What kind of challenges and/or opportunities has recent volatility in the international markets created for the Quality at-a-Reasonable Price approach you and David use in International Premier?
While we always aim to select companies with low ROIC volatility, it’s essentially impossible to do the same for price volatility. Sometimes the market is just driven by factors other than the prospect of long-run value creation. To compensate for this, we view share-price volatility as an opportunity to buy more of what we believe is a good company at a more attractive price.
So as long we think that stock-price volatility looks likely to be temporary, we try to use it to our advantage. This is exactly how David and I have been viewing the recent market weakness. We’ve been selectively putting money to work over the last few months as opportunities have arisen, mostly in industrial companies.
Though you and David are bottom-up investors, do you have any views on the Brexit-driven political situation and how it affects the portfolio's U.K. investments?
The political situation in the U.K. continues to dumbfound. As a Brit, I find myself almost peeking through my fingers when watching the news on TV these days.
In recent days the news from London and Brussels appears more optimistic that an orderly Brexit can still be agreed on. With the latest Brexit deadline of 31st October fast approaching, however, it’s still not clear what will happen. While we are indeed very much bottom-up investors, clearly the eventual outcome of Brexit will likely have material impacts on the British pound as well as on the U.K. and (to a lesser extent) European economies.
All of this uncertainty is a great shame. We find the U.K. an inherently very attractive investment market. Indeed, there are more U.K. companies in the database of quality businesses—which we’ve been building for more than a decade—than any other country. We’re actually significantly underweight in the U.K. relative to the size of the opportunity set even as we maintain a sizeable U.K. weighting in the portfolio because of that uncertainty.
For now, then, we continue to watch and wait. Meanwhile, the U.K. companies that we hold either have very high export shares—such as Victrex, which produces an ultra-high performance polymer called PEEK—or are so robust in our estimation that there will be a minimal impact from whatever form Brexit takes. Restore, which is active in long-term paper document storage for its clients, would be one example of a robust U.K. holding.
Can you discuss a company that has been lagging of late and why you and David believe it can improve?
Kardex, a Swiss company that develops and manufactures automated storage and materials handling systems, has been one of the weakest stocks in the portfolio over the last quarter. Its stock price peaked in June before it took a further downturn after the company reported at the end of July that first-half order inflow had turned slightly negative, which went against the market’s expectations.
While its main ‘Remstar’ business of automated commercial carousel storage and retrieval systems, which made up 82% of its revenues in fiscal 2018, still saw 9% order income growth, its much smaller ‘MLOG’ business—high bay racking and conveyor systems—saw orders fall by 43% in the half-year period.
Kardex
3 Years through 9/30/19
We remain sanguine on the stock for a few reasons. First, this substantial drop-off in orders at MLOG is easy to rationalize. MLOG is a project-based business—unlike Remstar—so it does therefore experience a certain lumpiness to order income. It’s also essentially a German business, and Germany has experienced a significant fall in industrial production recently, primarily due to weak exports stemming from global trade tensions.
Second, and more important, we think the longer-term prospects for the business remain robust. Our confidence stems from the structural market drivers for warehouse automation: increasing industrialization, automation, and the rise of e-commerce. The U.S. also has a low penetration of automated warehouse systems as compared with Europe, and this represents a long-term growth opportunity. Furthermore, Kardex generates more than 50% of its profits from recurring spare parts and maintenance activities, which makes its business materially less cyclical than headline order inflow numbers would suggest.
Can you also talk about a company that has been doing well? What has led to its recent strong performance?
Carl Zeiss Meditec is a good example—it was one of the companies I met with on my recent trip to Munich. It had a strong quarter, and its shares powered to new all-time highs. The company makes and services ophthalmic devices, such as microscopes, intraocular lenses, and therapeutic eye lasers, and microsurgery devices, including surgical microscopes and other micro-surgery visualization equipment.
Carl Zeiss Meditec
3 Years through 9/30/19
The attractions of the business include market growth driven by ageing populations and healthcare investments in emerging markets, a differentiated product portfolio based on brand and market-leading innovation power, and a steadily increasing share of recurring revenues driven by consumables sales and servicing activities.
The company has been in the Fund since its inception nearly nine years ago. Over the last decade it has consistently produced ROICs of around 30% while growing the top line at an average of around 8% a year, and the market has rewarded this powerful combination. The company’s nine-month numbers released in August saw another 11% increase in revenues and a 36% jump in EBIT (earnings before interest & taxes), which led to another very positive response from the market.
Is there a newer position you’d like to discuss?
Yes. Another company I met with in Munich is NORMA Group, a German company that manufactures and sells metal and plastic engineered joining technology products such as connectors, clamps, and pipe couplings. Its main market is the auto industry, where it makes mass-produced, low-cost items that are designed into its customers’ products and single sourced.
NORMA Group
3 Years through 9/30/19
While the business generates consistent ROICs in excess of 35%, it has almost no aftermarket business, so it is exposed to some degree to the auto cycle, which has been weak in 2019. Together with some internal cost issues, industry weakness drove its stock to lows not seen in more than five years. In our view this meant the valuation was extrapolating short-term cyclical and cost issues while not placing enough emphasis on the inherent qualities and value generation of NORMA’s business model. With short-term sentiment and earnings growth temporarily driving its stock price, the risk / reward has become such that we’re content to patiently wait until investors focus once more on the business’s inherent qualities.
All performance information reflects past performance, is presented on a total return basis, reflects the reinvestment of distributions, and does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, so that shares may be worth more or less than their original cost when redeemed. Shares redeemed within 30 days of purchase may be subject to a 2% redemption fee, payable to the Fund, which is not reflected in the performance shown above; if it were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained at www.roycefunds.com. Gross operating expenses reflect the Fund's total gross annual operating expenses for the Service Class and include management fees, 12b-1 distribution and service fees, and other expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund's most current prospectus. Royce & Associates has contractually agreed, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Service Class's net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below 1.44% through April 30, 2020.
Mr. Rayner’s thoughts concerning recent market movements and future prospects for small-company stocks are solely those of Royce & Associates, LP, and, of course, there can be no assurances with respect to future small-cap market performance.
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.
