Trustnet Magazine Issue 21 September 2016 | Page 30

STOCKPICKER SUBJECT TO CHANGE Alan Custis, manager of the Lazard UK Omega fund, highlights three stocks undergoing a structural transformation in order to improve their financial productivity W e approach stockpicking from a simple position: the more financially productive a company, the higher the valuation the market should be willing to pay for it. The most obvious way to look for alpha is to identify companies where we feel this relationship between financial productivity has come undone and to buy good businesses at attractive valuations. However, we also look for companies making changes that will enable them to become better businesses. By improving their financial productivity (measured by return on GLOBAL CATERING AND SUPPORT SERVICES BUSINESS COMPASS GROUP is a longstanding holding. Today we would describe it as a quality compounder with high barriers to entry and structural growth drivers. However, this wasn’t always the case – a change in management in 2006 led to a large restructuring programme in which the company pulled out of 48 underperforming countries and changed 70 per cent of management in six years. This resulted in an expansion in EBIT margins, which in turn led to a considerable improvement in return on capital employed. 28 equity or return on capital employed, for example), we believe that over time they will increase in value. There are many changes that can bring about improved returns: management change, acquisitions, introducing new product lines and selling underperforming businesses are just a few examples. Structural change does not always run smoothly, so we believe it is important to stay close to management and ensure they achieve the expected milestones along the way. However, when it goes well, the upside opportunity can offer real value. PROVIDENT FINANCIAL IS AN EXAMPLE OF A COMPANY at an earlier stage in the process. Its 130-year history as a homecollected credit business has moved with the times and its non-standard credit card division has grown phenomenally over the past five years. At the same time, Provident Financial’s management has consistently reduced the rate of nonperforming loans. We believe that it can repeat this success with its Satsuma business, disrupting the payday lending market and increasing its automotive loans business. EVEN EARLIER IN THE JOURNEY IS AUTO TRADER, the UK’s dominant digital automotive marketplace. Its strong market position means it has pricing power and high operating leverage in a capital-light business model. We believe that by taking advantage of opportunities such as crossselling, it can raise revenues, improving returns. As the market leader it is also well-positioned to benefit from industry change, such as growth in personal contract financing. Structural change is often challenging, but it rewards investors who understand the transformational potential.