What do Netflix (NFLX), Airbus (AIR) and Pernod Ricard (PI) all have in common? Very little on the surface; a disruptive TMT stock, an aerospace firm and a 200-year old spirits maker – but they all dominate their chosen field.
Netflix is the leading home entertainment service, Airbus operates a duopoly with Boeing, and Pernod is second only to Diageo (DGE) as the largest drinks company in the world. And they are all found in Capital Group’s Gold Rated New Perspective fund.
Investment director David Polak says Capital’s approach is to invest in large, truly international companies with at least 25% of revenue or assets outside of their home market – Barclays (BARC) bank qualifies for example, where Lloyds (LLOY) does not.
There is a focus on the long term; more than 35% of the portfolio holdings have been in the fund for more than eight years, a further 15% for between five and eight years. And ideally these businesses operate as triopolies or duopolies – with great barriers to entry.
“Take Facebook (FB) for example. Despite the data scandal of last year, it is stronger than ever,” says Polak. “In fact, we consider it is now even better company, harder to topple. Facebook spent a considerable amount of money on protecting its database following the disaster, meaning any competitor would have to spend a similar amount – which is hard to do as few companies have that kind of cash.”
Capital also likes markets where there has been merger activity; “tighter supply and consolidation should mean higher valuations” Polak adds.
Are the portfolio managers – seven of them, with an average 28-year investment experience – worried about the disruptors becoming the disrupted?
“It is hard to see how some of these tech giants would be knocked off the top spot,” says Polak, “but we are aware of the threats. Rather than competitors it is more likely regulation and policy would cause their demise.”
Tech firms such as Amazon (AMZN), also a holding, have recently begun experimenting with fintech initiatives – hinting at parallels with the emerging market conglomerates and calling to mind the phrase “jack of all trades, master of none”.
But Polak and his colleagues are not worried by this divergence, saying that as long as a tangential development chimes with a company’s strengths then it is only going to strengthen their offering.
“You have to be a more tolerant investor when it comes to these companies. Innovative firms fail. Amazon Fire Phone was failure – but out of that project came Amazon Web Services which is now driving revenues,” says Polak. “We have a sense of the adjacencies of companies we invest in, their strengths and their weaknesses. We are reasonable judges being long term investors. If they went in a direction that alarmed us, we would speak with management.”
Netflix
“People are concerned by Netflix’s debt levels and high valuation,” says Polak, “but we think it has only scratched the surface of its potential market.”
Currently Netflix has around 150 million subscribers globally, but Capital believes the potential for growth is only capped by the number of people who have broadband worldwide – currently two billion people. Polak names Netflix strength as its ability to localise its focus; in Asia there are local market series and made-for-Netflix films, across Europe there are local language offerings. He also cites the high production quality; “The Crown cost $150 million to make and you could tell. Some of the scenes were just beautiful”.
Morningstar equity analyst Neil Macker is less bullish on Netflix, considering the stock currently overvalued at the $394 share price, but agrees the global addressable market is huge.
“Already the largest provider in the US, Netflix has expanded rapidly into markets abroad as the service now has more subscribers outside of the US than inside,” he says. “The firm has used its scale to construct a massive data set that tracks every customer interaction. It then leverages this customer data to better purchase content as well as finance and produce original material. We believe that this data and ability to leverage will help Netflix remain the largest provider in the US and enjoy success in many of its newer markets.”
Airbus
Airbus may have recently retired one of its flagship models, but Polak says this is no cause for concern – rather it shows the firm is willing to bite the bullet and face shorter term pain for long term gains.
“The tech development on the newer models is impressive. As customers we are now able to travel in more comfort, enjoy improved cabin pressure. But for operators these newer models mean more efficient engines, lighter planes – once orders hit an inflection point this generates free cashflow for Airbus,” he says.
Morningstar senior equity analyst Chris Higgins says Airbus enjoys a competitive advantage over peers thanks to its significant intangible assets from the technically demanding and highly regulated industries that it operates within, and customer switching costs emanating from the high cost of failure associated with commercial aircraft, helicopters, and military hardware.
Pernod Ricard
Pernod’s presence in cognac in China and whisky in India, give the firm a solid emerging-market volume growth opportunity. Pernod’s investment into its China and India distribution channels have paid dividends for the firm, which manufactures Jameson whiskey, Malibu rum, Absolut vodka, Beefeater gin, Perrier Jouet champagne – to name just a few.
Capital like the firm as it is well placed to benefit from consolidation within the sector – something Morningstar equity analysts also note. Philip Gorham says: “Outside of the top five firms, the industry is highly fragmented, with local players often dominating in niche product categories or narrowly defined geographies. These firms present a new wave of merger opportunities for the industry consolidators – including Pernod – to strengthen their presence in emerging markets.”
