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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 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.

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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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Technology Stocks

JD.com Going Towards Asset-Heavy Model Bulls For Now

Business Strategy and Outlook

JD.com has emerged as a leading disruptive force in China’s retail industry by offering authentic products online at competitive prices with speedy and high-quality delivery service. JD’s mobile shopping market share has increased from 21% in 2016 to 27% in 2020 on approx. JD adopted an asset-heavy model with self-owned inventory and self-built logistics, while Alibaba has more of an asset-light model. 

JD is a long-term margin expansion story driven by increasing scale from JD direct sales and marketplace, partially offset by the push into JD logistics in the medium term. JD is the largest retailer in China by revenue. Among listed Chinese peers, JD’s net product revenue in 2020 was two to three times higher than for Suning, the second-largest listed retailer. JD’s increasing scale in each category will allow it to garner bargaining power toward the suppliers and volume-based rebates. Since 2016, JD no longer fully reinvests its gains from improving scale and is committed to delivering annual margin expansion in the long run. Gross margin improved yearly from 5.5% in 2011 to 15.2% in 2016, and following the consolidation of JD Finance in second-quarter 2017, gross margin improved year over year from 13.7% in 2016 to 14.6% in 2020. 

In the medium term, it is foreseen the investment into community group purchase, JD logistics and the supermarket category will hold back some of the margin gains. JD is unlikely to have non-GAAP net margin increase in 2021. Starting in April 2017, the logistics business became an independent business unit that will open its services to third parties. Management is squarely focused on gaining market share instead of profitability at this point, and to do so, it has invested heavily in supply chain management, integrated warehouse, and delivery services to penetrate into less developed areas. As the logistics business gains scale and reaches higher capacity utilization, it is foreseen for, gross profit margin improvement. Management believes it is not time to turn profitable in the supermarket category in order to be a category leader in China.

Financial Strength

JD.com had a net cash position of CNY 135 billion at the end of 2020. Its free cash flow to the firm has continued to generate positive FCFF at CNY 8.1 billion in 2020. JD has not paid dividends. JD.com has invested heavily in fulfilment infrastructure and technology in recent years, leading to concerns about its free cash flow profile and margin improvement story. It is contemplated management will put more emphasis on growing revenue per user, expansion into lower-tier cities and the businesses’ profitability. Therefore, JD will not invest in new areas as aggressively as before, so it is alleged think JD will be able to maintain positive non-GAAP net margin versus being unprofitable before. its financial strength will improve in future. Most of the initial investments in the third-party logistics business have been carried out, and utilization of the warehouses has picked up. Its technology team is already in place without the need to add substantial headcounts. JD will also be cautious in its investment in the group-buying business and new retail, given a profitable business model has not been established in the market. JD has tried to improve its asset-heavy model by transferring a portfolio of warehouses to establish a CNY 10.9 billion logistics property core fund in partnership with the sovereign wealth fund of Singapore, GIC. JD will own 20% of the fund, lease back the logistics facilities and receive management fees for managing the facilities. The deal will be completed in phases with the majority of them completed in 2019.

 Bulls Say’s

  • JD.com’s nationwide distribution network and fulfilment capacity will be extremely difficult for competitors to replicate. 
  • The partnership with Tencent could allow JD.com to gain significant user traffic from Tencent’s dominant social-networking products in China. 
  • JD is now the largest supermarket in China, the high frequency FMCG categories have attracted new customers from less developed areas and can drive purchase of other categories.

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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Technology Stocks

APTIV ENJOYING STICKY MARKET SHARE THANKS TO CUSTOMER RELATIONSHIPS AND LONG TERM CONTRACTS

Business Strategy and Outlook

It is foreseen Aptiv’s average yearly revenue growth to exceed average annual growth in global light-vehicle demand by high-single-digit percentage points. The company provides automakers with components and systems that are in high demand from consumers and that government regulation requires to be installed. Aptiv’s high-growth technologies include advanced driver-assist systems, autonomous driving, connectivity, data services, and high-voltage electrical distribution systems for hybrids and battery electric vehicles. 

It is seen, Aptiv’s ability to regularly innovate and commercialize new technologies bolsters sales growth, margin, and return on investment. A global manufacturing presence enables Aptiv to serve customers around the globe, capitalizing on the economies of scale inherent in automakers’ plans to use more global vehicle platforms. Lean manufacturing discipline and a low-cost country footprint enable more favourable operating leverage as volume increases. 

Aptiv enjoys relatively sticky market share, supported by integral customer relationships and long-term contracts. The design phase of a vehicle program can last between 18 months and three years depending on the complexity and extent of the model redesign. The production phase averages between five and 10 years. Engineering and design for the types of products that Aptiv provides necessitate highly integrated, long-term customer relationships that are not easily broken by competitors’ attempts at market penetration. 

New Car Assessment Programs are used by governments around the world to provide an independent vehicle safety rating. Legislators, especially in the United States and in Europe, have set NCAP guidelines that will progressively require the addition of ADAS features as standard equipment through the end of this decade. If automakers intend certain models to achieve a 4- or 5-star safety rating, some ADAS features must be part of that vehicle’s standard equipment to even qualify for certain rating levels.

Financial Strength

It is seen, Aptiv’s financial health is in good shape. Since 2015, pro forma for the spin-off of Delphi Technologies in 2017, total debt/total capital has averaged 16.9% while total debt/EBITDA has averaged 2.9 times. Furthermost of Aptiv’s capital needs are met by cash flow from operations. However, the COVID-19 pandemic necessitated the drawdown of the company’s $2.0 billion revolver on March 23, 2020. The revolver was repaid after the company raised capital through share issuance and a mandatory convertible preferred in June 2020. Aptiv’s liquidity remains healthy at $5.2 billion, with around $2.8 billion in cash and equivalents at the end of December 2020. The company was also granted covenant relief, with a debt/EBITDA ratio of 4.5 times through the second quarter of 2021, up from 3.5 times. With the exemption of the credit line that includes the revolver and a term loan, which expires in August 2021, the company has no other major maturities until 2024.The company has approximately $4.1 billion in senior unsecured note principal outstanding with maturities that range from 2024 to 2049, at a weighted average stated interest rate of 3.2%. Aptiv issued $300 million in 4.35% senior notes due in 2029 and $300 million 4.4% notes due in 2046 in March 2019 to redeem senior notes due in 2020 with an interest rate of 3.15%. The bonds and bank debt are all senior unsecured, pari passu, and have similar subsidiary guarantees.

Bulls Say’s

  • Owing to product segments with better-than-industry average growth prospects like safety, electrical architecture, electronics, and autonomous driving, it is projected Aptiv’s revenue to grow mid- to high-single digit percentage points in excess of the percentage change in global demand for new vehicles.
  • The ability to continuously innovate and commercialize new technologies should enable Aptiv to generate excess returns over its cost of capital.
  • A global manufacturing footprint enables participation in global vehicle platforms and provides penetration in developing markets.

Company Profile 

Bed Bath & Beyond is a home furnishings retailer, operating just under 1,000 stores in all 50 states, Puerto Rico, Canada, and Mexico. Stores carry an assortment of branded bed and bath accessories, kitchen textiles, and cooking supplies. In addition to 809 Bed Bath & Beyond stores, the company operates 133 Buy Buy Baby stores and 53 Harmon Face Values stores (health/beauty care). In an effort to refocus on its core businesses, the firm has divested the online retailer Personalizationmall.com, One Kings Lane, Christmas Tree Shops and That (gifts/housewares), Linen Holdings, and Cost-Plus World Market.

(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
Dividend Stocks

JM Smucker Co: At Home Food giving Gains against Market Shares Stabilization still a Hindrance

Business Strategy and Outlook

Despite having leading positions in many categories (fruit spreads, peanut butter, dog treats, coffee, and cat food) it is seen Smucker lacks an economic moat, either via its brand intangible assets or entrenched retail relationships. It is anticipated that for most of its sales base, Smucker does not possess pricing power and its market shares are slipping. This dilemma cannot be attributed to a lack of support, as Smucker’s brand investments exceed that of its peers (with marketing and R&D averaging 7.4% of sales the last three years compared with 5.4% for peers). Rather, it is perceived these expenditures are not as productive as its competitors, a problem not easily resolved in long interpretation.

It is assumed Smucker’s organic sales growth will average 2% annually over the long term, slightly less than the growth that was seeming for the total at-home food and beverage industry. It was foreseen market share losses in coffee and dog food to persist (Smucker’s two largest categories, at 47% of sales), as Smucker struggles to compete with strong brands such as Starbucks (licensed by wide-moat Nestle) and BLUE (owned by narrow-moat General Mills). Further, the fruit and nut spread categories, another 15% of sales, exhibit minimal growth. Even so, 2% growth represents an improvement from the modest declines in organic sales the firm realized before the pandemic. It is contemplated Smucker will be one of the few packaged food companies to realize lasting benefits from the pandemic, given the high-single-digit increase in pets adopted during the crisis and the likelihood that more flexible work arrangements should result in higher consumption of at-home coffee. This impact will not be immaterial, as collectively, pet food and coffee compose nearly 70% of Smucker’s sales. Further, Smucker’s sales trajectory should improve as Uncrustables (5% of fiscal 2021 sales) becomes a greater portion of the mix, as the brand has grown double-digits in each of the past several years. In addition, recent and pending divestitures of slower-growing brands (Crisco, Natural Balance, private label dry pet food, juices, and grains) should further improve Smucker’s ability to accelerate its top-line growth

Financial Strength

After years of a conservatively leveraged balance sheet, with net debt/adjusted EBITDA consistently below 2 times, the Big Heart Pet Brands acquisition in 2015 increased the ratio to above 6. Smucker paid $5.9 billion for the business, 13 times EBITDA, it is believed to be rich, particularly considering the acquired brands’ poor positioning in the category. It is interpreted management was prudent in its decision to sell the nonstrategic canned milk business shortly thereafter for $194 million to free up capital in order to accelerate debt reduction. Share repurchases were also significantly curtailed in 2015, which could be seen as sensible. Net debt to adjusted EBITDA declined to a manageable 2.8 times by 2018, though it is anticipated, before the firm announced it was acquiring pet food producer Ainsworth for $1.9 billion, which increased leverage to 3.5 times in 2019 before falling to 2.4 times in fiscal 2021. Smucker’s free cash flow (CFO less capital expenditures) as a percentage of revenue has averaged high single digits to low double digits historically, and it is supposed similar results going forward. Smucker seeks to invest half of its capital in growth initiatives (capital expenditures and acquisitions) and return half to stakeholders via dividends, share repurchase, and debt reduction. While it is foreseen Smucker will invest 3.5% of annual sales in capital expenditures over the long term, we model an elevated level of investments in the next two years as the firm adds Uncrustables capacity. We think Smucker will continue to reshape its portfolio through acquisitions and divestitures, although we have not modeled unannounced transactions. We think Smucker’s dividend payout ratio will range between 40% and 50%, in line with management’s long-term targets, it is anticipated 2%-6% annual dividend increasing. It is estimated Smucker to repurchase 0%-5% of shares annually, which is seen as a prudent use of capital if the share price remains below fair value estimates.

Bulls Say’s

  • Smucker’s sales trajectory should improve over time due to the divestiture of slow-growing brands and the increasing mix of Uncrustables, which grows at a double-digit pace.
  • During the pandemic, consumers adopted 11 million pets and purchased 3 million coffee machines, which should provide a lasting benefit for categories representing nearly 70% of Smucker’s fiscal 2021 sales.
  • Executive leadership changes (newly created chief operating officer role, leadership changes for the U.S. sales organization and the pet food segment) should improve execution and enhance accountability.

Company Profile 

J.M. Smucker is a packaged food company that primarily operates in the U.S. retail channel (88% of fiscal 2021 revenue), but also in U.S. food-service (5%), and international (7%). Its largest segment is pet food and treats (36% of 2021 revenue), with popular brands such as Milk-Bone, Meow Mix, 9Lives, Kibbles ‘n Bits, Nature’s Recipe, and Rachael Ray Nutrish. Its second-largest category is coffee (33% across channels) with the number-two brand Folgers and number-six Dunkin’. Other large categories are peanut butter (10%), with number-one Jif, fruit spreads (5%) with number-one Smucker’s, and frozen hand-held foods (5%) with number-one Uncrustables.

(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
Shares Small Cap

Amidst Canadian Cannabis competition, Tilray seen to surpass

Business Strategy and Outlook

Tilray cultivates and sells cannabis in Canada and exports into the global medical market. It also sells CBD products in the U.S. The company is the result of legacy Aphria acquiring legacy Tilray in a reverse merger and renaming itself Tilray in 2021.

Canada legalized recreational cannabis in October 2018. Since then, recreational sales have come to represent an increasingly larger portion of sales for producers. Historically, legacy Aphria focused initially on flower and vape before expanding into edibles. In contrast, legacy Tilray focused on an asset-light, consumer-focused business model. Although the two strategies complement each other well, Tilray faces stiff competition to develop consumer brands that can lead to meaningful pricing power. 

Legacy Aphria had an extensive international distribution business, which generated the majority of its net revenue, a far larger portion than many of its Canadian cannabis peers. Legacy Tilray had also entered the global medical market. With both companies’ international capabilities intact, Tilray looks well positioned. The global market looks lucrative given higher realized prices and growing acceptance of the medical benefits of cannabis. Exporters must pass strict regulations to enter markets, which protects early entrants. It is forecasted roughly 15% average annual growth through 2030 for the global medicinal market excluding Canada and the U.S. 

In 2020, legacy Aphria acquired SweetWater, a U.S. craft brewery. Legacy Tilray previously acquired Manitoba Harvest to distribute CBD products in the U.S. It finally secured a toehold into U.S. THC when it acquired some of MedMen’s outstanding convertible notes. Upon U.S. federal legalization, Tilray would own 21% of the U.S. multistate operator. Furthermore, Tilray paid a great price while also getting downside protection as a debtholder. 

It is contemplated the U.S. offers the fastest growth of any market globally. However, the regulatory environment is murky with individual states legalizing cannabis while it remains illegal federally. It is supposed federal law will eventually be changed to allow states to choose the legality of cannabis within their borders.

Financial Strength

At the end of its second fiscal quarter 2022, Tilray had about $747 million in total debt, excluding lease liabilities. This compares to market capitalization of about $3 billion.  In addition, Tilray had about $332 million in cash, which will allow it to fund future operations and investments. Management has been deliberate with its SG&A spending given the slow rollouts and regulatory challenges the Canadian market has faced. Legacy Aphria was the first major Canadian producer to reach positive EBITDA, with legacy Tilray reaching positive EBITDA in the quarter immediately preceding its acquisition. However, the combined company continues to generate negative free cash flow to the firm, which pressures its financial health. With most of its development costs completed, it is alleged Tilray will have moderate capital needs in the coming years. As such, it is implied debt/adjusted EBITDA to decline. It is reflected Tilray is unlikely to require significant raises of outside capital. In September 2021, the company received shareholder approval for increasing its authorized shares in order to rely on equity for future acquisitions. This bodes well for keeping its financial health strong.

Bulls Say’s

  • Legacy Aphria’s acquisition of Legacy Tilray created a giant with leading Canadian market share, expanded international capabilities, and U.S. CBD and beer operations. 
  • Tilray’s management focuses on strategic SG&A spending and running a lean business model, benefiting its financial health in the early growth stage industry. 
  • Tilray management’s careful approach to expansion has allowed it to reach profitability faster than any of its Canadian peers.

Company Profile 

Tilray is a Canadian producer that cultivates and sells medical and recreational cannabis. In 2021, legacy Aphria acquired legacy Tilray in a reverse merger and renamed itself Tilray. The bulk of its sales are in Canada and in the international medical cannabis export market. U.S. exposure consists of CBD products through Manitoba Harvest and beer through SweetWater.

(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
Technology Stocks

We Like Intel’s Appointment of Micron CFO Dave Zinsner as its New CFO; No Change to FVE

Business Strategy and outlook

Intel is the leader in the integrated design and manufacturing of microprocessors found in PCs and servers. Intel historically differentiated itself first and foremost via the execution of Moore’s law, which predicts transistor density on integrated circuits will double about every two years, meaning subsequent chips have substantial power, cost, and size improvements. This scaling advantage was perpetuated through higher-than-peer-average R&D and capital expenditure budget that allows it to control the entire design and manufacturing process in an industry .

As cloud computing continues to garner significant investment, Intel’s data center group will be an indirect beneficiary. Mobile devices have become the preferred device to perform computing tasks and access data via cloud infrastructures that require large-scale server build-outs. This development has provided strong tailwinds for Intel’s lucrative server processor business. Morningstar analyst believe Intel will experience continued growth in the data center, though we note competition from AMD and customers designing their own ARM-based silicon are potent risks.

The proliferation of mobile devices has come at the expense of the mature PC market, Intel’s historic stronghold, with ARM and its cohorts joining AMD as chief rivals. The rise of artificial intelligence has also unleashed a new competitor in Nvidia for specialized chips to accelerate AI-related workloads. Consequently, Intel has built a broad accelerator portfolio via the acquisition of Altera for FPGAs, Mobileye for computer vision chips used in cars, and Habana Labs for AI chips.

We Like Intel’s Appointment of Micron CFO Dave Zinsner as its New CFO; No Change to FVE

On Jan. 10, Intel announced it appointed David Zinsner as CFO, thus filling the vacancy created by current CFO George Davis’s planned retirement in May 2022. Morningstar analyst think that Zinsner is the right CFO to manage this lofty spending budget, as Micron has successfully executed its new technology ramps on an average capex of $9.2 billion over the past four years. Morningstar analyst  are maintaining our $65 fair value estimate for wide-moat Intel; shares appear undervalued and present an attractive buying opportunity for long-term, patient investors.

Financial Strength

Intel typically operates with ample liquid cash reserves. At the end of 2020, the firm held about $36.4 billion in total debt and nearly $24 billion in cash and cash equivalents, short-term investments, and trading assets. Morningstar analyst expects the firm generates sufficient cash flow and has ample resources to meet its debt obligations, capital expenditure requirements, potential acquisitions, and shareholder returns. 

Bulls Say 

  • Intel is one of the largest semiconductor companies in the world and holds the lion’s share of the PC and server processor markets. The firm has sustained its position at the forefront of technology by investing heavily in R&D, and this trend should continue. 
  • Intel has made a string of savvy acquisitions to build its Artificial Intelligence and automotive offerings, including Altera, Mobileye, Habana Labs, and Movidius. 
  • The data center group has indirectly benefited from the proliferation of mobile devices. Server processor sales will be the main driver of growth in the near future

Company Profile

Intel typically operates with ample liquid cash reserves, which we believe is justified as an offset to the semiconductor industry’s cyclical nature in general and Intel’s higher capital intensity in particular. At the end of 2020, the firm held about $36.4 billion in total debt and nearly $24 billion in cash and cash equivalents, short-term investments, and trading assets. We think the firm generates sufficient cash flow and has ample resources to meet its debt obligations, capital expenditure requirements, potential acquisitions, and shareholder returns.Intel’s dominant manufacturing operations require massive capital outlays for expensive equipment, fab construction, and the maintenance of a clean room environment. Morningstar analyst estimates utilize historical patterns and the expected progression of Moore’s law to attain an average annual capital expenditure of $14 billion over the next five years. Of this outlay, 70% is for maintaining existing capacity, with the remainder used for process development for the 7-nanometer process node and beyond.

 (Source: Morning Star)

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
Dividend Stocks

Smucker Continues to Benefit From At-Home Food Consumption but Struggles to Stabilize Market Shares

Business Strategy and Outlook

Despite having leading positions in many categories (fruit spreads, peanut butter, dog treats, coffee, and cat food) Morningstar analysts believe that Smucker lacks an economic moat, either via its brand intangible assets or entrenched retail relationships. Morningstar analysis shows that for most of its sales base, Smucker does not possess pricing power and its market shares are slipping. This dilemma cannot be attributed to a lack of support, as Smucker’s brand investments exceed that of its peers and suspected that these expenditures are not as productive as its competitor.

Morningstar analysts expect that Smucker’s organic sales growth will average 2% annually over the long term, and it is also expected that market share in coffee and dog food will persist as Smucker struggles to compete with strong brands such as Starbucks  and BLUE. As per Morningstar analyst perspective, Smucker will be one of the few packaged food companies to realize lasting benefits from the pandemic, given the high-single-digit increase in pets adopted during the crisis and the likelihood that more flexible work arrangements should result in higher consumption of at-home coffee. This impact will not be immaterial, as collectively, pet food and coffee compose nearly 70% of Smucker’s sales. Further, Smucker’s sales trajectory should improve as Uncrustables (5% of fiscal 2021 sales) becomes a greater portion of the mix, as the brand has grown double-digits in each of the past several years. In addition, recent and pending divestitures of slower-growing brands (Crisco, Natural Balance, private label dry pet food, juices, and grains) should further improve Smucker’s ability to accelerate its top-line growth.

Financial Strength

After years of a conservatively leveraged balance sheet, with net debt/adjusted EBITDA consistently below 2 times, the Big Heart Pet Brands acquisition in 2015 increased the ratio to above 6. Net debt to adjusted EBITDA was 2.4 times in fiscal 2021. Smucker’s free cash flow as a percentage of revenue has averaged high single digits to low double digits historically and similar results are expected forward also. Smucker seeks to invest half of its capital in growth initiatives (capital expenditures and acquisitions) and return half to stakeholders via dividends, share repurchase, and debt reduction. Morningstar analysts expect that Smucker will invest 3.5% of annual sales in capital expenditures over the long term. Analysts also expect that Smucker will continue to reshape its portfolio through acquisitions and divestitures. The estimated dividend payout ratio will range between 40% and 50%, in line with management’s long-term targets, with forecasts anticipating 2%-6% annual dividend increases. Morningstar analysts also expect Smucker to repurchase 0%-5% of shares annually, which we view as a prudent use of capital if the share price remains below our fair value estimate.

Bulls Say

  • Smucker’s sales trajectory should improve over time due to the divestiture of slow-growing brands and the increasing mix of Uncrustables, which grows at a double-digit pace. 
  • During the pandemic, consumers adopted 11 million pets and purchased 3 million coffee machines, which should provide a lasting benefit for categories representing nearly 70% of Smucker’s fiscal 2021 sales. 
  • Executive leadership changes (newly created chief operating officer role, leadership changes for the U.S. sales organization and the pet food segment) should improve execution and enhance accountability.

Company Profile

J.M. Smucker is a packaged food company that primarily operates in the U.S. retail channel (88% of fiscal 2021 revenue), but also in U.S. food-service (5%), and international (7%). Its largest segment is pet food and treats (36% of 2021 revenue), with popular brands such as Milk-Bone, Meow Mix, 9Lives, Kibbles ‘n Bits, Nature’s Recipe, and Rachael Ray Nutrish. Its second-largest category is coffee (33% across channels) with the number-two brand Folgers and number-six Dunkin’. Other large categories are peanut butter (10%), with number-one Jif, fruit spreads (5%) with number-one Smucker’s, and frozen hand-held foods (5%) with number-one Uncrustables.

 (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
Shares Technology Stocks

NextDC benefits from industry megatrends

Business Strategy and outlook

NextDC is well-placed to benefit from industry megatrends, including the growing adoption of cloud computing, the Internet of Things, and artificial intelligence, leading to exponential growth in data creation. As per Morningstar analyst forecast NextDC will materially expand its capacity over our 10-year forecast period in order to meet growing demand for data center services. 

The COVID-19 pandemic has accelerated the digital transformation of many businesses and expedited demand for co-location data centers. Large numbers of employees have made the transition to remote working arrangements, leading to a greater reliance on digital technologies such as video conferencing and cloud-based platforms, and reducing the need to store servers at a centralized location. Beyond the COVID-19 pandemic, it is expected that remote working levels will remain elevated above pre-pandemic levels, resulting in continued demand for digital technologies and potentially less need for physical office space. This shift has increased demand for data centers and hybrid and multi cloud data storage solutions, which are supported by co-location data centers like NextDC. Hybrid solutions, which combine traditional infrastructure with cloud storage, can improve business outcomes through reduced latency and costs, increased security and resilience, and the flexibility to connect to multiple clouds based on business needs. These solutions provide greater flexibility and allow businesses to scale their data storage capacity based on workflow. 

As per Morningstar analyst, interconnection services are becoming increasingly important for NextDC as more businesses make the transition to hybrid cloud storage models. As of fiscal 2021, interconnection revenue contributed 8% of NextDC’s total recurring revenue and this will trend higher over time as its network ecosystem matures.

Financial Strength

NextDC is in sound financial health. The company raised AUD 862 million in fiscal 2020 via an institutional placement and share purchase plan. Proceeds from the equity raising will be used to fund the development of a third Sydney data center and further capacity expansion at its existing and new sites. Morningstar analyst forecast, gearing, measured as net debt/EBITDA, to deteriorate to above 3.6 times in fiscal 2023 as NextDC continues to invest heavily in portfolio expansion, before recovering from fiscal 2024 as capacity utilization improves. Morningstar analyst forecasted that NextDC will invest about AUD 4.0 billion during the 10 years to fiscal 2031 to grow total power capacity at a CAGR of 16%. It is also expected that NextDC will only consider paying dividends when it has accrued sufficient franking credits, otherwise the capital would be better spent on investments or repaying debt.

Bulls Say

  • NextDC is well placed to benefit from industry megatrends including the growing adoption of cloud computing, the Internet of Things and artificial intelligence leading, to exponential growth in data creation. 
  • The shift to cloud-based services increases the need for enterprises to connect to numerous cloud providers and the connection is fastest, safest and most efficient in a co-located data center. 
  • The COVID-19 pandemic has accelerated the digital transformation of many businesses and is leading to increased demand for cloud-based services.

Company Profile

NextDC is an Australia data center developer and operator with a focus on co-location and interconnection among enterprise and government customers, global cloud and information and communications technology, or ICT, providers, and telecommunication networks. NextDC provides physical space, cooling, power, and security services and offers optional technical and project management support. The company’s tenants house their servers within the data center and can connect to each other via physical and virtual connections.

 (Source: Morning Star)

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.