This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Chris Elliott manager of the Evenlode Global Income fund, picks stocks embracing disruption.
Often referred to as the "City of Light" for its leading role in the Age of Enlightenment, Parisians have always adapted to change. Now its businesses must adapt to a world where industries are rapidly evolving.
Disruption is on the lips of every CEO in the capital, as new technologies upend long-established names and business models. Where companies could once dominate their niche, they now must constantly innovate to maintain leadership positions.
To better understand the challenges facing French companies in our investable universe, Ben Peters and I recently visited Paris to assess how these companies are adapting to a rapidly changing world.
Sanofi (SAN)
Sanofi has revamped its research strategy with three major changes in approach. Firstly, the primary area of research has switched from small molecules to biologics. Secondly, new treatments are multi-targeting various conditions rather than individual illnesses – creating more market opportunities and reducing development uncertainty.
Finally, the firm is increasingly moving away from licensing drugs for sale and towards proprietary drug ownership of the underlying technology.
Alongside these developments, Sanofi is countering pricing pressure for established products, which are non-patent protected, by selling into emerging markets, where volume growth has been excellent. Distribution and sales strategies are localised to the country or region, leveraging Sanofi’s experience as a key differentiator for growth in these markets.
Euronext (ENX)
The European exchange operator is looking to diversify revenues away from transactional fees earned on the trading of equities. To do this, Euronext is focusing on innovation and new markets.
The company has developed the fastest global trading platform, Optiq.
This attracts volumes from high frequency traders and, more importantly, Euronext can licence the technology for use on other exchanges. This helps drive recurring cash flows, cushioning the business from cyclical downturns.
Euronext is also seeking to create public exchanges for other asset classes, most notably fixed income and exchange traded funds.
In fixed income, there is an unmet need: 34,000 LSE bonds do not actively trade due to liquidity constraints. But perhaps a greater opportunity lies in ETFs. Relative to the US, Europe has only a third of the penetration of ETFs, and 70% are traded over the counter. These drivers give Euronext attractive avenues for investment, growth and diversification over the long term.
Publicis (PUB)
Disruption in global advertising has accelerated due to the rise of digital advertising channels, such as Facebook, and ongoing pressure on consumer goods companies to improve margins. However, Publicis has been ahead of the industry in adapting to these changes by simplifying its internal structure to a centralised solutions-based approach.
The company also now provides a digital platform via the acquisition of Sapient and serves as a strategic consultant for customers seeking to achieve greater ad spend efficiencies. For example, Publicis cited the dramatic savings made by Expedia, who switched from an expensive TV campaign to a more effective digital campaign at half the cost.
Publicis also explained the importance of remaining data agnostic, offering the services to analyse data but not selling the data itself. This is particularly important to customers who want to control their own data and use external data from the best source. The company operates with low debt and high free-cash flows, enabling it to invest through the downcycle and take share as others adapt more slowly.
Essilor (EL)
Essilor is the world leader in the production of lenses and in developing the underlying technology. While we do not currently hold Essilor, we do hold Luxottica the company expected to merge with Essilor in the coming months.
Essilor operate ever closer with opticians, partnering to provide training and marketing services around the technical excellence of their product. This contrasts with Luxottica, the maker of Oakley and Ray Ban sunglasses, who control the vertical business processes from material procurement and manufacturing, to marketing and sales.
An experienced management team has been tasked with finding the synergies between these business models and driving savings. The equity ownership culture of Essilor – 54% of employees hold shares – needs to be "sold" to Luxottica but is highly encouraging from a governance standpoint. The merger offers great opportunities, most evidently in China where online sales are growing rapidly, and consumer lens choice is less differentiated by technology and more by brand.
Conclusion
We already knew these companies had excellent competitive positions, economic moats and an ability to generate free cash flow. However, it was refreshing to observe the cultural embrace of new technologies and a view of change as a positive influence. Management teams appear to understand the strong positions they hold will only be retained through careful planning and taking advantage of inevitable change. The French proverb remains true; qui n’avance pas, recule: those who do not move forward, recede.
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