- The Shariah ETF will
invest in companies of a high quality with wide economic moats
- The Shariah ETF will take
active positions against the index with typically 30 positions against the
index’s 400 constituents
- Historically, Sanlam Investments has managed to outperform
indices through a rigorous valuation process that selects high quality
businesses
Performance Review
In February the Shariah ETF’s net
asset value decreased by 1.1% in Dollar terms.
With the UK leading the way with its successful rollout of
the Covid-19 vaccine, reopening hopes have given a further lift to cyclicals,
and stocks which benefit from growth and recovery in the economy.
Source of all data: Sanlam Investments. Past performance is
no guarantee of future performance.
What Has Driven This Performance?
The best performing stock this month was Inditex
(11.4%). Taylor Wimpey (9.6%) and
Boston Scientific (9.4%), a new position in the fund this year, also
performed well.
Inditex reported results in March and the market
rewarded the shares in February on anticipation of a good results outcome
versus its more challenged peers. Even though the lockdown last year had a
severe impact on the company, Inditex still managed to keep revenue down only
24.5% at constant currencies as store trading hours were reduced by 25.5%.[1]
Online revenue was up 77% at constant currencies, now contributing 32% of
revenue from 14% in 2019,[2]
helping offset the severe instore sales drop. Online remains an important focus
for Inditex as operating margins are nondilutive to group operating margins and
less capital-intensive compared with stores. As the company continues to shift
more of its sales online over time there will be a net benefit of more free
cash flow for the firm.
The macro environment
for Taylor Wimpey continues to improve as the company will reinstate a
dividend in 2021.[3] Overall,
management has a positive medium-term housing market outlook given the interest
rate environment, supportive policies and good levels of unsatisfied demand.
Following the company’s announced expectation for 2021 operating margins to be
18.5-19%,[4]
management notably expects 2022 to be up a further 100bps year on year.
Management is confident that by 2023 operating margins could be back at
a target range of 21-22%,[5]
helped by incremental volumes from new land acquisitions.
Kao (-7.6%), and Nestle (-6.7%) lagged during
the month. Kao reported results during
the month, missing its full-year guidance and announcing a wider shortfall in
operating profits than expected. Although
demand for hygiene-related products (hand soap, hand sanitizer, home care
products, etc.) increased due to the Covid-19 pandemic, performance of
Cosmetics Business and Human Health Care Business was weak. Whilst in the short term Kao is facing the
realities of the wearing of facemasks affecting its makeup sales, and competition
in baby diapers in China, Kao’s strength in its detergent and skin care brands
remains entrenched. Kao continues to rationalise its cosmetics portfolio with a
greater focus on higher margin prestige brands, and expansion in to China’s
duty-free channel. Whilst the effects of
C-19 are evident, the gradual return to normality should have a positive impact
on this part of the business as travel resumes, and consumers go back to normal
social and working habits. Kao is a
defensive, high quality company with a strong balance sheet and a commendable
track record of dividend growth.
The consumer staples sector as a whole has lagged the market
since the vaccine news back in November, with a clear divergence between stocks
that are obvious beneficiaries such as L’oreal and Shiseido, and
those who do not perhaps have an obvious short term benefit from the world
normalising, such as Kao and Nestle.
This also includes consumer staples giant Procter and Gamble,
whose recent weakness we have been able to use to initiate a new position at a
more favourable valuation. Our long term
theses for these high quality companies remain well intact.
Source of all data: Sanlam Investments. Past performance is
no guarantee of future performance.
Portfolio Activity
We initiated a position in Procter and Gamble during
February, We view P&G as a high quality business with a decent opportunity
to unlock value from its exceptionally strong portfolio of brands, which serves
approximately 4.8bn people worldwide. We are attracted by management putting
greater emphasis on value creation to drive shareholder returns through
productivity and efficiency initiatives. We believe management’s focus on
driving productivity savings could add up to 200bps to gross margins over the next
couple of years. We also see organic growth possibly picking up to the 3% level
with a greater focus on core brands and new product initiatives.
P&G has remarkable record of 62 consecutive years of
dividend increases and we see no reason why this will not continue for the
foreseeable future. This is a fundamentally robust business producing an
excellent return on capital employed of at least 80% during recent years.
We find P&G average free cash flow conversion ratio of
100% over the past seven years as a very appealing metric. After a recent pullback in P&G, the stock
is on the same level as 18 months ago whilst earnings have grown strongly over
this period. With a free cash flow yield
of over 5% two years from now we regard the current share price as attractive
for patient long term investors in a businesses with low debt, a strong market
position and a return on equity of 28%.
Outlook
The investment
world continues to change, and the world is very different to a number of years
ago. There were large drawdowns during
the last 7 years but every pullback was an opportunity to add equity
exposure. Global equity markets have
reached new highs as Central Banks printed $7trillion to fight Covid-19.[6]
For illustrative purposes only. Past performance is no
guarantee of future performance.
Today we are
witnessing extraordinary gains from shares which generate low cash flows
(relative to market value) or burn cash.
Good stories
often end with bad outcomes if they are not backed by sound fundamentals. During
the 2000 technology bubble, the 2008 financial crisis and the 2020 Covid
induced market meltdowns, investors suffered tremendously. Businesses not
supported by sound fundamentals collapsed in the market corrections that
followed; we aim to minimise the risk of being invested in businesses not
backed by sound fundamentals.
We will not
participate in good stories unless they are backed by measurable free cash
flows, and are trading at or below intrinsic value. Every financial crisis is
an opportunity to invest in sound businesses.
We used the opportunities presented to us by the Covid-related market
drawdown, and the subsequent vaccine-induced volatility in the recent months to
invest in superior businesses like Boston Scientific, Procter & Gamble,
Inditex and Edwards Lifesciences.
To remind our
investors, our core investment principals
have been unchanged for the 13 years since the strategy launched:
- Identify businesses with durable high returns on
capital with strong recurring free cash flows
- Stay invested whilst the business is trading at
or below our assessment of fair value
- Don’t sell a great business only because it is
temporarily over valued
- Repeat steps 1-3 over a full investment cycle
Our
high-quality strategy means we avoid businesses which constantly invest all
their free cash flows in the hope of a better future outcome. These types of
businesses are very popular with investors at the moment, however at Sanlam
Investments we prefer businesses where we can identify how the cash is
generated and reinvested.
Source: Seeking
Alpha
The quote from
Charlie Munger below is insightful:
“There are two kinds of businesses: The
first earns 12%, and you can take it out at the end of the year. The second earns 12%, but all the excess cash
must be reinvested — there’s never any cash. It reminds me of the guy who looks
at all of his equipment and says, ‘There’s all of my profit.’ We hate that kind of business.”