales come from websites and mobile platforms, while the rest come from call centers. The competes in a crowded OTA industry in China, including Meituan, Alibaba-backed Fliggy, Toncheng, and Qunar. The company was founded in 1999 and listed on the Nasdaq in December 2003. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Challenging Scenario of Omicron, weak produce and Labour Scarcity create obstacles for Lamb Weston

Business Strategy and Outlook

Lamb Weston, the largest provider of frozen potatoes to North American restaurants, has secured a narrow moat, based on the firm’s cost advantages and entrenched restaurant relationships. The North American commercial potato market is highly concentrated with only four players: Lamb Weston (42%-43% share), McCain (30%), Simplot (20%), and Cavendish (7%-8%). Lamb Weston and Simplot both secure their raw potatoes solely from the Idaho and Columbia Basin region, an area ideally suited for growing potatoes, with very high yields. These firms secure potatoes at a cost 10% to 20% below the average price per pound. There is minimal unused land and water resources in this fertile area, so it is expected this advantage to hold for at least the next 10 years. Further, as the dominant player, Lamb Weston maintains a scale advantage. Given the high fixed costs in this capital-intensive industry, scale benefits are meaningful. Lamb Weston’s long-standing strategic partnerships with its customers provide another facet of the firm’s competitive edge. French fries are the most profitable food product for restaurants, and a key menu item. 

Lamb Weston is facing many headwinds that will dampen its earnings near term, but its long-term prospects should remain intact. The omicron variant will cause the traffic recovery in full-service restaurants (19% of sales) to pause, but consolidated sales should return to prepandemic levels in fiscal 2022, given resilience in quick-serve restaurants (58%) and retail (16%). Inflation, shortages, and a poor-quality potato crop should impair margins the next several quarters, but profitability should be fully restored by fiscal 2024. 

French fries are an attractive category, as consumers across the globe are increasing consumption, with volumes up low single digits in developed markets and up mid to high single digits in emerging markets. Lamb Weston is investing in additional capacity in China and the U.S. to meet this growing demand. While capacity utilization was uncharacteristically low during the pandemic, as herd immunity increases, French fry demand should recover, absorbing additional supply.

Financial Strength

When Lamb Weston separated from Conagra in November 2016, the firm initially reported net debt to adjusted EBITDA of 3.7 times, but leverage fell to 3.0 times last year (even considering the impact from the pandemic), and it will moderate to a very manageable 2.1 times by fiscal 2024. In addition, it can be guaranteed about the Lamb Weston’s ability to service its debt, with interest coverage (GAAP EBITDA/interest expense) averaging 7 times the past three years, and our forecast calling for a 8 times average over the next five years. As Lamb Weston’s business is capital intensive, the primary use of cash is capital expenditures, which averaged 9% of sales the three years before the pandemic, as the firm expanded capacity to meet strong customer demand. The industry began to operate at a more level utilization rate (mid-90s expected even before the pandemic hit in 2020, after 100% experienced the previous two years) causing capital expenditures to moderate to 4%-5% of sales during the pandemic. Investments should increase to 11% and 17% of sales in 2022 and 2023, respectively, as Lamb Weston expands capacity in China and the U.S. and range from 5.5% to 6.0% over the remainder of the decade. Dividends should be another significant use of cash, and It is expected for dividends to increase at a high-single-digit rate annually, generally maintaining a long-term pay-out ratio in the low-30%s, in line with management’s target. Lamb Weston has made a few small tuck-in international acquisitions in recent years, and is suspected that this may continue, but analyst have not modelled future unannounced tie-ups, given the uncertain timing and magnitude of such transactions. Instead, Analyst have opted to model excess cash being used for share repurchase, which is viewed as a prudent use of cash when shares trade below our assessment of its intrinsic value.

Bulls Say’s

  • Lamb Weston’s geographical and scale-based cost advantages should help ensure the firm remains a dominant player in the industry. 
  • Lamb Weston is a valued supplier of restaurants’ most profitable food product, and restaurants are hesitant to switch so as not to disrupt supply and quality. 
  • French fries are an attractive category, as per capita consumption is increasing in both developed and developing markets.

Company Profile 

Lamb Weston is the world’s second-largest producer of branded and private-label frozen potato products, such as French fries, sweet potato fries, tots, diced potatoes, mashed potatoes, hash browns, and chips. The company also has a small appetizer business that produces onion rings, mozzarella sticks, and cheese curds. Including joint ventures, 52% of fiscal 2021 revenue was U.S.-based, with the remainder stemming from Europe, Canada, Japan, China, Korea, Mexico, and several other countries. Lamb Weston’s customer mix is 58% quick-serve restaurants, 19% full-service restaurants, 8% other food service (hotels, commercial cafeterias, arenas, schools), and 16% retail. Lamb Weston became an independent company in 2016 when it was spun off from Conagra.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

PHILLIP NARROWING IT’S BUSINESS FOCUS, 50 FACTORIES TO LESS THAN 35 IN 5 YEARS

Business Strategy and Outlook

Philips is a one-stop shop for imaging-related devices with an established footprint in many hospitals, which positions it to benefit from long-term healthcare trends like the transition to nonor minimally invasive procedures, increased hospital demand for efficiencies or detection of sleep apnea. Through several divestitures and acquisitions Philips has transformed itself from an industrial-medical conglomerate into a healthcare company and primary supplier across hospitals, which facilitates the introduction of new products and the displacement of smaller suppliers with more depth in a single product line, but lack of breadth. In many of its underlying markets the company operates an oligopoly where significant market share is controlled by a few players. Several of the company’s products require proprietary software or service, which provide stability to cash flows and help to lock in the customer. In addition the company has carried out several divestments and acquisitions, which is supposed to have reinforced the company’s positioning. The company continues to narrow its business focus, with the sale of its domestic appliances business in 2021. 

It is alleged the company has room to improve its margins through improved operations management and cost efficiencies. Philips has made inroads on this front with a manufacturing footprint consolidation, where it has moved from 50 factories to less than 35 in five years. In D&T Philips has a large installed base built during many decades, which is suspected, has potential for improved service retention rates through remote monitoring, product sophistication and risk-sharing agreements. In connected care, Philips had a significant product recall on its sleep apnea installed base in 2021, which is assumed will result in a permanent loss of market share against Resmed. It is foreseen a long-term conversion pathway in toothbrushes from manual to electric, as a large percentage of the population still brushes manually. It is expected.6 the monitoring market will be a long-term beneficiary of COVID-19 due to hospitals realizing the need for efficiencies in patient management when hospital occupancy is high.

Financial Strength

As of September 2021, Philips had EUR 3.8 billion in net debt, which represented a 1.3 net debt/EBITDA ratio. Debt is denominated in euros and U.S. dollars, with an average interest rate of 2.0% and an average duration of around eight years. It is counter thought, Philips’ indebtedness level will be problematic given its relatively stable cash flow generation, and it is alleged, the company will have additional room for acquisitions, investments and dividends/buybacks. In the first quarter of 2021 Philips announced the sale of its domestic appliances business for EUR 4.4 billion. The proceeds will strengthen Philips’ balance sheet even more, giving the company more room to reinvest in the healthcare business, where it holds a stronger competitive position.

Bulls Say’s

  • Philips’ large installed base in imaging devices and existing footprint in many hospitals is an advantage that allows them to cross-sell and introduce new products with less effort than other smaller players.
  • Philips is a market leader in large unpenetrated markets such as sleep obstructive apnea and electric toothbrushes, where there are significant growth opportunities ahead.
  • The firm’s divestments are reducing the conglomerate perception Philips has among investors, which will provide more visibility on cash flows and future growth opportunities.

Company Profile 

Philips is a diversified global healthcare company operating in three segments: diagnosis and treatment, connected care, and personal health. About 48% of the company’s revenue comes from the diagnosis and treatment segment, which features imaging systems, ultrasound equipment, image-guided therapy solutions and healthcare informatics. The connected care segment (27% of revenue) encompasses monitoring and analytics systems for hospitals and sleep and respiratory care devices, whereas the personal health business (remainder of revenue) includes electric toothbrushes and men’s grooming and personal-care products. In 2020, Philips generated EUR 19.5 billion in sales and had 80,000 employees in over 100 countries.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.