Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and here with me today to give his three stock picks is Richard Bullas, Manager of the Bronze Rated Franklin U.K. Smaller Companies Fund.
Hello, Richard.
Richard Bullas: Hi, Emma.
Wall: So what's your first U.K. stock?
Bullas: The first one I'd like to mention is a company called Lavendon (LVD), which is a £350 million company based in the U.K. Lavendon is an equipment rental business, so they rent out things like powered-access platforms, like boom lifts, scissor lifts, cherry pickers, primarily to end markets such as construction, facilities management, utilities and telecoms.
So they had a new chief exec joining the group about two years ago, who actually came in, did a lot of self-help in a difficult period of time, sort of managing sort of procurement and looking after the efficiency within the business and driving profitability and returned a couple of employees for the business in a difficult market.
It’s the market leader in the U.K., number one in the U.K., number one out in Germany, but also number one out in the Middle East as well. That's all they do, it's not general hire, it's access platforms.
So actually the U.K. at the moment, which is about 40% of profitability, you sort of reach an inflection point in the U.K. where sort of construction activity is now going to come back to the U.K. and they're starting to see volume coming through again in the U.K., but also price increases, which is quite a key determinant for profit growth in the future.
So I like what's out in the U.K., Germany is now stabilising and actually out in Saudi Arabia and the Middle East –where they've a notable market share, a 70% market share – there’s a huge infrastructure spend going on in the Middle East at the moment. That's about 30% of profitability, up to $2 trillion worth of infrastructure spend on cities and roads and oil and gas plants ahead of the 2020 Expo and the World Cup out there. So they’re really well-placed out in the Middle East to grow. That's the one I'm quite keen on for the fund. It’s a key holding in the small-cap fund.
Wall: I mean, it is globally diversified, which is great, but the thing with construction is it is very based on macro. I mean, one of the reasons why construction is picking up in the U.K. is because of the recovery, because of the new housing that's all out there. Similarly in the Middle East, there is a lot of construction that was massively paused when they went into recession especially in Dubai. Is that a concern that it's so reliant on that macro backdrop?
Bullas: It is. It's been in position for the fund for a number of years and we've slowly sort of built up a position as we've gained confidence in the outlook in the business. So you are seeing a cyclical recovery now in their end markets and that's what I'd say, characterise a company as. So hence, where I'm at a point now where if I would bounce a risk and reward and it's now top position in the fund.
So, yes, we watch that sort of data very, very closely, bringing the data points we're seeing now in terms of construction in the U.K., Europe stabilising and Middle East growth coming through, I'm pretty confident the company's actually got a great platform for growth in those end market recoveries.
Wall: What's your second stock then?
Bullas: Second one I'd mention is Avon Rubber (AVON), which has been a key stock for the fund since we took it over two years ago. Avon Rubber is a manufacturer and rubber technology is the combining theme between the two divisions. They have two divisions, both world-leading market-class divisions, one is defense division, where they manufacture a respiratory mask, a gas mask or nuclear chemical and biological gas mask, primarily for militaries. So they have a 10-year source requirement agreement with the Department of Defense in America, supplying them number one mask in the world, the opportunities for that to now – to sell that to other non-DoD militaries around the world. That's going very well. So a lot of investment in the business is starting to come through in terms of top line growth.
The other side of the business is the dairy division; two different divisions with dairy, the connection is rubber. Dairy, they supply a liner and some technology that goes into milking cows, automating milking processes. Big market out in America for them and actually going of bit of a cyclical recovery our in America in terms of their markets with dairy. This is the best conditions for dairy farms in America for the past sort of four years with milk prices starting to rise, feed cost starting to reduce, so farmers' margins are quite wide, hence they're willing to sort of spend a bit more on sort of automated milking processes. So, very well placed to benefit from that upturn in the U.S.
Wall: These are the intense farming methods that have been so berated on The Archers?
Bullas: It is intense; you're right. But this sort of lines they provide are sort of in the consumables, they sort of wear out after so many sort of million compressions, there is a replacement cycle with this sort of equipment they provide as well.
Wall: What's your third stock?
Bullas: The third stock is, I'd just mention Topps Tiles (TPT), which is a tile retailer. 320 stores up and down the U.K. Topps has had difficult five years, in the downturn from 2007 onwards, I mean reduction in housing transactions and consumer confidence retrenching. Tile sales are highly correlated to housing transactions. We're seeing that really as a secondary play on the housing recovery. So we started to buy in the stock about 18 months ago in the anticipation that at the end of '13, early '14 we're going to start to see a pick-up in sort of tile sales for the group.
That's what we're starting to see now. They've come through the downturn in great shape. They have taken market share from 22% to 28% to the U.K. So really well placed now for the recovery in the top line growth and that's starting to come through now in very positive like-for-like growth. So it’s fixed-cost operating model, so quite high operational gearing, so any sort of increase in sales will lead to material increase in profitability.
Wall: A lot of companies like that where massively battered by e-commerce. I mean, how much have Topps Tiles turned to that part of their business, or is this model sort of immune to e-commerce threat?
Bullas: In terms on online sales, it is a potential threat. I mean, I think only about 2% of their sales actually are online, their sort of marketing portal is their website really, so it's used for information rather actually transactions. So, it's just a difficult product to sell online. It's easy to deliver, but then you've got the returns issue as well. So there are competitors out there, without a doubt they're offering cheaper tiles. But I think Topps are actually well placed now, I mean that sort of breadth of store base and having that in-store knowledge and service capability for them to set them up apart from the cheaper online competitors.
Wall: Richard, thank you very much.
Bullas: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
