The first category comprises growing profit pool, where an industry or sector has long-term structural growth drivers that will increase the size of the available profits to companies in that industry, in real terms. The primary driver of returns to shareholders for companies operating in growing profit pools are compounding earnings, as these companies tend to prefer organic and inorganic investment in their businesses ahead of distributions to shareholders.
Diploma, a value-add distributor serving industrial and life sciences end markets, is an example of a company benefiting from its exposure to growing profit pools, including electrification, industrial automation and infrastructure spend. And within these growing profit pools, Diploma is also taking market share and has a long runway of potential future growth ahead.
Diploma has strong and enduring competitive advantages – a decentralised model of 17 smaller distribution businesses with strong technical expertise in their respective niches and a focus on significant value add across the group.
The second category comprises stable profit pools or market share opportunities. This is where a company is operating in an industry with a stable or much lower growth outlook but where there are significant opportunities to win market share and drive continued earnings growth. For companies operating in stable profit pools, the primary drivers of shareholder returns will be earnings growth, shareholder distributions in the form of dividends and share buybacks, and an improvement in the company’s valuation multiple.
An example in this area is Grainger, the UK’s largest professional landlord. The supply of private-landlord rental properties is shrinking in the UK as private landlords face headwinds, such as energy efficiency regulations, while demand continues to grow. We believe the build-to-rent segment will take share from small private landlords, and this is an opportunity that Grainger can exploit; it operates its buildings professionally, maintains high occupancy at around 98%, and has pricing power as it grows rents at least in line with inflation.
Lastly are declining profit pools or self-help opportunities. Companies in this category are delivering sub-par performance, due to declining industry growth rates, and/or simply a lack of execution. Here, we look for a catalyst to drive a significant improvement in operational and financial delivery. The primary drivers of shareholder returns for self-help opportunities are an inflection in earnings and a rerating of the share price.
These are turnaround situations and Anglo American is one such example, in which a new management team is seeking to improve the performance of the business through the three strands of operational excellence, portfolio simplification and driving growth. Portfolio simplification is the most outwardly visible change and is focused on transitioning Anglo American to focus on future facing commodities – principally copper and premium higher grade iron ore, with some further growth options in the fertiliser Polyhalite.
This simplification includes divestments of the nickel and steel-making coal businesses, alongside the completed de-merger of the platinum group metals business, and either a divestment or demerger of De Beers – the diamond business. Upon completion of the simplification, Anglo American will become a more focused, faster growing miner with higher margins, higher returns on capital and lower capital intensity.
As we have highlighted in this article, there are many opportunities to invest in world-class businesses in the UK, such as Grainger, which is more locally oriented, and Diploma and Anglo American, both resolutely global businesses.
The UK market has a strong mix of domestic and overseas-focused businesses. We take a diversified approach, from more structural growth companies such as Diploma to self-help opportunities, to create a balanced all-weather portfolio.
Imran Sattar is manager of the Liontrust UK Equity fund