In this latest instalment of the Investment Q&A, Samantha Gleave, co-manager of Liontrust European Dynamic, discusses the fund’s investment process, including how a company can qualify for its ‘cashflow champions’ watch list.
The interview also touches on the importance of the macroeconomic environment, concerns related to energy prices, the impact of recession in Germany and why the fund is tilting towards value. Samantha concludes with a balanced outlook on European equities, while also at stock level, highlighting opportunities in names like Novo Nordisk, Inditex and Partners Group.
Why you should listen to the interview
Listeners will find out more about an intrinsic part of Liontrust’s Cashflow Solution process and how it helps the managers to quickly identify (and own) companies that generate significantly more cash than they need to sustain their planned growth yet are lowly valued by investors on that measure. In addition, listeners will understand more about the investment opportunity set in Europe given Germany’s slide into recession, how concerns about Europe’s energy supply may impact European stocks, and a top down outlook on current and future valuations.
Quotes that sparked our curiosity:
The most important driver of shareholder returns
“We have a Cashflow Solutions process, which as the name suggests, focuses on corporate cash flows. We think cash flow is the most important driver of good share price returns. That simply means we’re looking to buy companies or a fund that are generating strong and sustainable cash flows and/or are attractively valued on those cash flows, and where the management team have a really strong focus on cash generation in their businesses, and also quite a prudent approach to how they then go on to spend that cash.
“We screen stocks in the investment universe on the basis of initially, two simple cash flow ratios; the first one’s a quality ratio, so it’s free cash flow over assets, it’s like cash return on capital. And the second ratio is a value ratio, so it’s free cash flow yield. And we simply add together those two ratios for each stock in the investment universe and then rank stocks on that aggregated score. And we have a simple rule at that point. We’re only going to look at the top 20%, so the best cash flow stocks, for further investment analysis. And that top 20% is what we call our ‘Cashflow Champions’ watch list.
Growth – or value?
“I think it’s fair to say that today, in this year, we have had more balance in the portfolio in terms of style positioning. So, if we were to go back to the years prior to Covid, this fund had really quite a significant growth tilt and that worked well. Our market regime indicators took us to growth. Whereas in the last few years, the fund has had much more of a positive tilt to value. Now, importantly, high forecast growth stocks have been derated significantly in the last 12 months. So, we have reduced the negative tilt that we had away from growth this year, and we’ve brought it back up to a more neutral, modestly positive position.
“I think it’s worth noting overall, we are still positive on value. Value has rerated in the last 18 months or so, but it’s still sitting at at quite an attractive discount to its longer term average valuation. So, we still have this positive tilt to value, but yes, we’ve reduced that negative tilt that we had away from growth. And we’ve added a couple of stocks into the fund that have more growth characteristics, but it is important to find growth at attractive value at this point.”
Favourite stocks
“A name that we added a little while ago was Inditex, the retail company, the owner of the Zara clothing chain. That’s enjoying very strong business momentum at the moment. It’s enjoying positive revenue growth that’s translating through into strong growth in cash earnings, helped by an improvement in their profit margins. The company has a very strong balance sheet and we expect good cash returns to shareholders. The stock is trading on a dividend yield of close to 5%.
“More recently, we’ve added a position in Partners Group Holding AG, the Swiss-headquartered, private equity business. This is a business that generates a very high cash return on capital score, from an investment process point of view. It’s had quite a challenging backdrop in recent months in terms of exit opportunities for some of its portfolio companies. And also it’s been a bit more challenging on the fundraising side. We think we’re past the worst on that. And this is a business that is exceptionally well run. The senior management team have a lot of skin in the game and we think the backdrop for fundraising and for exits is set to improve over the next 12 months. Longer term, there’s huge opportunity for this business from private wealth clients across Europe that want to increase their allocations to private markets.”
Energy supply to Europe
“I think at the moment there certainly is an increase in uncertainty in terms of the outlook for energy prices and that’s a headwind for growth in Europe. So, we’ll be watching those indicators quite closely. I think in the short term, we probably should expect the base case is, higher volatility and gas and oil prices, and I’m sure corporates will be watching that very closely in Europe. So, it could be a challenge to growth. And of course higher oil prices, higher gas prices, that’s an inflationary effect, which will also challenge growth.”
Conclusion
Key takeaways include detailed insights into the fund’s screening systems, and the impact macroeconomic factors have on companies and how that influences portfolio inclusion. The important point here of course is that a number of indicators are additionally offering a fairly positive reading on European stocks (ex-Germany). As Samantha comments, “We see plenty of opportunities to purchase attractive stocks in Europe.”
Main image: calvin-hanson-POqJeWrVfnU-unsplash
