Most investors have long-term investment goals or needs. However, equity markets have been affected by a growing trend of short-termism in recent years. Companies are under pressure to deliver short-term financial results due to a greater emphasis on quarterly earnings, share price movements and market activity. But short-termism can lead to insufficient investment in the sources of a company’s competitive advantage, as well as capital allocation decisions that are value destructive and misaligned with the needs of investors.
Quality companies understand that they are there for the long haul. Because they operate in stable, growing industries, with low sensitivity to economic and market cycles, they don’t subscribe to short-termism. These capital light companies are able to invest more heavily in research and development (R&D) as a percentage of sales, driving product innovation and improving brand awareness and loyalty. This not only contributes to self-funded future growth, but also strengthens barriers to entry and protects companies from disruption and competitive threats.
Their financial strength and hard-to-replicate enduring competitive advantages enable them to generate and sustain higher levels of profitability than the broader market over the long term. These competitive advantages are most prevalent in the consumer staples, healthcare and technology sectors. This is where the Investec Global Franchise Fund is primarily focused, and it is these consistent businesses that we label ‘quality’. Below we have highlighted some of the key holdings in our portfolio and the attributes that make them attractive to us.
Healthcare giant, Johnson & Johnson, touches the lives of over a billion people every day across the globe. The 131-year old company is the largest holding in our portfolio, and one of our greatest compounders. The business dominates global healthcare, with 70% of its sales in either number one or two market share position. This well-diversified business spans consumer healthcare, medical devices and pharmaceuticals. While consumer brands such as Band-Aid, Listerine and Johnson’s baby products may be well known to many, the group is a world leader in surgical equipment and pharmaceutical drugs. The pharmaceutical division is the group’s biggest contributor to profits and it offers a host of treatments in areas such as cardiovascular, immunology, infectious diseases, oncology and neuroscience.
A substantial investment in R&D, fuelling a strong product pipeline, has enabled Johnson & Johnson to maintain its top position in the healthcare industry. Last year alone, this cash-flush company spent US$9.1 billion on R&D. The robust pipeline in its pharmaceutical business, combined with the improvements in the consumer and medical device businesses, instils confidence that it is well placed for consistent performance in the years ahead. It has an impressive track record of growing dividends for more than five decades, creating long-term value for shareholders. Furthermore, the company’s strong balance sheet, boasting US$8.5 billion of net cash, offers significant downside protection.
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Technology heavyweight, Microsoft Corp, which was first purchased by the Global Franchise Fund in February 2011, is one company whose success can be attributed to its dynamic approach to innovation. It has evolved from the historical focus on Windows and on-premise licence applications, to a cloud-centric and mobile-enabled company. Microsoft is concentrating its efforts on higher value, recurring revenue cloud and Office365/Windows 10 subscription solutions to increase sales and profits. These changes will enable Microsoft to better monetise a user’s lifetime, upsell additional functionality, and integrate Office with other cloud services. Currently, more than 1.2 billion people across the globe use Microsoft Office and 80% of Fortune 500 companies are on the cloud. The expectation is for this commercial cloud business to grow even further to an annualised revenue run rate of US$20 billion in the 2018 fiscal year. Furthermore, the public cloud services market is projected to expand to nearly $385 billion in 2020, and Microsoft wants to capture a larger slice of this market. While there are clear drivers of growth for Microsoft, it is encouraging that the company has also been addressing its cost base. The combined focus on top-line growth and improvements in the cost base has benefited shareholders. Since 2008, it has consistently returned capital to shareholders in the form of dividends and share repurchases, returning another 6.7% in 2016.
Visa Inc., one of the largest retail electronic payment networks in the world, is also one of our top ten holdings. It has 44 million merchant locations globally, enabling its 3.1 billion Visa credit card holders to make payments in real time. Visa’s advanced processing network is capable of handling more than 65 000 transaction messages a second. With US$8.9 trillion worth of transactions recorded in 2016, the company is looking to gain a foothold in China and expand its European network. Its economies of scale, technological innovations and global reach give it a competitive edge to sustain consistent returns for shareholders over the long term.
The world’s largest online booking portal, Priceline, is another key holding in our portfolio. The company owns a host of websites for booking accommodation, rental cars, restaurants and other related services. These include booking.com, Kayak, rentalcars.com, Agoda and OpenTable. Booking. com, a major generator of Priceline’s profits, offers more than 1.3 million properties worldwide. What’s more, Booking.com consumers book over 1.4 million room nights every 24 hours. Priceline’s online booking business has grown substantially over the last few years and the company continues to expand into new geographic locations. Its targeted online advertising campaigns have helped Priceline to remain high in search results and maintain its top spot in the online travel market. The company has enjoyed strong revenue and earnings growth over the last decade. It has also consistently ploughed money back into the business, giving rise to further growth at higher rates of profitability. Its strong partnerships, powerful online brand, mass appeal of its online booking network and ongoing investment in the business should help Priceline to sustain its competitive advantage for years to come.
The Investec Global Franchise Fund is built from the bottom-up with a focus on long-term value creation. Our quality holdings typically have an ability to grow with a lower dependence on the economic cycle than the average business. The current volatile market environment has not significantly changed the fundamentals of these companies, and we believe quality stocks remain an attractive investment over the long term.
All information provided is product related, and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing, up to 10% of fund net asset value to bridge insufficient liquidity, and scrip lending. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. The fund is a sub-fund in the Investec Global Strategy Fund, 49 Avenue J.F. Kennedy, L-1855 Luxembourg, Grand Duchy of Luxembourg, and is approved under the Collective Investment Schemes Control Act. Additional information on the funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). Issued by Investec Asset Management, October 2017.