Single-use medical scopes, teeth straighteners, pet care and groceries. These are just some of the areas where Ned Bell has been finding value in the global small to mid-cap arena.
In a presentation entitled “A game plan for managing volatility”, Bell and senior equity analyst Joel Connell this week profiled some of the holdings in Bell Asset Management’s Global Emerging Companies Fund.
The fund's aim is to outpace the benchmark, in this case the MSCI World SMID Index, over rolling three-year periods. Since its inception in late June 2016, it has returned 11.4 per cent a year.
“This is the creme de la creme of global small- to mid-cap investing,” Bell said in a briefing on Wednesday.
“These are fantastic companies. They've got very high quality franchises that are quite unique. It's really important that they've got good organic growth characteristics.”
Bell groups some of the fund's picks in various buckets to underscore the different role the companies play in the portfolio.
The fund, which is outside Morningstar coverage, uses the following buckets:
- Partners Group (PGHN): Partners Group Holding is a publicly-traded, private-market investment group with worldwide operations, primarily in North America and Europe. The company's investments originate mostly from its private equity, private debt, private real estate, and private infrastructure deal flow.
- Rightmove (RMV): Rightmove is a UK-based company that runs rightmove.co.uk, the UK's largest online real estate portal and property website. It is listed on the London Stock Exchange and is a constituent of the FTSE 100 Index.
- PoolCorp (POOL): World’s largest wholesale distributor of swimming pool supplies.
High return on capital
- Broadridge Financial Solutions (BR): Leading provider of investor communications, technology-driven solutions, and data and analytics to the financial services industry.
- Novozymes (NZYM): Danish global biotechnology company, focusing on research, development and production of industrial enzymes, microorganisms, and biopharmaceutical ingredients.
- Mettler Toledo (MTD): Mettler-Toledo supplies weighing and precision instruments to customers in the life sciences (50pc of sales), industrial (42pc), and food retail industries (8pc).
Strong balance sheet
- Icon (ICLR): Icon is a global late-stage contract research organization that provides drug development and clinical trial services to pharmaceutical, biotechnology, and medical device firms.
- Arista (ANET): A software and hardware provider for the networking solutions sector. Operating as one business unit, software, switching, and router products are targeted for high-performance networking applications, while service revenue comes from technical support.
- Checkpoint Software Technologies (CHKP): A multinational provider of software and combined hardware and software products for IT security, including network security, endpoint security, cloud security, mobile security, data security and security management.
- Bunzl (BNZL): A FTSE 100-listed global distributor of non-food consumables, including disposable cutlery, cleaning products, and personal protective equipment.
- Kroger (KR): The leading American grocer, with 2,757 supermarkets operating under several banners throughout the country as of the end of fiscal 2019. Around 82pc of stores have pharmacies, while over half also sell fuel.
- AmerisourceBergen (ABC): an American drug wholesale company that was formed by the merger of Bergen Brunswig and AmeriSource in 2001.
- Idexx Laboratories (IDXX): Primarily develops, manufactures, and distributes diagnostic products, equipment, and services for pets and livestock.
- Align Technology (ALGN): A medical (dental) device company primarily known for the Invisalign system, which is an alternative to traditional braces to correct a wide range of malocclusion issues.
- Ambu (AMBU): Denmark-based company providing single-use flexible endoscopes and is dedicated to optimising hospital workflows and improving patient care.
- CHR Hansen (CHR): Founded in 1874 and relisted in 2010 after five years of private ownership, Chr. Hansen is a global bioscience company with 2,700 employees across 30 countries.
- Church and Dwight (CHD): The leading producer of baking soda in the world. Around a dozen of its products are sold under the Arm and Hammer brand umbrella, such as baking soda, toothpaste, cat litter, and carpet cleaner.
- Cerner (CERN): Cerner is a leading supplier of health care information technology solutions and tech-enabled services.
Bell says he finds bargains by restricting his focus to about 150 companies, some of which are outside Morningstar coverage. “Getting to know them really well means you are far less likely to make mistakes than if you're just willing to invest in anything that comes along.”
Since the end of May, Bell has invested in names such as confectionary giant Hershey (NYSE: HSY), IT consulting company Booz Allen Hamilton (NYSE: BAH), and Zebra Technologies (NASDAQ: ZBRA), which makes barcodes and specialty printers.
“The companies we've got have grown their earnings 15 per cent annually. The point being you don’t just need to own the large-cap tech stocks for growth, you can get down into the weeds of SMID and find some terrific businesses that are growing really well organically.
“They’re not going to grow much this year, but once we come out of the other side of COVID-19, we’ll find those organic growth drivers will come back and these high-quality companies are the ones that are going to rebound fastest.”
Some of the companies Bell and Connell singled out for praise include Idexx Laboratories, Align Technologies, Danish medical devices maker Ambu and Kroger, which is the largest holding in the portfolio.
'These are fantastic companies. They've got very high quality franchises that are quite unique. It's really important that they've got good organic growth characteristics': Ned Bell on the Global Emerging Companies Fund.
Here are some of Connell’s thoughts (with corresponding Morningstar comments where applicable) on Idexx Laboratories, Ambu, Align Technologies, and Kroger:
“They're the market leader in animal health diagnostics. If you have a pet and take it to the vet for some type of diagnostic test then there's a high likelihood that Idexx's platforms play a role in that test,” Connell says. “So they are over three times' the size of the next three largest competitors. They make up more than 80 per cent of the industry R&D spend so they're in a strong competitive position and as they have some great structural drivers in terms of pet ownership trends, which we think bode well for continued long-term growth.”
Morningstar’s Debbie Wang, writing in late May, has a different take. The stock is currently trading at US$365, which means it’s overvalued by 120 per cent against her fair value estimate of $US166.
“We’re holding steady on our fair value estimate as we still expect further pressure on margins to show up over the next few quarters along with slower top-line growth,” Wang wrote in early May after strong first quarter results.
“Considering there’s likely to be a dip in high-margin consumables along with Idexx’s goal to keep its reference labs open (with its relatively high fixed costs), this should weigh on profitability in the near term. Nonetheless, we see nothing to suggest Idexx’s strong narrow moat has eroded. We think the firm’s cost advantage through its network of reference labs, as well as switching costs associated with benchtop analysers, should weather the COVID-19 crisis just fine.”
Connell sees Ambu as benefiting from increased demand in the short term but also in the long term. “Ambu produces a range of patient-monitoring and diagnostic products and the key growth driver is single-use scopes. These are scopes to see inside a patient's body. They're used in a range of procedures such as a bronchoscopy and a colonoscopy.
“Currently there's around 100 million endoscopic procedures performed globally each year. And at the moment, the overwhelming majority of procedures are done using reusable scopes. The big issue with those reusable scopes is that there's risk of contamination or infection if they're not cleaned or sterilised properly – which unfortunately happens much more than you'd expect.
“Ambu's single-use scopes basically eliminate that risk of infection, which is great from patient-health point of perspective, and it also reduces the risk of litigation for the hospital. So we expect Ambu's single-use scopes to take significant share of reusable scopes over the next five to ten years.
Connell says the single-use market is set to grow from its current size of about $500 million. “Ambu estimates this could grow to $2.5 billion by 2024 so that's a fivefold increase. And we think that's very achievable based on the work that we've done.”
“We saw many dental clinics close or only doing emergency dental work during much of the June quarter, so this is going to weigh quite heavily on near-term earnings of many dental-related companies,” Connell says.
“But we do expect a fairly sharp recovery as the dental clinics reopen and we do still think there are some excellent structural growth stories like Align Technology, which we own. Align is the market leader in clear aligners, we're thinking the InvisAlign brand.
“This year is certainly going to be very weak for Align but we expect a strong recovery next year because they've got a very strong net cash balance sheet and they've continued to invest through the downturn.
Align is trading at US$317, which is an 82 per cent premium to the US$175 fair value estimate of Morningstar analyst Soo Romanoff. She assigns the company no moat and says it carries a high uncertainty rating because of competitive threats. “The company faces stiff competition from a host of competitors with comparable offerings at a lower price,” Romanoff says in her most recent note of 30 April.
“Peers have had some time to catch up with Align's product complexity and automated production expertise through internal development and acquisitions, which should have an adverse impact on the company’s competitive positioning. The company will continue to experience meaningful growth from unpenetrated international markets and the expansion into generalist dentistry and consumers, but this growth will likely adversely impact average selling price.”
“One of the companies we think is still being mispriced is US food retailer Kroger,” says Connell. “They’re one of the largest food retailers in the US, just think a Coles or Woolies. We initiated our position in Kroger in July last year. At that time, we identified a number of catalysts and the stock was trading at a very attractive valuation—just under 10 times PE and close to 10 per cent free cash flow yield.”
Kroger is trading at about US$35, which is in line with the US$30 fair value estimate set by Morningstar analyst Zain Akbari. “Our estimate or narrow-moat Kroger should not change significantly after exceptional first-quarter sales growth that suggests it is on track to meet our full-year targets,” says Akbari. “Our view that the pandemic will accelerate grocery digitisation also remains, as does our long-term forecast of low-single-digit top-line growth against 4 per cent adjusted EBITDA margins on average over the next decade.”