By JAMES SPENCE
3M and Reckitt Benckiser have been sold within the portfolio and Nidec has been added.
After many decades of impressive growth, we believe 3M now faces considerable pressure from lower quality substitution, powered by powerful retail and procurement platforms of which Amazon is the most notable player. Secondly, 3M now has proportionately less growth opportunity than any time in its history – by geography and by market segment. Following a period of review, 3M has been sold from the Global Leaders portfolio.
3M is a somewhat unique company. Its corporate DNA is based on product invention and development across very wide product segments, appealing to both household and industry buyers. It has been at the vanguard of US companies pushing into a globalised world. It runs thousands of product lines across four divisions without seeming inchoate: safety & industrial (34% of group sales) , transportations & electronics (29%), health care (21%) and consumer (16%). Group sales total US$32bn, meaning that an additional US$1bn is needed to achieve 3% growth. This is a hard task in the world of materials where products can be readily substituted, in many cases.
To some extent 3M is the victim of its own successes: its ranges have been extended so successfully that each new augment provides progressively less revenue potential, on a proportionate basis. It has branched overseas: developing mid markets beneath its upper markets. With this push largely achieved its products are at risk from the blurring of mid and lower tier products with the lower tier given more prominence via growing price transparency afforded by retail platforms. Buyers find themselves less motivated by brand as they are encouraged to trade off quality and brand perceptions against price.
The visible merits of 3M lie in its commitment to R&D, although it would be dangerous to assume that past successes can simply be extrapolated forward, it’s impressive margins (21% operating margins) and ROIC but these speak more of past successes than future opportunities. Finally, 3M has paid an increased dividend in every one of the past 61 years and a dividend for the past 100 years.
Management attention has been drawn into managing in a low growth environment as the company has begun to lose its GDP-plus reliability and growth rates descend back to underlying global growth rates, or even below. Inevitability, rounds of restructuring become the new norm, mixed in with the persistent drum beat of litigation surrounding past products toxicity.
Reckitt Benckiser has been an investment in the Global Leaders portfolio since 2015, it has generated a total return of 18.8% since first investment, the position has been sold in full.
The consumer packaged goods industry is going through a disruptive transition where niche brands and private labels are gaining market shares over established players. Millennials, in particular, bear less allegiance to brands in less glamorous household categories, and private labels have seen increased penetration, even among the high-income demographic. Digital marketing initiatives has brought down the cost of expansion of new brands, whilst online distributors’ infinite shelves and AI driven reviewing systems often display relatively unknown brands in an analogous fashion to branded goods. Where we see resilience is in the upper reaches including luxury segments where prestige branding still holds sway and are positively accented by social media influences (‘the Instagram effect’).
Even in Emerging Markets, the growth driver over recent decades for many multinationals, we are seeing more competitive pressure as local players gains an edge with comparable quality goods and in many cases more innovative products and marketing strategies tailored to their home market. Some established players have navigated the trends better, Nestle for example, by embedding themselves into high growth and high margin segments such as coffee and pet nutrition, with an acute awareness of local preferences.
Reckitt Benckiser faces considerable challenges in this environment. The owner of well-known brands such as Dettol, Durex and Nurofen have experienced a series of unfortunate events over the last few years, compounding the negative industry evolution. The company is suffering from low growth syndrome. Having been a stellar performer historically with best-in-class margins, what concerns us the most is the negative trend in the wider industry unanimous to global consumer groups, and Reckitt’s ability to successfully navigate exogenous growth problems in their product categories.
Neither of Reckitt’s two business units – Health & Hygiene Home – are immune. Household products such as detergents and disinfectants, an important category for Reckitt, is one that sees little differentiation and path to future product improvement. It makes for easier choice when it comes to downgrades by the consumer to a white label replica on value considerations unlike food & beverages, where consumers are highly specific about their taste partialities and sentimental attachments. In consumer health, Reckitt bets on higher growth potential as it builds up its portfolio with infant nutrition, supplements and OTC drugs. However, competitive pressures have also crept into OTC as generics and private labels such as the launch of Amazon’s own label Perrigo brand poses challenges to Reckitt’s own brands Nurofen and Mucinex.
Even if the company can return to market growth, we now envisage a cap of 3-4% growth at the top-line. Margin pressures are also likely to persist as the company needs to accelerate investments significantly both in product innovation and marketing to regain market share and restore trust.
The RB2.0 Strategy, introduced in 2018, is reorganising the group into two business divisions, with separate management and P&L accountability, providing an option for a spin off down the road. A new CEO, Laxman Narasimhan, joins in September and his background at PepsiCo and Mckinsey suggests he will be familiar with the issues in hand. However, whilst the general view is that Reckitt’s problems have been largely self-inflicted and company specific, the view we have taken and the reason we are recycling capital out of this name into other holdings is that the challenges facing large branded goods companies with sub optimal portfolios will prove exceptionally difficult to box out of.
Nidec Corporation (listed in Japan) is a new addition to the Cerno Global Leaders Strategy.
Nidec is the top global supplier of brushless Direct Current (DC) motors, accounting for around a half of all production. Domiciled in Japan the group is truly global with production sites across Europe, Asia and North America.
Motors are simply any power unit which generates motion. An electric motor converts electric power into motive energy. They work via a current creating an electromagnet, which is then used to power a core spindle around. Brushless DC motors combine superior attributes of small size, large power output, ease of connection and positioning control.
This is not a new technology. Brushless DC motors became possible after the development of solid-state electronics in the 1960s, and Nidec began producing them in 1975. However, unlike many products, the applications of advanced DC motors have proliferated over time. This derives from the integral nature of the technology to the secular trends of electrification and mobility. Where these themes collide you will tend to find DC motors.
Two additional undercurrents have favoured Nidec: the drive for efficiency and reduced scale. 50% of the world’s electricity is consumed by motors. The economic and regulatory necessity of increasing the output ratio from this level of consumption is a powerful one. Likewise, the demand for ever declining scale appears relentless. Nidec’s ability to bring innovative products to market which do more while taking up less space has been central to their success. It is our observation that these forces are powerful and ongoing providing long term support for the company’s core IP: the production of small, efficient motors.
The breadth of the company’s offering stems from this wide applicability. Its revenue verticals are diverse, from IT equipment and factory automation to EV traction motors and camera shutters. To some observers their product portfolio might appear to lack a ‘killer product’, a ‘game changer’. But this is its strength, in our view. Most products are not flashy, but they are enablers, and hard to substitute.
The evolution of Nidec’s portfolio offers some insight into the importance of its management and corporate philosophy. Led by CEO and founder Shigenobu Nagamori the group has created a dynamic philosophy focused on the continuous search for adjacencies in products, technology, markets and customers. This enabled the company to diversify away from the original core business of hard disk drive motors in 2006, well ahead of the end of the PC boom. The business now accounts for just 12% of revenues, although Nidec holds a market share of 85%. The group’s focus since 2010 has been to reposition the portfolio towards Automotive, Appliance, Commercial and Industrial sectors through some 34 acquisitions. AACI verticals now account for 55% of sales. Despite this flurry of activity the group has maintained its first quartile return on capital profile through improving acquired businesses and gaining synergies with the core.
Given the central role of Mr Nagamori in this strategy succession risk is a concern. Comfortingly the company has been proactive in this regard, promoting Executive VP Hirojuki Yoshimoto to President in 2018 with Mr Nagamori focusing solely on his CEO role.
This ability to persistently locate opportunities in adjacent domains instils a robust ability to adapt and remain relevant. The group’s position is further buttressed by a deep patent portfolio, switching costs and the multi-disciplinary technological expertise needed to produce advanced motors.
Since 1997 Nidec has delivered compounded sales growth of 14% per annum with operating profits expanding at 15% over the same period.