Joel Connell, Senior Global Equities Analyst at Bell Asset Management, travelled to North America for two weeks in June attending the Jefferies Global Healthcare Conference, R.W. Baird Consumer and Technology Conference, and visited a range of companies in New York, New Jersey, Philadelphia, Kansas City and Montreal.
What was the purpose of your trip?
The research trip involved a combination of ‘discovery research’ in order to find new ideas for the portfolio and ‘maintenance research’ meetings with a number of companies that we know very well, some of which are currently held in client portfolios. My meetings were predominately focused on Healthcare and Consumer related companies, but I also met with companies across a range of other sectors including IT, Financials and Industrials.
What was the general feeling from the corporate management teams you met with?
Management at most of the companies I met with were overwhelmingly positive about macro conditions in the US and across most parts of the globe. The benefits of US tax reform have given corporates more capital and confidence to spend, unemployment remains at multi-decade lows and consumer confidence in the US is the highest in nearly 20 years. While interest rates are rising, they still remain low by historical standards and are not yet having a material impact on household spending patterns.
As an example, Ametek, a US industrial company that provides niche electronic instrumentation to a variety of end markets across the globe, including energy, general industrial, healthcare, trucking, defence and aerospace, noted that for the first time in a long time they were seeing ‘broad based strength across all regions and sectors’. Other companies such as Fiserv and Jack Henry and Associates who provide technology services to clients in the Financial sector, were very upbeat and positive about the macro conditions, with the Fiserv CEO noting that this was the ‘best market from a selling perspective since 2006’.
Do you think positive economic conditions are sustainable? Any headwinds to note?
Fundamental operating conditions remain very positive for most sectors of the market, however there are a number of headwinds that we are monitoring closely, including wage inflation, rising logistic/freight costs, rising interest rates, commodity/input cost inflation and elevated valuations in some segments of the market. Fears surrounding tariff wars and political instability are rising but until recently have largely been ignored by investors. While we do not expect any of these risks to derail the positive momentum in corporate earnings in the near term, we do expect volatility to remain elevated in the second half of 2018 and looking into 2019. The current conditions are leading to a greater focus on stock specific fundamentals, balance sheets and valuations, which we think is very conducive to our investment approach delivering outperformance.
Any key takeaways for the healthcare sector?
Performance and sentiment in the healthcare sector is somewhat bifurcated. On the one hand, many of the companies in the med-tech and life sciences / tools segments are delivering strong performance and sentiment remains very positive. While we view fundamentals for many stocks in these sub-segments of the market to be attractive, we see some risk around valuations and tough comparisons in late 2018 / early 2019. On the flip side, many large cap pharma and biotech stocks have underperformed and are attracting very little attention from investors at the moment. There is still uncertainty about how Trump’s drug pricing reform proposals will play out but we believe that valuations look quite attractive for certain names in the sector such as Johnson and Johnson. We expect M&A activity across the healthcare sector to pick up in the second half of 2018. Overall, we remain overweight Healthcare as we believe many names in the sector offer an attractive combination of defensive earnings growth and attractive valuation.
Any interesting new ideas for the portfolio?
Two thirds of the companies I met with were names that we do not currently hold in any client portfolios. Two of the more interesting names were:
- Marsh and McLennan – Marsh and McLennan (MMC) is a global professional services firm offering risk, insurance and consulting services across a range of different industries. We have been following the company closely for a number of years and our meeting with management in New York reiterated the positive investment case. MMC has delivered very consistent returns over a long period of time at relatively low levels of volatility – they are one of only 17 companies in the S&P500 to grow EPS at >8% every year since 2010. Growth has been driven by a combination of organic revenue growth (typically 3-5% per year), contribution from M&A (~2% per year), excellent margin expansion and consistent share buybacks. The investment case is also well supported by a high quality and disciplined management team, solid balance sheet and 2% dividend yield. We believe this is a good quality company trading at a reasonable price (17.5x P/E) and subsequent to our meeting with management we established a position in MMC.
- Ecolab – Ecolab is the world's leading developer of hygiene, water, and energy solutions for the hospitality, food services, health services, industrial and energy markets. 90% of the company’s revenue is recurring and the company has an incredibly diverse global customer base including many of the world’s leading multi-national companies such as Apple, McDonald’s, Coca Cola and Starbucks. After delivering 3 years of earnings growth below the company’s long term 15% EPS growth target, impacted by a number of factors including FX headwinds and the oil market downturn, 2018 should be a stronger year for Ecolab with organic revenue growth moving back to 4-5%, the company delivering strong incremental margins and buying back stock to help return to mid-teens EPS growth. Raw material inflation remains a headwind in the near term but this should be largely offset by increased pricing. The company also ranks highly from an ESG perspective, receiving a AAA rating from MSCI and was named by Newsweek as the second greenest company in the US in 2017. We do not currently have a holding in Ecolab but view it as a high quality company and are monitoring the stock closely for an attractive entry point.
Did you meet with any existing portfolio holdings?
Yes, 16 of the 49 meetings I had were with existing portfolio holdings. Along with positive meetings with portfolio holdings such as Becton Dickinson, Alimentation Couche Tard, CGI Group and Mettler-Toledo, two of the highlights were:
- Zoetis – Zoetis is a leading global animal health company that develops and manufactures medicines and vaccines for the livestock and companion animal markets. We have held Zoetis in our portfolio for over 2 years, having established a position at approx. $40 versus the current share price of $85. My meeting with management at the company’s head office in New Jersey yet again reinforced the positive aspects of the long term investment case. Zoetis faces far less risk from regulation and generics than human health companies and has good pricing power due to the fragmented and largely cash-pay customer base. Their scale provides good competitive advantages with respect to high levels of investment in R&D, the industry’s largest salesforce and excellent diversification by product, animal species and geography. We believe that Zoetis is very well placed to continue growing the top line in excess of the 4-5% market growth rate and will deliver ongoing margin expansion to help drive defensive double digit earnings growth.
- Cerner – Cerner is a leading global supplier of healthcare information technology (HCIT) to hospitals, health systems and physician practices. My meeting with management further reiterated the positive long term investment case for Cerner. The company recently signed a massive $10b, 10 year contract with the VA which follows on from a $4b contract with the DoD awarded in 2015. This contract helps to underpin Cerner’s long term target of 7-12% revenue growth, particularly given that almost 90% of revenue is recurring or highly visible in nature. The company invests a significant amount of money in R&D (>$700m p.a.) to drive solid organic growth and ensure it maintains its competitive edge for the long term and is also well supported by a strong net cash balance sheet. In addition to meeting with Cerner’s CFO, Marc Naughton, I was also given a tour through the company’s technology centre which showcased the impressive technological capabilities of the software platform. We recently established a position in Cerner at an average entry price of approx. $57 and believe that the long term investment case remains very attractive.
Implications of the trip for your portfolio?
My research trip has uncovered a number of interesting new investment ideas that we will conduct further research on in the coming months. We would not expect to make any major changes to the portfolio but the rising market volatility that we have seen over the past 6 months is certainly presenting some very good investment opportunities.
We will continue to invest in highly profitable companies with strong franchises, high quality management teams and solid financials, while remaining diligent about the price we are willing to pay for these stocks. In particular, we continue to find many good investment opportunities in the small and mid-cap space where there is often greater disconnects between quality and value, particularly as the amount and quality of sell side research continues to deteriorate following the implementation of MiFID II. Additionally, stocks in the small and mid-cap segment of the market arguably face less ETF driven momentum risks than large and mega caps and therefore will be less prone to indiscriminate selling should ETF flows turn negative.