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Safe Bets In Turbulent Times
Fiona Clark, 17 August 2011
There is not really such a thing as a “safe bet”. We learned from our experiences in the GFC that quality, well run businesses with attractive earnings outlooks and strong balance sheets could still be sold heavily. Some even more so than their less attractive peers due to profit taking (as they had performed well) and blanket selling. They key difference however, was that these high quality companies bounced back much more quickly when conditions improved and outperformed over the whole cycle.
With this in mind, there are some ways we can reduce risk and provide some comfort during turbulent times. One of these is to invest in companies with indirect exposure to a particular risk factor. For example, we quite like the resources sector and many of the larger resources companies. However, by investing in companies that service the resources sector, our exposure to commodity prices is reduced. Most large resource projects have long lead time times so the earnings of the service companies are much more stable. One company in this realm is Campbell Brothers, a global laboratory and minerals testing business. The buoyant outlook for commodity prices should typically drive increased exploration. Despite this, management is aware of the cyclical risk of mineral dependency. They are therefore focused on continued diversification across sectors and geographies, especially environmental testing and industrial testing. They are also growing food testing capabilities. Campbell Brothers is a high quality business with good management.
Another way of ensuring limited downside risk is to look for companies whose valuation has been negative impacted by external factors which should not limit its future prospects. A good example here is Telstra, which has traded under a cloud of regulatory and political uncertainty for quite some time. With the announcement of the NBN deal, some of this uncertainty has lifted and management should be able to focus on running the business. We do not expect exceptional earnings growth from Telstra, but it provides defensive and stable earnings and a very attractive fully franked and sustainable yield. Most importantly, the valuation is is not stretched, limiting the potential downside during a financial market storm.
There is also the classic defensive investment strategy – which companies actually do BETTER when economic conditions are tough. Rather than the fancy restaurant, maybe we’ll have “restaurant night” at home. Instead of expensive specialty store brands, maybe the supermarket brands will suffice. The best example in our view in this category is Woolworths, which has a terrific history of providing strong returns on equity for shareholders and outperforming in difficult market conditions. Quality management who have delivered on their earnings promises, a simple and logical business model, a strong balance sheet and decent yield, Woolworths may not provide a “wow” growth factor but should certainly help investors sleep more easily at night in turbulent times.