Article 28 July, 2020

“Never let a good crisis go to waste”

Churchill's quotation has particular relevance today.

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Of all Winston Churchill’s many famous quotations, one which perhaps gets less airtime but is particularly apt today was his suggestion to “never let a good crisis go to waste”. Its beauty is the simplicity with which it turns the situation on its head. Rather than dwelling on one’s current predicament, it forces listeners or readers to think about how they can turn the situation to their advantage. At its core is the concept that a crisis is abnormal so, in the words of American politician Rahm Emanuel (who used the quotation himself), “it’s an opportunity to do things you think you could not do before.” Step-change can be enacted to either alter course or accelerate an existing path.

How does this tie into a business and investing perspective? We think in two ways, predominantly. The first ties into how we think about the Innovation pillar of our sustainable investing framework, while the second relates to how businesses can make themselves more valuable over time.

A sustainable business requires constant innovation to respond to changes in market fundamentals, the environment and society. This is imperative for business longevity and for the benefit of all stakeholders. Innovation is often looked at in a relatively narrow sense, being naturally associated with technology and spending on research and development. While this is important, we take a broader view of innovation, which we believe encapsulates changes in strategy, process and product. This is equally applicable in times of change, where businesses need to evolve when faced with challenge and opportunity, as it is in times of success, when companies have the financial strength to reinvest. And it encapsulates changes to culture and behavioural change as much as it does those to business models, processes or product sets. The opportunity to implement more radical change, for the future benefit of all stakeholders, is typically greater amidst a crisis.

“A crisis can offer the opportunity for equity investors to increase conviction in those holdings which are having a ‘good crisis', as well as take advantage of pessimism to buy good companies at bargain prices.”

Innovation in a crisis can therefore increase the sustainability of a business franchise, but actions taken in a crisis can also increase the level of profits this franchise earns. We’ve referred to the concept of ‘Corporate Darwinism’ previously, where the ‘strong get stronger’ in a downturn. This can favour the highest quality cyclical businesses over those with more defensive end markets in terms of ability of compound value over longer time horizons. The ‘lockdown winners’ narrative from the COVID-19 crisis is well-versed – from those aiding working from home, to e-commerce and bingeable TV content streaming providers. These are hardly secrets, though, and share prices in many cases reflect this success.

Look beneath the surface, however, and several less obvious examples are emerging, from recent trading statements and company meetings, of companies in our portfolio which have heeded Churchill’s advice. They are either making changes to the business or using the crisis to their advantage to take market share. And the beauty is that although these actions have made the businesses more valuable, the stock market is yet to cotton on, so the benefits are mostly ahead of us.

Prime examples are distributors Electrocomponents and Essentra. Service is a key differentiator for a distributor, typically defined in terms of speed, reliability and product availability. Never is this service more important for customers than during a crisis. Both Electros and Essentra have taken share with existing customers in recent months, and the goodwill gained by delivering to customers under the harshest conditions is, in our opinion, likely to lead to sustained gains in the future. The management team at specialty insurance and re-insurance provider Lancashire Holdings have bided their time in markets with unattractive pricing for years but have now raised ~20% in additional capital to go after growth opportunities being presented by dislocations in global property and casualty insurance markets amidst the COVID-19 crisis. Management believe these are the first ‘hard market’ conditions since the wake of 9/11. Discount retailer B&M used their ‘essential retailer’ status to sell to a new, higher socio-economic category customer in DIY and gardening categories while competitors were closed, expanding their addressable market. And clean air catalyst producer Johnson Matthey has used the current downturn to accelerate an existing plan to consolidate their manufacturing footprint into low cost, highly efficient modern plants in eastern Europe.

Finally, it’s worth reminding ourselves of current holdings benefitting today from changes enacted during a prior crisis of one form or another. Anglo American entered this downturn from a position of strength thanks to the major restructuring that has taken place under current CEO Mark Cutifani. This has allowed them to be an acquirer of a distressed asset (the Sirius Minerals potash mine in Yorkshire), a 180-degree improvement from their position as a distressed seller in the prior commodity downturn. Similarly, UK housebuilders such as Persimmon see their balance sheets in far better nick than when they entered the Global Financial Crisis. Net cash balances and landbanks with high embedded margins offer a much better risk-reward balance to shareholders. And online gambling company 888 is now a leader in safe gambling procedures as a direct result of a previous fine levied against them for failings in handling vulnerable customers. Their innovation here – both technologically and in terms of processes and culture – has positioned them to take share in markets, such as the UK, where regulation is tightening.

Like our portfolio of companies, I remain watchful regarding the business cycle outlook but always maintain one eye on opportunity. A crisis can offer the opportunity for equity investors to increase conviction in those holdings which are having a ‘good crisis', as well as take advantage of pessimism to buy good companies at bargain prices. I’m excited to have had the chance to do both.

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