Lazard's 3 top picks for the global covid recovery

-- | 08/07/2021

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Lex Hall: Predictable earnings and large competitive advantages are the hallmarks of the companies that Lazard Investment Management's Global Equity Franchise seeks and with me today is Warryn Robertson. He's going to talk us through a few key holdings in the fund.

Good day Warryn, welcome back to Morningstar.

Warryn Robertson: Lex, always a pleasure to be with you.

Hall: Now, let's talk a few names in the fund. I'll just remind people that the sector exposure is healthcare 26.5%, industrials 22% and utilities 13.84%. So pretty defensive sectors there. One thing that I'm curious to get your opinion on is the geographic exposure 49% U.S. and 12% in France. What are you seeing in France, in particular, just before we get into a few names?

Robertson: Yes, sure. Look, it really is a function of our bottom up stock picking. So it's not a case where, even though we do like the country of France, particularly in some of the wine regions. We're not saying from a top down or a thematic perspective, we really want to be in continental Europe. And we're not saying that we necessarily want to be out of the United States, it's driven by those bottom up stocks selection. But what we are saying is that there are some opportunities occurring in continental Europe, around the recovery from the COVID driven pandemic. They were initially the hardest hit, they have recovered well, today, but we do expect that to be a patchy and a long process this is not something we're going to be over at the end of this calendar year. Our working assumption is calendar '19 levels of economic activity won't return until calendar '23. As a general rule, some companies will be faster, some companies will be slower, but that is our general economic thesis if you want.

Hall: Okay. Sectors, in particular in France that you -- healthcare or…

Robertson: No, no within France, it's largely related to their industrial. But what it really is, and what it really comes down to is some of the infrastructure (indiscernible). So one in particular is Vinci, which operates one of the largest (indiscernible) networks in France. And we can see some strong recovery there on its toll roads. They're still down something like 25%, where they were calendar '19, but year-to-date, they're up 20% on where they were this time last year. And what's interesting is with the reduction in travel bans, so you haven't been able to travel more than 10 kilometres away from your house until early May. The anecdotal evidence is that you'll see significant increases in those Pan-French motorways and what we're seeing is, over the last 10 weeks, we're seeing traffic growth, which is in the order of 200% year-on-year, which sounds ridiculously high, but it just reflects the silly low levels that we were in this time only 12 months ago. So that's where it really is, we think the markets under appreciated just how fast that bounce back will be and the value propositions that company in particular presents.

Hall: Okay. Let's quickly then go through a few more names CVS Health in particular, an integrated health care services provider.

Robertson: Yeah, so it's a U.S. focused business. It's one of our U.S. holdings, the largest pharmacy retail network in the U.S., second largest pharmaceutical benefits management business, and it's got a small health insurance company as well. The key thesis is really around the integration of those three businesses together, which we think will sort out two of its problems that it currently had and had for the last couple of years. Where essentially, thanks to the rollout of the health hubs, it's increasing the proportion of medical care can provide. So first, it really does correct a lot of that competition created by the online players in terms of the store space that it has, it's traditional pharmacy network, we think will be reinforced by this. Secondly, the health insurance business provides them with a capacity to lower costs when patients check into their medical centre or hospital. So again, that lower cost with greater throughput we think is critical to them being able to migrate throughout the next three to five years. They're playing one of the most important roles in the rollout of the U.S. vaccine programme which is really being beneficial to increasing foot traffic back into their pharmacy network. We've seen that with improving profit margins quarter-on-quarter. The concept that Amazon was going to kill this business is sort of now not really playing out, strong cash generation is coming through. And the business is trading on what we think is giveaway multiples 10 times per year or less, today is fairly cheap for what is the dominant player in this segment. So positive towards it.

Hall: Sounds good. Second name is Nielsen, which is probably synonymous here with what we hear about the ratings of television and so on.

Robertson: Yeah, exactly. So, it's got a monopoly on TV ratings in the U.S. Leading market position in the consumer buyer measurement business. And it's seen as the, if you want the honest cop in the room in terms of determining those ratings. Typically, there are, you know, Google can likewise do it around some things, but it's not as they've got conflicts of interest, arguably. Where the business opportunity came was, in essence, COVID-19 had a large impact with advertising, people think that that's going to mean significant revenue declines. 75% odd of Nielsen's revenues are locked in with multi-year contracts with leading media and consumer product group companies. So those multi-year contracts with process providers really meant that COVID came, it had an impact, it reduced EBIT by about 4%. But it was significantly less than many of its advertising brethren. And it fell in line with a lot of the other advertising agencies around the globe, even though its business model is very, very different. The company is well positioned to participate now, in the upside, we see it's, our valuation is based around the low end of management guidance over the next three to five years, even though they've had a history of beating guidance. We're at the lower end of that, we apply a multiple, which is well below its history, and we still think there's 50% upside to the share price. So if they get anywhere near what management says they're going to get, this stock could quite easily double over the next two to three years.

Hall: Okay. And finally, I wanted to ask you about this one, which is a household name here in Australia, too. But I would have thought the barriers to entry would have been fairly low and that's H&R Block the tax return preparation company.

Robertson: Yeah, look, you're right, there are relatively low barriers to entry, say in comparison to CVS or Nielsen. But it's still a pretty darn good business. It has tight, steady market share across the U.S. in terms of its core, tax stores business, it's got about an 80% market share and the U.S. dominates. So I think of the 25 million tax returns they do around the globe, more than 20 million are out of the U.S. So it really is a U.S. business. It does one in six tax returns in the United States. And its core client essentially, is a small business or operator or husband and wife or couple who essentially use H&R Block to prepare their assisted return. These people essentially 10% of their household income is the tax credits that they generate from that return. It's a complex financial transaction. And that means they're incredibly stable, much more than what people really do and do give credit to the business. Yeah, they've sort of built an online presence, now. They sort of lost that dominant position to Intuit many, many years ago. But they've improved that offering. And it's actually working well for them. The most recent data that we have out of the last tax season is that they've gained market share some of the strongest gains they've had in more than a decade. And that's come at the expense of other players in the market, obviously, but the stock still trading on, what we think at giveaway multiples, six, seven times earnings, if you look at a couple of years, it's paying a dividend that it has done consistently now for 50 years. And it's on a free cash flow yield of about 15%.

So lots of cash generation, a really strong business and COVID hurt it because they delayed the tax year. And this is a company that literally sits around and does nothing for 46 weeks of the year. Lex, it makes all of its money in the six weeks of the tax preparation year. So when the government changes that, it changes the financial outcomes of the company, but not permanently. It's only a timing issue and the market sort of lost patience with this in the COVID pandemic. And the company now is on giveaway multiples, we think at current prices.

Hall: Fantastic. All right. Well, that's CVS Health, Nielsen and H&R Block. Warryn Robertson, thank you very much for your insights and your tips today.

Robertson: Thanks, Lex. Pleasure to be with you.

Hall: I am Lex Hall for Morningstar. Thanks for watching.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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