Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined today by Blake Hutchins, Manager of the Investec Global Quality Equity Income Fund, to give his three stock picks.
Hi, Blake.
Blake Hutchins: Hi, Emma.
Wall: So, what's the first stock you'd like to highlight today?
Hutchins: Yeah. So, I selected a U.S. stock to start with, which is, ADP. They are very high-quality business and they provide human capital resources for companies and they'll do everything from payroll to recruitment and also, they benefit from the outsourcing trend of HR in the U.S. and in Canada. Actually, they pay 1 in 6 people in the U.S. which is an interesting fact.
Wall: Does that mean it's quite linked to how the domestic economy is doing in the U.S.? We've actually seen record low unemployment in the U.S. which presumably is quite good for this company. But is it sensitive to those kind of changes?
Hutchins: Yeah, at the margin. I mean, they have very much a recurring revenue stream which we like which provides defensive nature across the cycle. About 90% of their revenue is actually recurring each year. So, whilst there is some element of cyclicality to do with employment, actually across the cycle and you see in the last recession they actually grew their revenues. They are currently growing about 8% top-line with margins also progressing. So, we actually like the defensive nature of the business and the very cash-generative nature of the business.
Wall: What's the second stock today?
Hutchins: So, the second stock, I picked a European stock, which is, KONE, probably the best manufacturer of lifts and escalators in the world. They have grown very strongly in China recently and there is an interesting element to that in that they present a little bit of risk which we found gave us the valuation opportunity to get involved in the stock. But then also the way that KONE makes the majority of their money is through servicing the lifts.
So, once they've installed them, in a few years the safety and the servicing elements of those escalators and elevators is so important and that's still very much happening in China. The health and safety standards are increasing in China all the time which is the great long-term driver of KONE's business.
Wall: And I suppose the great competitor of that is Schindler's Lifts. How much market share does KONE have and is that a concern or is it this recurring revenue that really is interesting?
Hutchins: Yeah, it is, and it's actually what we think is the real opportunity for KONE is for its installed base of lifts is to make sure that they service those lifts that they have installed. Currently, in Europe and in the U.S. the proportion of lifts that KONE manufacture that they service is around 80%, but in China that's only around 50% or less and as those standards become more important, KONE can actually benefit from that.
And then in terms of market share, to your point, is actually there's an interesting replacement cycle that is due to happen in Europe. We have a lot of old buildings. So, it's not just about China. There is a replacement cycle of original equipment in Europe to happen on a five to seven-year basis.
Wall: What's the third and final stock?
Hutchins: So, the third one is a U.K. stock and it's one that I tend to get a lot of questions on. So, I picked GlaxoSmithKline actually. It's the biggest holding in the fund. We've been encouraged by recent results with Glaxo. They now have separated their business into three very sensible divisions, pharmaceuticals, vaccines and consumer. So, those three divisions in themselves are very high quality. All of them have growth prospects, they have high returns on capital, they are cash generative and they are capital light, all features that we look for when we analyse stocks for the fund.
Wall: And the pharmaceuticals industry in general, their share prices suffered a few years ago quite significantly when people were worried about this patent cliff. They've rallied since then. So, at this valuation, do you still find Glaxo compelling?
Hutchins: We do actually and there's still a lot of self-help to come from Glaxo. If I think about their consumer division, they are actually only making operating margins of 11% in that division. Reckitt, which is another holding of ours, they make mid-20s or 30% margins in a comparable division. So, we like the self-help angle with Glaxo and also, they've got a pretty good run of time now where there won't be any more patent expiries. So, we think they are pretty well set despite some of the controversy that's out there in the market.
Wall: Blake, thank you very much.
Hutchins: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
