Manager Insight

A lock maker, a convenience store operator and an industrial lubricant manufacturer feature among this Mawer manager's picks.
By Michael Ryval | 11/10/18

Although international equity markets are preoccupied with global trade wars and political volatility, David Ragan tends to ignore those issues and focuses strictly on bottom-up stock-picking. Moreover, while Ragan is cautious about share price valuations being high, he is confident that the companies he owns are strong, well-capitalized and capable of riding out severe market turbulence.

About the Author
Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

"Markets are not broadly inefficient. If it is a known quality company, then the market typically ascribes a higher valuation, especially on a price-earnings basis," says Ragan, a director at Calgary-based Mawer Investment Management and lead manager of the 5-star rated $6.4-billion Mawer International Equity. "There are a lot of very good companies in the world and the market prices them appropriately. Quality companies are trading at 20 times earnings and higher. Low-quality companies are more like low teens. Good companies are being recognized."

Ragan admits that his job is challenging because the market is generally quite accurate. Yet sometimes companies are overlooked or underappreciated. "The ability of a company to reinvest and grow organically at a high return on capital, and the compounding of this reinvestment, is something the market may underappreciate," says Ragan, a Calgary native who joined Mawer in 2004 after he had earned a bachelor of commerce from the University of Calgary.

"There aren't any secrets in the market. Very few times do you find a high-quality company that is trading at a materially lower price-earnings multiple than other high-quality companies," says Ragan. "In aggregate, the market is efficient. That's why we don't buy the market. We do a lot of work on 50 companies and come up with one idea."

One of those companies that he favours is Assa Abloy, a Swedish maker of residential and commercial locks that is the largest in the world. "We've known this company for a while, like other people. Its return on capital varies from 13.9% to 23% for the past decade," says Ragan, who shares stock-picking duties with portfolio manager Peter Lampert and equity analyst Jorg Hampel. "The industry is still relatively fragmented so Assa Abloy can continue to acquire smaller lock makers and can plug them into its very efficient manufacturing and distribution network."

Ragan notes that 60% of industry sales go toward replacement of broken locks. "If the lock in your home breaks you have no choice to delay and must replace it as soon as possible. And you will replace it with the same one which matches the others in your home because you don't want to introduce a new key." In addition, there's been a revolution in the use of electronic key-less locks in establishments such as hotels and motels. "The cycle is getting much faster. And that's a potential long-term trend as more businesses go electronic versus mechanical. That replacement cycle suddenly gets much shorter."

Acquired last May, the stock is trading at about 19.7 times forward earnings. "Most locks are still mechanical," says Ragan. "But even if the trend to electronic doesn't happen we're still getting a great company trading at a reasonable price."

Another favourite in a portfolio with about 50 names is Japan's Seven and i Holdings, which operates the 7-Eleven convenience store chain. "They make over half their operating profit in Japan, but their convenience store business is growing around the world," says Ragan, adding that the firm's return on equity and return on capital are both about 8%.

Ragan notes that initially he did not like the firm's capital allocation. Then there was an internal power struggle and a new chief executive emerged. Mawer regarded this as a positive move and took a position in April 2016. "In Japan, it's almost unheard of to have a CEO fired and replaced by someone else."

On a forward basis, the shares are trading at 20.8 times earnings. While the shares are up about 20% since their acquisition, Ragan maintains there is more upside. "The valuation is pretty good especially for a Japanese company where the risk-free rate is 0%."

Meanwhile, for many years Ragan has favoured Fuchs Petrolub, a Germany-based maker of value-added industrial lubricants used in a variety of applications from metal-forming to food production assembly lines. "They have over 100,000 different formulations and sell a lot of smaller quantities of high-value lubricants," says Ragan. "The cost of the lubricant is very small for the customer, but it's incredibly important. If for, instance, a potato-chip assembly line stopped working because somebody switched lubricants to save a few euros or dollars, they will lose a lot of money very quickly."

Debt-free, in business for 80 years and controlled by the Fuchs family, the firm boasts a return on equity of over 20%. The stock is trading at 19 times next year's earnings. Acquired in 2007, the stock has quadrupled in value since then. Thus far, Ragan sees no reason to sell the holding.

Going forward, Ragan concedes that a severe market correction would hammer all stocks, even quality firms such as Fuchs. "In the short term, we would ask, 'What's going to happen to the survival of these companies? And in the long term what will be their intrinsic value and ability to generate cash?'"

But firms like Fuchs have staying power because of strong balance sheets and the ability to pass price increases through to customers. "If you are a customer, you need their product."

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