Each week, a professional investor tells MoneyWeek where they’d put their money now. This week: Rahul Sharma of Neec Vapital.
The Japanese tsunami, the Arab world in turmoil – investors could be forgiven for feeling that the world has become a dangerous place. Throw in fears over high government indebtedness, and the world of investing looks very bleak indeed. But there is a silver lining to the crisis we have just lived through. Companies have streamlined operations and been able to make deep, structural cost cuts. As a result, balance sheets are in very good shape. This should enable firms to be more profitable than in past peaks as demand recovers.
So how best to exploit this? US companies have been the most radical in their restructuring. And as firms begin to reinvest cash, the US is where employment is improving fastest within the developed world. That in turn should enable customers to loosen their purse strings, particularly the wealthy, whose confidence and proclivity to spend is rising disproportionately fast. So the investment sweet spot is companies that are benefiting from cost cutting, but whose customers are healthy enough to allow them to exercise pricing power (ie, the wealthy).
My first pick is Ford Motor (NYSE: F). There’s likely to be some near-term disruption due to the events in Japan, but the longer-term picture has improved dramatically. The US industry has addressed its deepest structural shortcoming: its relationship with the labour unions. The crisis has also allowed the industry to address chronic oversupply. As a result, inventories are now in line with sales. This has seen the return of pricing power, which the industry hasn’t enjoyed in decades. Add to that Ford’s youthful and relevant product line-up and the company is perfectly placed. It is already making the most money it has in years, with US demand 30% below peak levels. The best is yet to come. Ford will benefit from further scale economies as the market picks up and, more importantly, benefit from the sizeable cash flow this should throw up, which it can then return to shareholders.
Williams-Sonoma (NYSE: WSM) is the top furniture retailer in America. This industry has died a thousand deaths in recent years, as the housing market went into freefall well before the recession began. But an unexpected benefit was that significant cutting back of capacity in the market saw Sonoma gaining market-share. Also, the crisis has seen consumers turn to trusted brands that offer both value and quality. It is here that Sonoma, with its strong brand, can deliver. A natural progression of sales to the internet is allowing the business to cut its capital-intensive store base while improving profitability. Sales and mark-ups are still well below historical highs and the industry consolidation and cost cutting of recent years should pay dividends for years to come.
Cosmetics group Estée Lauder (NYSE: EL) is moving from being a family-run business with little focus on returns to a professionally-run organization with a tight focus on productive marketing, cost savings and cash-flow generation. There’s lots of room for improvement: Estée makes an 11% margin rather than ‘best-in-class’ margins of 20%, despite owning the strongest brand platform in the industry. Demand is strong in the developed world and its brands are aspirational in Asia – plus it’s only scratching the surface of its potential in markets such as India and Brazil. Analyst forecasts are thus likely to prove far too low over the years ahead.