Elevators, FMCG among 4 top stocks

-- | 14/03/2018

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Glenn Freeman: In this edition of "three top picks" I'm talking with BMO Asset Management's Tony Cousins. One of the companies that he mentioned is in a sector that you really wouldn't expect.

Tony Cousins: Well, I guess, I mean, when we are looking at picking stocks, we concentrate on a strict combination of value and quality. The three key characteristics there are higher than market dividend yield, much lower than market debt to equity, and very importantly, higher than market return on equity. We like to buy companies that consistently deliver high ROE. And this is about compounding. If you own companies that consistently deliver high profitability or compounding wealth creation within the enterprise at a higher rate and compounding works, not desperately exciting but it works. So, that's what we look for in companies and sectors.

An example of this, which really isn't very glamorous at all, is the elevator industry. The elevator industry is an oligopoly. 70 per cent of world elevators are controlled by four companies, Kone, Schindler, Otis and Thyssen. Two of those you can't buy. Otis and Thyssen are a part of much bigger conglomerates. So, it's not the easy thing to invest in (indiscernible) two major companies. But as an oligopoly the pricing behavior is very disciplined. And you want to avoid investing in industries which have rampant price wars because that really destroys profitability.

Other attractive things about this industry, more than half of elevators in the world are more than 25-years-old. So, there's a big replacement cycle there. This plays to urbanisation and as people move into cities, the demand for elevators grows up. The growth of Asia; people are happy to live in high rises in Asia. They need elevators. And an ageing population; people like me don't walk up the stairs. We get the elevator and we get the escalator. But the real beauty of this business model is in maintenance and spare parts, because that is a capital light business which is mandated by public health and safety bodies and that is where these companies really make their money. So, the two companies that you can buy, we own them both. They are Kone out of Finland and Schindler out of Switzerland. So, it's an industry that delivers the characteristics that we want in a stock.

I think branded consumer goods, companies like Nestlé and Unilever, I mean, these are – they are crushingly dull, but again, they are in industries where certainly in emerging economies the consumer wants to own brands and they have a high exposure to these emerging economies through the acquisitions they have made. And what's so important about brands? Brands provide a huge barrier to entry. They make very high returns on capital, these companies, and the competitors maybe able to produce a similar product, but intellectual property stops them from producing the same brand. And brands have proven time and time again to be very, very important in personal consumption habits. People trust it.

This report appeared on www.morningstar.com.au 2022 Morningstar Australasia Pty Limited

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