Long Term Value

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  • 13 mins 18 secs
Greg Herr sits down with us to discuss why they put value in long-term investing, what exactly constitutes good value & the ever-increasing appeal of the video game industry.


Alliance Trust PLC


Alliance Trust PLC
River Court
5 West Victoria Dock Road

Phone: 01382 938320

PRESENTER: Greg Herr is Portfolio Manager at First Pacific Advisors and he joins me now. Greg, you’ve got a long-term value-based approach to investing, what exactly does that mean to you?

GREG HERR: Mark, there’s, the long-term value connotes a few different things. The first part, long term suggests to us if you’re not willing to own a business over the course of the next ten years, then you shouldn’t be investing in the first place. So we look out and try to understand what a business might look like over a five-plus-year period in order to think about investing initially. Value for us means a business makes all the quality criteria that we’re looking for but then is selling at a significant discount to our assessment of the company’s intrinsic value.

PRESENTER: You’re talking five, ten years out. How can you look that far into the future with any degree of confidence?

GREG HERR: So what we’re trying to suggest with that is to say let’s take any business that has a product or a service for its customers. If we look out over the next five years, is there anything obvious to us that might come, that would be some kind of a substitute for that service or product? Is there anything that a competitor might do that might cause some kind of a disruption to that service or product? Obviously when you start getting out to ten years, it’s very far into the future, but the goal is, the exercise is to say would we be willing to own this business if it maintained a discounted valuation almost in perpetuity, and if we can’t say yes to that because of anything we know today that might come in the future, then we should avoid it in the first place.

PRESENTER: What sort of portfolio turnover does this investment approach typically generate?

GREG HERR: So what we do whenever we think about building a new position in the portfolio is we always think about we’re going to be owning this for the long term. So what we’re typically waiting for is the difference between where the market is pricing the business today and our assessment of its intrinsic value, for that discount to close. Now our experience in the past has been it takes three to five years for that discount to close, but we’re not wed to any particular holding period. So if a business becomes fully valued in a relatively short period of time because with the valuation discipline we will sell out of it. So there’s no particular holding period we’re emphasising. This past year, for example, we’ve added three new positions and we sold out of four, in the context of a 19-20 position portfolio.

PRESENTER: Can you tell us a bit more about your valuation techniques and in the round what sort of value do you see in equities today?

GREG HERR: Now, so for us valuation is very important on a company by company basis. So we’re assessing how much of a discount we see in a company’s share price versus our assessment of what we think the business is worth. Now for the markets overall I would say valuations are generally stretched across the entire quality universe we look at, things have been very buoyant for a long time, and so overall it’s a challenge to find high quality businesses at very discounted valuations.

PRESENTER: Many market commentators say that 2019 has been a pretty tough year for value. Has it been a tough year for you?

GREG HERR: You know, it’s been a tough year in the sense that it’s been driven by a lot of seemingly macro or political factors, and there’s been fairly significant volatility in the performance of the market. So there’s been significant stretches where it’ll move 5% or 10% a very short period of time. You know, we don’t focus on any particular environment when we’re constructing the portfolios, so again on a company by company basis is how we build them, and 2019 so far has been a year we’ve had relatively reasonable performance, so we will continue to be doing that in the years ahead.

PRESENTER: What stocks have you sold in the last 12 months and what’s the story behind that?

GREG HERR: So the businesses we sold, we sold out of four positions. We sold out of Edenred and IMCD here in Europe. Edenred is a corporate vouchers provider; IMCD is a chemicals distributor. Both businesses are very high quality but had reached our assessment of intrinsic value so we sold them. In the US, we sold out of ExxonMobil, because it had reached also our view on what the business was worth. And the fourth company we sold is a Mexican business called FEMSA, which is both an operator of retail stores in Mexico as well as the largest coke bottler in the world, and in that case we sold because there’s been a shift in the political environment in Mexico and we’ve decided that rather than continue to own the company based on the developments and the potential for shift in shareholders’ rights and what might happen in the political environment, we’ve decided to sell that one and move on to some other positions.

PRESENTER: And what have you purchased?

GREG HERR: So we’ve purchased three new companies this year. The first in the UK is Melrose, which is the private equity as a publicly traded vehicle. The company had bought GKN a number of years ago and is working through some improvements in that portfolio. Then we bought Tencent which is a China-based company with significantly broad technology portfolio, but it is the world’s leader in video games. And then third is Ubisoft which is based in France and is the third largest independent video game publisher, so two companies tied to the video game industry.

PRESENTER: Why do you think video gaming has got such a bright future?

GREG HERR: You know, we’ve researched a number of video game companies over the last several years and we’ve seen a number of trends really across the industry. The first thing I would highlight is over the last five or six years the industry’s gone from customers making a one-time physical purchase of a game to the point where we all now have connected devices. And so games are being sold digitally, they’re downloaded by the customers. And then once the customers own the games, they’re typically downloading additional content over time. So the industry’s gone from that one-time sale to now the franchises are much more valuable because they have this ongoing recurring sales to them.

The second thing we’ve seen with the research is that it’s getting increasingly difficult to produce these very high quality AAA franchises: the amount of money that’s required, the amount of developers and the amount of time make it difficult even for some of the largest best finance companies in the world to produce these. Also, we’re seeing a significant shift where the industry is saying we’ve traditionally been very fragmented but there’s room for significant consolidation over time. And so we looked out and we say both Tencent and Ubisoft have the opportunity to take advantage of these trends, and we think both are selling at very attractive discounts based on our purchase positions in the portfolio.

PRESENTER: So are you confident there’s a big enough pool of people to play these games and they’ve got enough time to do so?

GREG HERR: No, it’s an interesting question. Over the last 20 years the industry has gone from 275 million game players 20 years ago to two billion game players today. And they’re playing an average of an hour a day. If we think about mobile devices now getting into additional countries, greater penetration, there’s still fairly significant growth we see in the future for new players.

PRESENTER: If more people are spending longer playing video games, does that mean that things like cinema and TV look less attractive as investment propositions in the future?

GREG HERR: Well it’s really interesting if you look at the amount of someone’s freetime and how they chose to spend it, whether it’s television, the internet in general, gaming, what you’re seeing is that over time television has been a declining amount of viewership or time spent. Internet overall has grown, but it’s plateaued. And I think you’ve gotten to a point where there maybe needs to be some new applications to drive the internet higher, and video games has just continued to grow over time, and we would expect that amount of customers’ attention to continue to grow.

PRESENTER: You’ve got a holding in Inditex, which is the parent company of Zara, the fashion chain, why do you want to put your investors’ money into the high street?

GREG HERR: We’ve seen online competition causing all kinds of problems on the high street, there’s no question. Now, the Inditex model if you think about it is fast fashion at attractive prices. The fast fashion piece means that they are copying what they see in the marketplace from the luxury brands, and they’re also getting real time feedback from their customers. The attractive price points because they’re so large, they’re able to buy the materials that they use to make their clothes, very attractive costs and then turn around and sell at attractive price points. Now, what’s happening with the high street and what’s happened actually with the share price for Inditex which is the parent of Zara is the market’s starting to have concerns about is the online business going to displace their historical business. Now Inditex has both high street shops and the online business, we think the combination of the two is actually going to make them more valuable over time. Here’s why.

So as online has grown in terms of customers looking at blogs, looking at social media postings, you can imagine that there’s a demand for more and more fashion all the time. So they want new fashion. And so we’ve seen this response from the luxury companies where they introduce new collections and they’re much more frequently coming into the market. That plays very much to the strength of Inditex. Then we see that the online business for them, they’re getting about a third of the orders being picked up in Zara stores and about half of the online returns are going back through the stores. So the combination of the two together we think makes it an even more valuable business.

PRESENTER: Doesn’t fast fashion rather clash with the principle of being eco-friendly which is something that young people in particular seem to care a very great deal about?

GREG HERR: Well, it’s interesting. Young people are very worried about the environment, but at the same time they’re very worried about fashion and signalling and appearances. So sometimes we have these contradictory situations where they’re seemingly interested in both things and then the behaviour tells you something else. So there’s seemingly a lot of demand for fashion and new fashion all the time. What I can tell you about Inditex specifically is the company has been going through a multi-year process of looking at its environmental exposure and thinking about specifically all that material they use to create their clothing: is there other efficiencies and can they do things with the process that eliminate waste that they would have had several years ago in their manufacturing process? And we’re seeing a significant change in how they do things as a result and we think that’s something that’s going to be beneficial for sustainability over time.

PRESENTER: When it comes to investments where do you see the biggest threats and opportunities over the next few months?

GREG HERR: You know, I would say the biggest challenges are some of the macro-related challenges. We’ve seen the ongoing issues with China and the US over tariffs. That’s having a ripple effect through multiple geographies and sectors. Manufacturing in places like Germany has really slowed down. We’re seeing the impact for US companies that have Chinese supply chains. And so we’re watching that very carefully. We think that demand-related impact is the most likely to affect our portfolio today. In terms of the opportunities, it’s very much company by company. What I would say is again I think the video gaming industry looks very attractive. There’s a theme there in the portfolio. And other than that there are some companies that we own, Ryanair for instance, AIB Group in Ireland, where they’ve been significantly impacted by concerns about Brexit or some other macro-related things, and there could be some benefit for those businesses as well.

PRESENTER: Greg Herr, thank you.

GREG HERR: Thank you

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