Business Strategy and Outlook
International Flavors & Fragrances is a global leader in the specialty ingredients space. The company has grown rapidly via acquisition, having added DuPont’s nutrition and biosciences business in 2021 and Frutarom in 2018. IFF holds an enviable asset portfolio focused on value-added products used in food and beverages, fragrances, personal care, enzymes, probiotics, and pharmaceuticals. Its legacy business operated in the $20 billion-plus flavors and fragrances industry with a roughly 25% market share. Key competitors include Givaudan (25%), Firmenich (16%), and Symrise (12%). These four flavor and fragrance companies command roughly three fourths of the global market. IFF’s products affect the desired taste, smell, or mouth feel based on customer specifications.
IFF has four reporting segments divided by end market. Nourish is the largest segment, which generates a little over half of revenue. This segment holds IFF’s legacy taste segment and DuPont’s ingredients business, including plant-based protein formulations and other vital ingredients like texturants and emulsifiers.
Health and biosciences, which generates a little over 20% of revenue, is mostly the legacy Danisco industrial enzymes and cultures (probiotics) businesses. IFF has a roughly 20% share in both the enzymes market and the cultures market.
The scent segment, consisting of IFF’s legacy fragrances business, generates a midteens percentage of revenue. IFF’s smallest component is pharma solutions, producing inactive ingredients such as excipients (pill binders) and time-release polymers.
Proprietary formulations are critical drivers of revenue growth. For example, rather than supplying simple flavor solutions, IFF can deliver innovative solutions that modulate the consumer experience. These “fine-tuning” solutions can reduce costs for customers, allowing for the use of cheaper ingredients, extend a product’s shelf life, or add probiotic nutrition. Additionally, the company’s offerings help customers remove undesirable content (fat, sugar, and sodium) from a product without sacrificing the consumer experience.
Financial Strength
IFF has an elevated debt level, thanks to the roughly $10 billion in debt that the company raised to fund the DuPont nutrition and biosciences and Frutarom acquisitions. As of Sept. 30, 2021, total debt was a little over $11.5 billion and the company held roughly $0.8 billion in cash and cash equivalents. Management reported a net financial debt/adjusted EBITDA ratio of 4.1 times as of Sept. 30, 2021. However, management plans to use excess cash flow to repay debt, toward the goal of achieving a net debt/EBITDA ratio of less than 3 times by early 2024, or 36 months after the DuPont nutrition and biosciences acquisition closed. While IFF will carry elevated leverage, its indebtedness should prove manageable, given the relatively stable cash flows we expect the company to generate. Further, IFF is undergoing a portfolio review to divest noncore assets as a way to accelerate debt reduction, such as the microbial control divestiture in 2022 for $1.3 billion. As such, we believe IFF should be able to meet all of its financial obligations, including dividends, pensions, and postemployment benefit liabilities.
Bulls Say’s
- As the largest specialty ingredients producer globally, IFF holds an enviable portfolio of market-leading products spanning multiple industries.
- The company is well positioned to capitalize on further growth in developing markets, where it generates the most sales.
- IFF’s high R&D spending (around 6% of sales) acts as a barrier to entry, underpins innovation, and promotes future growth
Company Profile
International Flavors & Fragrances produces ingredients for the food, beverage, health, household goods, personal care, and pharmaceutical industries. The company makes proprietary formulations, partnering with customers to deliver custom solutions. The nourish segment, which generates roughly half of revenue, is a leading flavour producer and also sell texturants, plant-based proteins, and other ingredients. The health and biosciences business, which generates around one fourth of revenue, is a global leader in probiotics and enzymes. IFF is also one of the leading fragrance producers in the world. The firm also sells pharmaceutical ingredients such as excipients and time-release polymers.
(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.
Business Strategy and Outlook
Marathon has comprehensively reshuffled its portfolio in the past five to 10 years, discarding most the conventional projects it historically focused on and doubling down on U.S. shale. The international assets it has retained, in Equatorial Guinea, will be harvested for cash flows that can be redeployed in the U.S. Elsewhere, the firm is still just getting started. It entered the Permian Basin in 2017, and is ramping quickly from a very low base of production. The position is fairly fragmented, limiting the scope for long-lateral development (though management is attempting to address this with acreage trades, bolt-on acquisitions, and acreage swaps).
Well results thus far have been reasonably impressive, and are consistent with a West Texas Intermediate break-even level under $40 per barrel (comparable to, but not significantly better than, what other Permian producers typically achieve). The Oklahoma portion of the portfolio could have similar potential, but this is more speculative–the firm’s drilling results to date have been middling, and the natural gas weighting and high cost of development have been weighing on its potential returns there. Activity in both of these areas has been dialed back to a minimum since the 2020 downturn in crude prices.
Financial Strength
Marathon holds about $4.0 billion of debt, resulting fairy strong leverage ratios. At the end of the last reporting period debt/capital was 27%, and net debt/EBITDA was about 1 times. These metrics are likely to improve further. The firm can generate free cash flows under a wide range of commodity scenarios. Management’s benchmark five-year plan is based on $1 billion capital expenditures annually, and that should generate $1 billion annually in free cash (which can comfortably fund its base dividend, leaving it with plenty left over for debt reduction). So it’s pretty unlikely that the firm will need to tap its liquidity reserves, but if it does there’s $500 million cash on the balance sheet, and it has an undrawn $3 billion revolver.
Bulls Say’s
- Marathon’s acreage in the Bakken and Eagle Ford plays overlaps the juiciest “sweet spots” and enables the firm to deliver initial production rates far above the respective averages.
- Holding acreage in the top four liquids-rich shale plays enables management to sidestep transport bottlenecks and avoid overpaying for equipment and services in areas experiencing temporary demand surges.
- Marathon was one of the first U.S. shale companies to establish a track record for free cash flow generation.
Company Profile
Marathon is an independent exploration and production company primarily focusing on unconventional resources in the United States. At the end of 2020, the company reported net proved reserves of 972 million barrels of oil equivalent. Net production averaged 383 thousand barrels of oil equivalent per day in 2020 at a ratio of 67% oil and NGLs and 33% natural gas.
(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.
Fund Objective
The fund aims to achieve capital growth equal to, or greater than the Benchmark with lower volatility over the long term by investing globally in listed securities of companies having their registered office or exercising a preponderant part of their economic activities in emerging countries through the underlying fund.
Approach
The strategy’s robust foundation and consistent execution remain attractive features. The rules based, quantitative process is built on academic research demonstrating low-risk stocks leads to better risk adjusted returns. After an initial liquidity filter, Robeco’s quant model ranks the 2,000-stock universe on a multidimensional risk factor (volatility, beta, and distress metrics), combined with value, quality, sentiment, and momentum factors. In recent years, enhancements to refine the model have been added, including short-term momentum-driven signals that can adjust a stock’s ranking up or down by a maximum 10 percentage points. This should prioritise buy decisions for stocks that rank high in the model and score well on short term signals, and vice versa. From 2020 the team also allows liquid mega-caps to have more 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 Emerging Markets Index. A 200- to 300-stock portfolio is constructed with better ESG and carbon footprints than the index; rebalancing takes place monthly, generating annual turnover of about 25%. Stocks are sold when ranking in the bottom 40% of the model.
Portfolio
The defensive nature of the strategy translates into a higher allocation to low-beta and high-yielding stocks in the utilities, consumer staples and communication services sectors, while consumer discretionary stocks are a large underweight. The valuation factors embedded in the model have steered the fund clear from index heavyweight Meituan, while positions in Alibaba and Tencent were sold in August and September 2021, respectively. 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. However, the team’s decision to increase the maximum absolute weight in mega-caps to 4% from 3% for liquidity purposes has increased top-10 concentration to around 20%, double the level at inception. Still, 29% of assets remain invested outside of large- and mega- caps, about three times the MSCI Emerging Markets index’ allocation.
Performance
This defensive strategy has generally offered good volatility reduction during turbulent markets, capturing 67.77% of the losses of the MSCI Emerging Markets Index since inception, and 76.89% of the upside return. It did not live up to expectations in the coronavirus-dominated markets of 2020, falling more than the index, explained by market dynamics that did not work in its favour. Exposure to dividend stocks and traditional low-risk stocks did poorly compared to high-growth and momentum stocks; the tilt to mid and small caps also detracted. The portfolio lagged during the subsequent recovery that benefited underweight technology and e-commerce stocks. While the value rally in the final quarter did help, cyclical value stocks that are not favoured rallied the most. Consequently, the fund underperformed the Emerging Markets Minimum Volatility Index by 11 percentage points. Things changed in 2021, benefiting from low risk exposure and value tilt during the correction of Chinese e-commerce stocks following a regulatory crackdown. Taiwanese financials and Indian IT stocks aided returns, helping to recoup lost grounds. The fund’s alpha since inception versus the MSCI EM index remains positive, yet slightly behind the minimum volatility index. Although three- and five-year absolute returns have been below index, Sharpe ratios are broadly similar to index with a lower drawdown since inception.
About the fund
The fund aims to achieve capital growth equal to, or greater than the Benchmark with lower volatility over the long term by investing globally in listed securities of companies having their registered office or exercising a preponderant part of their economic activities in emerging countries through the underlying fund.
The investment strategy of the underlying fund seeks to capture the low risk anomaly. Analysis by Robeco has shown that low-risk stocks (in terms of volatility and beta) are able to generate returns equal to, or greater than, the market with lower associated risks. The beta of a stock or portfolio is a number describing the correlated volatility of an asset in relation to the volatility of the benchmark that the asset is being compared to.
(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.
Business Strategy and Outlook
APA Corp. is an upstream oil and natural gas producer with assets in the U.S. and overseas. The vast majority of its domestic production is derived from the Permian Basin. This was a key growth engine for the company until 2020, when the coronavirus-related collapse in crude prices forced the company to dial back on drilling capital. After a hiatus, development operations have restarted, albeit at a slower pace–Permian volumes are likely to decline slightly during 2021. Drilling is currently focused on the same reservoirs that APA’s competitors are targeting (the Spraberry and Wolfcamp intervals in the Midland Basin and the Bone Spring and Wolfcamp formations in the Delaware). But in the past the firm also focused on its own discovery in the Permian region, the Alpine High play. Alpine High wells are characterized by very strong initial production rates but with a much higher gas and natural gas liquids content than it is probable elsewhere in the Permian. More recently, it has also been testing its East Texas Austin Chalk acreage.
APA also holds a large acreage position in Egypt, where it has operated for nearly a quarter of a century. It is now harvesting cash flows there, and will probably keep volumes more or less flat in the next few years (drilling new wells to offset declines from older ones). But reported volumes could fluctuate as APA’s revenue and profits in Egypt are governed by production-sharing contracts (due to cost recovery provisions in these contracts, lower crude prices translate to higher volumes, creating a natural hedge, helping the company to cope with this very weak commodity environment). Meanwhile, it is awaited modest production declines from APA’s mature assets in the North Sea.
Further, the company’s focus has now widened to include Suriname, following a string of exploration successes in Block 58 (which APA is appraising with its 50/50 partner, Total). The evidence to date suggests a very large petroleum system, which could be potentially transformative for the company. At this point, it is alleged that it is very likely that one or more of the discoveries will progress to the development stage, though none have been officially sanctioned yet.
Financial Strength
APA Corp has started to turn the corner after several years of above-average indebtedness. The firm has now strung together several quarters of substantial free cash flows, and while very high commodity prices have played a part, it is alleged the firm can maintain its current course at midcycle prices (reinvesting only a moderate portion of its operating cash while keeping production flat slightly growing). The deconsolidation of its Altus Midstream subsidiary won’t directly impact the firm’s financial health, though its leverage ratios will improve as reported debt will no longer include the Altus revolver, which has no recourse to APA. The Altus transaction will make it easier for APA to monetize that investment though, which potentially paves the way for further balance sheet strengthening. At the end of the last reporting period, consolidated debt was $7.4 billion. On an annualized basis net debt/EBITDA was 2.5 times, and debt/capital was over 100%. However, both metrics will improve after the deconsolidation. Anyway, there is little chance of a liquidity crisis anytime soon. The term structure of the firm’s debt is extremely spread out. Only about $500 million comes due before 2025, and only $3.2 billion matures in the five years after that. That means APA can forget about the principal on over half of its debt until at least 2030. Additionally, the firm has a liquidity reserve composed of $400 million cash and well over $3 billion in committed bank credit. The revolver does include a covenant ceiling of 60% for debt/capital, but capital is defined to exclude impairments since mid-2015. On that basis, APA is unlikely to come close.
Bulls Say’s
- APA’s international operations in Egypt and the North Sea generate high rates of free cash flow under midcycle conditions, given exposure to Brent crude pricing, low operating costs, and minimal maintenance capital requirements.
- APA has a long runway of drilling opportunities in the high-growth, low-cost Permian basin.
- The recent discovery in Suriname could open the door to large-scale developments there, and the partnership with Total means APA’s capital commitment will be greatly reduced.
Company Profile
Based in Houston, APA Corp. is an independent exploration and production company. It operates primarily in the U.S., Egypt, the North Sea, and Suriname. At year-end 2020, proved reserves totaled 874 million barrels of oil equivalent, with net reported production of 440 mboe/d (66% of which was oil and natural gas liquids, with the remainder comprising natural gas).
(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.
Business Strategy and Outlook
Diamondback Energy was a modest-size oil and gas producer when it went public in 2012, but it has rapidly become one of the largest Permian-focused oil firms through a combination of organic growth and corporate acquisitions, most notably Energen in 2018 and QEP Resources in 2021. The firm consistently ranks among the lowest-cost independent producers in the entire industry, supporting a sustainable margin advantage.
Keeping costs low is baked into the culture at Diamondback, and it is alleged, operations to remain lean and efficient, despite the recent expansions. From the outset, the company has enjoyed a competitive advantage that enables it to systematically undercut its upstream peers. This was initially based on the ideal location of its acreage in the core of the basin, and helped by the early adoption of innovations like high-intensity completions (resulting in more production for each dollar spent). More recently, the firm has started seeing significant economies of scale as well.
Management has fiercely protected the balance sheet over the years and has been willing to tap equity markets when necessary, as it did several times during the 2015-16 downturn in global crude prices. But that’s ancient history now. Diamondback’s financial health is excellent, and the firm can maintain or grow its production while generating substantial free cash flows under a wide range of commodity scenarios. It is viewed little to no chance that the firm will choose to allocate more capital for new drilling than appropriate, which means production will probably stay flat or grow at low-single-digit rates for the foreseeable future. Excess cash will be used for debt reduction or returned to shareholders. To preserve flexibility for management, the firm has not committed to a specific reinvestment rate or vehicle for capital returns, like certain peers have, but it does intend to distribute at least half of its free cash somehow.
Finally, it is emphasized that, the firm’s stake in its mineral rights subsidiary, Viper Energy Partners. This vehicle owns the mineral rights relating to some of Diamondback’s most attractive acreage, further juicing returns on drilling for the parent
Financial Strength
Diamondback has historically maintained excellent financial health, with one of the strongest balance sheets in the upstream coverage. The Energen acquisition pushed up its leverage ratios for a brief spell in 2019, COVID-19 kept them elevated in 2020, and the Guidon and QEP deals extended these period of above average leverage into 2021. But borrowing never reached an unsustainable level, even in these periods, and the firm’s leverage has already recovered. At the end of the last reporting period, debt to capital was 36% and annualized debt/EBITDA was 1.1 times. And as the firm is capable of generating substantial free cash under a wide range of commodity price scenarios, it could be held that, these ratios to continue improving. The firm has targeted debt reduction of at least $1.2 billion in 2021 using its free cash flows plus the over $800 million in asset sale proceeds from its sale of noncore assets. Consolidated liquidity stands at roughly $2 billion with no material debt maturities until 2023.
Bulls Say’s
- Diamondback is one of the lowest-cost oil producers operating in the United States.
- Stacked pay in the Permian Basin multiplies the value of acreage, and further value can be unlocked as additional plays are proved up over time.
- Diamondback has been an early adopter of enhanced completion techniques and is expected to remain at the leading edge.
Company Profile
Diamondback Energy is an independent oil and gas producer in the United States. The company operates exclusively in the Permian Basin. At the end of 2020, the company reported net proven reserves of 1.3 billion barrels of oil equivalent. Net production averaged about 300,000 barrels per day in 2020, at a ratio of 60% oil, 20% natural gas liquids, 20% natural gas.
(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.
Business Strategy and Outlook
Railroad turnaround legend Hunter Harrison led Eastern Class I railroad CSX from early 2017 until his death in December that same year. Before joining CSX, he turned around three railroads. Most impressively, his leadership improved Canadian Pacific’s reported OR from 81.3% in 2011 to 58.6% in 2016. While his time was cut short at CSX, Harrison laid the foundation for rapid improvement. As his replacement, the rail installed James Foote, who is quite familiar with Harrison’s precision railroading model from years working at Canadian National.
This has been Foote’s first opportunity to lead a Class I railroad and, on top of that, CSX operates a complicated spiderweb network in a densely populated area. This differs from the railroads Harrison and Foote ran in Canada, which are mostly linear and run through remote locations. Even so, considering CSX’s impressive operating ratio improvement over the past four years, we think Foote has executed admirably carrying the precision railroading, or PSR, baton–the rail posted an impressive 58.4% OR in 2019 and kept it near 58.8% in 2020 despite lower volume for the year. Previously, CSX’s OR had been range-bound between 69.4% and 71.5% for seven years, even as other rails progressed. In fairness, CSX lost almost half of its highly profitable coal franchise during that time and still maintained a respectable OR.
Foote has overseen the implementation of Harrison’s PSR playbook at CSX, particularly in terms of rightsizing all assets, including human resources, real estate, sorting yards, motive power, and rolling stock. Fewer assets and longer trains drive up network fluidity, resulting in labor productivity gains, better service levels, and higher potential incremental operating margins. Better service also creates greater intermodal opportunities. Intermodal saw first-half 2020 volume headwinds from COVID-19 disruption, but has since rebounded on robust retailer restocking and tight truckload market capacity (rising truck-to-rail conversions). CSX’s domestic intermodal volume may face congestion-related constraints lingering into early 2022, but we still see intermodal as a key long-term growth opportunity for CSX.
Financial Strength
CSX’s balance sheet is in good shape. The firm held more than $2.2 billion of cash and short-term investments compared with $16.3 billion of total debt at year-end 2021. Debt increased slightly in 2020 as the firm took measures to shore up liquidity amid the pandemic–as most transports did. Net debt/EBITDA was about 2.0 times and EBITDA/interest coverage stood at a comfortable 10 times in 2021. It is expected that net-debt/EBITDA to remain near 2 times in 2022. Overall, we consider these levels secure, given CSX’s reliable cash generation. CSX employs a straightforward capital structure composed of mostly long-term unsecured debt to fund its business, although it uses a small amount of secured debt to finance equipment.
Bulls Say’s
- Thanks to PSR, CSX has posted impressive operating ratio gains in recent years despite losing half of its highly profitable coal business over the past eight years.
- Rooted in heavy service corridor investment over the past decade, CSX’s intermodal franchise has posted solid mid-single-digit container growth on average over the cycle.
- Compared with trucking, shipping by rail is less expensive for long distances, is 4 times more fuel efficient per ton-mile, and does not contribute to freeway congestion. These factors should support incremental intermodal growth over the long run.
Company Profile
Operating in the Eastern United States, Class I railroad CSX generated revenue near $12.5 billion in 2021. On its more than 21,000 miles of track, CSX hauls shipments of coal (13% of consolidated revenue), chemicals (22%), intermodal containers (16%), automotive cargo (9%), and a diverse mix of other bulk and industrial merchandise
(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.
Business Strategy and Outlook
American Airlines is the largest U.S.-based carrier by capacity. Before the coronavirus pandemic, much of the company’s story was based on realizing cost efficiencies from its transformational 2013 merger with U.S. Airways and strengthening the firm’s hubs to expand margins. While we think that American Airlines has done a good job at limiting unit cost increases, we note that the firm lagged peers in unit costs over the previous aviation cycle. Management sees the pandemic crisis as an opportunity to structurally improve the firm’s cost position relative to peers.
In the leisure market, it is expected low-cost carriers to prevent American Airlines from increasing yields with inflation. American’s basic economy offering effectively serves the leisure market, it is not expected that the firm to thrive in this segment. A leisure-led recovery in commercial aviation is anticipated, reflecting customers being more willing to visit friends and family and vacation in a pandemic than they are to go on business travel.
American Airlines will participate in the recovery of business and international leisure travel after a vaccine for COVID-19 becomes available. It is suspected that a recovery in business travel will be critical for American, as the firm’s high-margin frequent-flier program is closely tied to business travel. Business travellers will often use miles from a co-branded credit card to upgrade flights when their company is unwilling to pay a premium price. Banks pay top dollar for frequent-flier miles, which gives American a high-margin income stream.
The COVID-19 pandemic has presented airlines with the sharpest demand shock in history, and many of our projections are based on our assumptions around how illness and vaccinations affect society. We’re expecting a full recovery in capacity and an 80%-90% recovery in business travel that subsequently grows at GDP levels over the medium term.
Financial Strength
American is the most leveraged U.S.-based major airline due to its fleet renewal program and from the COVID-19 pandemic. As the pandemic has wreaked havoc on air travel demand and airlines’ business model, liquidity has become more important in 2020 than in recent years. American Airlines, more than peers, increased leverage, and diluted equity during the COVID-19 pandemic. We think American Airlines’ comparably higher financial leverage will make it difficult for the firm to maneuver going forward, and that management will have few capitals allocation options other than deleveraging post-pandemic. American Airlines came into the crisis with considerably more debt than peers, with gross debt to EBITDA sitting at roughly 4.5 times in 2019. American ended 2021 with $38.1 billion of debt and $13.4 billion of cash. It is expected that American Airlines will use incremental free cash flow to deleverage after the crisis. We anticipate EBITDA expansion and debt reductions will reduce gross debt/EBITDA to roughly two to three turns in the 2025-26 timeframe. The firm has $2.6 billion of debt coming due in 2022, and we expect that the firm will use cash on the balance sheet to pay the debt.
Bulls Say’s
- American Airlines has the youngest fleet among U.S. major airlines, which should dampen fuel expense and maintenance going forward.
- American Airlines has largely completed its fleet renewal, which should decrease capital expenditures going forward.
- Leisure travellers are becoming more comfortable with flying during the COVID-19 pandemic
Company Profile
American Airlines is the world’s largest airline by scheduled revenue passenger miles. The firm’s major hubs are Charlotte, Chicago, Dallas/Fort Worth, Los Angeles, Miami, New York, Philadelphia, Phoenix, and Washington, D.C. After completing a major fleet renewal, the company has the youngest fleet of U.S. legacy carriers.
(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.
