V. ANALISIS DE LA EMPRESA
13) Perfil de la Sociedad
Our portfolios have shifted towards higher quality companies with sustainable barriers to entry
A few discordant commentators question whether the elevated current levels of corporate profits in the US and Europe are sustainable. As bottom-up investors, however, we are more interested in the capital cycle as it affects individual companies than in aggregate corporate profitability. We are on the lookout for factors which might lead to improved returns on equity, in
7 The positions in Amazon.com and Priceline were eventually sold in February and September 2013, having risen respectively by 231 per cent and 1,055 per cent since the date of this piece. Amazon’s stock has continued to perform strongly, up 18 per cent from the date of sale to the end of 2014, yet the company still shows nothing in the way of profit (its net margin in 2014 was −0.3 per cent.)
particular: (1) the emergence of oligopolies in industries hitherto character- ized by low returns and excessive competition; (2) the evolution of business models with high and rising barriers to entry; and (3) management behav- iour which encourages these trends.
Even if European corporate profits decline in aggregate, our portfo- lio companies should be able to resist the trend. That’s because over time, Marathon’s European portfolio has shifted gradually towards higher quality companies with superior barriers to entry.
We have discussed at length our investments in so-called agency business models, including medical devices and building equipment (locks, electrical and plumbing fittings, etc). Essentially, these companies rely on an interme- diary to sell their products (a doctor, plumber, locksmith etc.) whose advice is relied upon by uninformed consumers who do not perceive the common interest of the producer and agent to sell high-margin products. These busi- ness models account for approximately 10 per cent of Marathon’s European portfolio and have an average estimated RoE for 2011 of 27 per cent, some 11 percentage points above the average for European non-financials. Exposure to branded consumer goods has also increased in recent years – including additions of beer stocks, Unilever and Swedish Match – and now represents around 9 per cent of the portfolio, with an average RoE of 48 per cent.
Another class of business whose weight in our portfolios has expanded in recent years has been subscription-based service companies with annu- ity-like revenue streams. Excluding telecom companies, which also have a high degree of subscription-based revenue, these companies now account for around 12 per cent of the European portfolio and have a forecast RoE of 42 per cent. The common theme here is a longer-term commitment made by the customer, together with an element of inertia when it comes to renewals. These factors, in combination with the scale economies which often arise in the provision of subscription services, make for significant barriers to entry and high and sustainable returns.
This is particularly true where the cost of the service is only a small proportion of the customer’s total spending, as is the case for a number of our portfolio companies, including Rightmove, Capita and a handful of information providers. Rightmove, the UK property listings website, enjoys a winner-takes-all network benefit from being the most popular website for property searchers. The company charges estate agents a subscription price per office which is well below the cost of less effective print advertis- ing. When we met the company in March 2011, 65 per cent of subscriptions for the year had already been received, and a further 20 per cent were to be received in May. Price increases this year are in the order of 16 per cent.
In the area of dialysis treatment, Fresenius Medical Care (FMC) has a 34 per cent market share in the US and makes substantial profits from private insurers for whom the cost of dialysis care is only 2 per cent of total outgo- ings. Negotiations with private insurers are on a state-by-state basis, limiting customer buying power, and increasingly insurers are moving to multiyear contracts with built-in price escalators. Capita, the UK business processing outsourcing company, has built up a base of multiyear contracts with local and central government and, increasingly, in the life insurance and pensions administration market. It has been able to improve its margins over time by delivering substantial cost savings for customers and in some cases building competence centres whose costs are spread across a number of clients.
In the area of information providers, portfolio companies such as Experian, Reed Elsevier, Wolters Kluwer and Informa have businesses with unique information whose value for customers depends on having a com- plete data set. Hence, it is hard to consider cancelling subscriptions even during economic downturns. Even Experian, whose data collection business is linked to the growth of credit markets generally, delivered modest growth during the financial crisis.
Together, the above three categories of stocks account for approximately 31 per cent of Marathon’s European portfolio. To these, one can add hold- ings in pharmaceutical and telecom companies, which have high returns (although there are more doubts about their sustainability), and one arrives at a total of close to 40 per cent of the total portfolio (nearer 50 per cent ex- financials). The average RoE of this group of stocks is 39 per cent, 2.4 times the average for non-financial stocks generally.
Although there is variability among this group in terms of sensitivity to the economic cycle and some business models will undoubtedly prove more durable than others, these high RoE business models are likely to outper- form more discretionary areas, particularly those exposed to weak domestic European consumption. Other more cyclically sensitive portfolio holdings are increasingly oriented towards global growth, especially in relation to emerging markets, whose prospects appear more promising than those in the mature Western economies. This shift to quality should render Marathon’s European portfolios less dependent on a precise answer to the question of whether aggregate corporate profits, whether for cyclical or structural rea- sons, are about to be squeezed.8
8 Of the 11 companies referred to in this article (Assa Abloy, Legrand, Geberit, Unilever, Swedish Match, Rightmove, Capita, Fresenius Medical Care, Experian, Reed Elsevier and