Investing in the future

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The search for pragmatic value not dogmatic value has led Antipodes Partners to invest in stocks such as Merck, Siemens and GE.

The firm’s chief investment officer, Jacob Mitchell speaking to Global Investment Megatrends, says that conventional value investing anchors too much to a cyclical framework.

“We’ve always approached value investing from the perspective of taking into account the starting price, the multiple you are paying and the quality of the growth you’re buying. We want to have more of an awareness of all types of changes, and react when the market is getting it wrong. It is different from value at any price.”

He contrasts this with conventional value investing.

He says: “This stock traded once upon a time at this on this multiple – something’s gone wrong – it’s going to go back. The problem with that framework is ultimately, disruptions and real secular change can be very long term. It can erode competitive advantage or enhance competitors.”

In the case of Merck, a significant holding, a quant process and further analysis identified that the stock was cheap in an expensive part of the market.

The key then was to consider how Merck was faring against the sort of challenges that have increasingly dragged on pharma prices – generally patent and political risk.

The stock has rebuilt its pipeline – especially through Keytruda, a late stage cancer immunotherapy treatment and Gardasil, a vaccine against genital warts ultimately protecting against cervical cancer.

End of the era of the drug blockbuster

However beyond this Merck is also protected against what Mitchell describes as fast followers.

“We call it the fast-follower phenomenon. You used to have drug blockbusters, but today, most of the larger companies will quickly get a me-too product out. So even before the patent cliff, you’re not getting the big profit pool you once did.”

He says that with Keytruda, a treatment which is essentially lifesaving, Merck has done so many trials that it has essentially locked out the fast followers.

“It is very smart. It’s got roughly 10 years. We’ll have a patent cliff eventually, but that is 10 years to find something to invest the free cash flows into.”

He adds that these are transformational therapies where they are not gouging the US patient base unlike firms such as Eli Lilly or Novo Nordisk which is insulin pricing at a massive premium. “We really avoid the obvious targets for drug price control and invest in the companies where you’ve got great innovation, and that are less vulnerable to the patent cliff.”

Clearly extraordinary developments might prove a tailwind but in this case, he feels it would have to be something as unlikely as the almost wholesale nationalisation of much of US healthcare.

He says: “It represents a P/E of 17 for what we see as a sustainable 12% grower, in a world where companies that grow sustainably at 12% are on a P/E of 25 or 26, even companies growing less than that, even if they sell toothpaste, they can be 24 or 25 times.”

He says the firms approach can be described a looking for multiple ways of winning.

“We ask why it’s a resilient the investment? What’s going on in the competitive environment? What is the product cycle? Why is it interesting, the regulatory issues involved, how’s the company mitigating those risks, and management and financial?”

Looking at industrials, he gives two other examples of firms which he believes may be undervalued and even mislabelled as conglomerates when both Siemens and GE are increasingly focused.

He says that they do have some overlap – in healthcare diagnostics, and in gas turbines – the latter an admittedly cyclical area of the market but a sector where absolutely no recovery has been priced in.

“That is not why we own them. With GE it is the undervaluation in aerospace and healthcare. The market is also being irrational around the credit risk in GE.

“With Siemens, the market is not recognising how much investment they’ve made in industrial 4.0, digital factory assets, which are roughly a third of revenue and profits. It’s the world’s preeminent software/hardware, design and automation business.”

He says that there’s a little bit of cyclicality in the business, especially on the hardware side but if you look at Siemens you are getting the business at roughly half the multiple it would be valued at on a standalone basis.

“There’s a fashion today which sort of dictates that everything has to be broken up. Maybe if it was demonstrable for a long period of time, that it had underperformed a as a corporate but quite frankly, it’s compounded at about 8%, which is much higher than GDP and it’s higher than the average corporate compounds. We wouldn’t mind having all the assets spun out to us a pure play companies. But I don’t think that has to happen, to realise the investment case.”

The fund manager is seeking this pragmatic value in an investing world skewed by ultra-low interest rates, though he suggests that growing populism from both left and right, is likely to bring an end to the policy of just using monetary policy and expects more emphasis on fiscal policies. We may be seeing the end of the post Global Financial crisis era almost 12 years on.

He notes that while good companies are often funding growth from balance sheets, the poorer credits still have access to borrowing.

“It’s often the worst quality credits that are accessing that cheap funding and there’s a real risk that is zombifying the economy.

“You have to be very careful not to just to fall into the trap of anchoring to a low multiple, because there will be times it’s a genuinely value trap, while with the crowding that we’ve had into quality, and price is pretty extreme on any measure.

“If you want to buy a top quintile growth, you’re basically paying about two and a half standard deviations more than you’ve typically paid. It’s in consumer staples, devices, medical devices, life sciences, software and the bond proxy types. Someone described it to me the most unenjoyable bull market.”

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