Steven McBoyle
The pandemic has created numerous challenges for many business models in real estate. The ongoing demise of the brick-and-mortar channel for retail brands has accelerated with the pandemic, once again raising questions about the fate of shopping malls. In addition, reverberations of work-from-home for commercial real estate, along with net migration out of cities and apartment buildings has been heavily debated during this period. All of this has created negative sentiment for the industry—and justifiably so for the most part. Yet we believe there are pockets of real estate that look likely to emerge stronger and benefit in 2021.
Many investors currently lack confidence in real estate, be it for residential, commercial, or hospitality—or even in certain geographies. As we typically do, we have been trying to use this industry pessimism to our advantage by investing in highly aligned management teams that have long track records of capital deployment in times of dislocation like this one. Kennedy Wilson (KW, Financial) is a founder-led, real estate investment manager. The company has more than 30 years of experience using cycles to their advantage. Today, their portfolio is about a 50/50 split between the U.S. and the U.K./Ireland, with the former heavily weighted towards multi-family developments in the Pacific West and mountain states, all tax friendly locales seeing population growth and positive employment trends. They also have office exposure with long-term leases and desirable tenants such as Costco and Microsoft.
We are also attracted to the service and/or brokerage models in real estate, where Colliers is a great example. We like its globally recognized brand and its global platform in outsourcing and advisory, leasing, and capital markets. More recently, Colliers (CIGI, Financial) has been involved in investment management and even engineering and design through an acquisition. The company's leasing business has endured declines in transactions during 2020, yet we believe that should improve next year. Meanwhile, their overall portfolio of services is shifting more toward services with less emphasis on transactions—which should create additional recurring revenues. Finally, Colliers exhibits many of the high-quality attributes that we look for. It's an asset light, highly cash generative, founder-led business with a proven track record, high insider ownership, and a variable cost model.
Mark Rayner
In spite of considerable tumult in 2020, we believe that the golden rule for long-term investors remains unchanged: buy companies with competitive advantages—and try to ensure that these are both defensible and fulfill an enduring customer need. If these companies are also experiencing market demand growth, that's the icing on the cake. The pandemic has not changed this iron law. Indeed, we think it will make the strong even stronger as weaker players leave the market either by being acquired or by impaired profitability.
An especially good place currently to look for investments is among those companies that possess strong competitive advantages, but whose stock price has suffered during 2020 from what appears to be undue emphasis on short-term demand. One good example is Ossur (OCSE:OSSR, Financial), an Icelandic company that designs, develops, produces, and sells non-invasive orthopedic products, though its main business is in prosthetics: artificial limbs, feet, knees, etc. for amputees.
The prosthetics market is essentially a global duopoly. Ossur and the private German company Ottobock share around 60% of the market, where significant scale advantages exist. These advantages can be seen in terms of both R&D—there is a growing trend toward higher-priced bionic limbs—and manufacturing and distribution, as Ossur and Ottobock are buying up the orthopedic workshops and clinics that actually do the limb fitting. Long-term demand for prosthetics is underpinned by the fact that 70% of amputations in developed markets are linked to diabetes. According to the International Diabetes Federation, 463 million adults were living with diabetes in 2019, which is forecast to rise to some 700 million by 2045.
We like Ossur's very high customer retention rates, which result from considerable emotional switching costs. A prosthetic limb effectively becomes part of an amputee's body. Switches between suppliers are rare, and each artificial limb requires regular servicing and spare parts, generating repeat revenues.
Despite these advantages, Ossur's stock price fell by more than 35% from its peak to trough in 2020. With most elective surgeries postponed and orthopedic clinics temporarily closed throughout much of the pandemic, the company reported a 23% decline in company revenues for the quarter ended June 2020. Yet these lost sales will likely lead to pent-up demand going forward as the desire or need for artificial limbs has been delayed, not cancelled. Furthermore, the ability for Ossur to press ahead with its program of rolling up orthopedic clinics and workshops will likely improve its long-term strengths.
Miles Lewis
We are bullish on select branded apparel companies for 2021. Companies with weaker brands and more debt-laden balance sheets were under pressure well before the pandemic, which has forced some to file for bankruptcy (including liquidation), reduce their store counts, and/or take on even more debt just to stay afloat. In 2020 alone, 66 retailers have already filed for bankruptcy, with more likely to come.
This level of bankruptcies is higher than any year going back to 1985, and more than 2019 and 2018 combined, a list that includes well-known players such as Brooks Brothers and J. Crew. The weaker companies that manage to survive will likely struggle to innovate and grow, as cash flow is redirected to service debt, resulting in a bifurcated competitive landscape that will have clear winners and losers.
Companies with durable, iconic brands and strong financial profiles look poised to thrive, starting in 2021. However, many that fit this profile have also seen their shares lag meaningfully in 2020, as their businesses have experienced significant challenges that look transitory to us. Two that we would highlight are Ralph Lauren (RL, Financial) and Levi's (LEVI, Financial).
While weaker brands are retrenching, Ralph Lauren and Levi's, enabled by their respectively strong balance sheets and cash flows, are opening new stores in desirable locations at lower rents while also investing in innovation, marketing, and e-commerce. With physical stores forced to shut down, Ralph Lauren and Levi's quickly focused their attention on e-commerce—with outstanding results that persisted even after stores reopened, implying that some of this growth will prove sticky. Growth in e-commerce sales also created a tailwind for margins that should grow stronger.
We believe that the value of each of these iconic brands has improved during the pandemic, which should also expand gross margins going forward. There are many ways to measure the value of brand. However, the ability to increase price is arguably the best—and both Levi's and Ralph Lauren have raised prices during the pandemic.
Like many other businesses, both also dramatically lowered their respective cost structures during the pandemic, which should allow them to reach prior levels of profitability on a lower base of sales. With recent positive news on a vaccine, we believe that 2021 will prove to be a year of strong sales growth for each. Improved sales, coupled with the aforementioned enhancements to profitability, should yield higher structural earnings power for Levi's and Ralph Lauren.
Important Disclosure Information
Mr. McBoyle, Mr. Rayner, and Mr. Lewis's thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.
The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.
