Trustnet Magazine Issue 38 March 2018 | Page 8

/ JANUS HENDERSON /
BACK FROM THE DEAD
Janus Henderson’s David Smith says amid the excitement surrounding
disruptive technology, some of the best value opportunities lie in
companies that have been “disrupted”
D
ESPITE THE PHRASE
“DISRUPTIVE
TECHNOLOGY” being
coined by Harvard
Business School
professor Clayton M Christensen in
1997, the concept has been around
for centuries. The car replacing the
horse-drawn carriage and the
telephone making the telegram
defunct are two examples from
yesteryear but the advent of the
internet has sped the pace up
dramatically. Just look at the
music industry, which has now
moved on to its second digital
iteration with streaming services
superseding downloads.
None of this should be news
and investors are increasingly
looking for ways to play the
disruptive technology theme,
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whether buying the disruptor or
selling the disrupted. This article
looks at the latter and whether
the disrupted can fight back.
Many pages of research have
been written about the rise
of electric vehicles (EVs) and
their potential to eradicate the
internal combustion engine.
This has led to a significant
derating in chemical company
Johnson Matthey whose main
division manufactures catalytic
convertors for diesel cars
and trucks. While no doubt
diesel-powered cars are under
structural pressure, the pace
of EV penetration needs to be
considered. How feasible is it
for the UK government to ban
cars with tailpipe emissions
by 2050? Can the current UK
electricity infrastructure support
the growth in EVs? Can enough
charging points be added to
support EV growth? Can battery
technology evolve to make EVs
suitable for longer journeys? One
of the bestselling all-electric cars
in the UK, the Nissan Leaf, has a
range of only 124 miles and takes
seven hours to charge. There are
many unknowns but investors’
desire to sell the disrupted can
create opportunities. Johnson
Matthey now trades on an
attractive valuation, significantly
lower than its long-term average.
While we are taking the threat
of EVs seriously and support their
benefit to our environment, one
needs to consider it in relation
to Johnson Matthey’s valuation.
Automobile catalytic convertors
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only make up a quarter of the
company’s revenues while there
remain questions over how
quickly this might trend to zero
over the long term. Also, the
company is not standing still and
has been increasing investment
in research and development
over the years (£850m spent in
the last five years). At its recent
capital markets day, the company
talked about its next generation
EV battery technology, eLNO,
to challenge the NMC batteries
currently being used in EVs. With
claims such as better ranges,
power and life cycle at a lower cost
it all sounded very encouraging.
No doubt there is execution risk
but historically the returns on the
company’s investments have been
in the high teens.
The advent of electric cars
and the fears around the impact
on business models reminds
me of the concerns over how
e-cigarettes and vaping could
have changed the face of the
tobacco industry. The tobacco
companies reacted quickly,
however, either buying up vaping
start-ups or developing their
own technologies. Although
vaping continues to grow, it
hasn’t proved to be the disruptive
force that was initially predicted.
Unfortunately, it couldn’t give the
same nicotine hit as traditional
cigarettes, the flavours weren’t
the same and the handheld
devices proved unsatisfactory for
some to use. This has led to the
tobacco companies to continue
to invest, recognising the need
to find suitable alternatives to
combustible cigarettes given
their structural decline over
health risks.
British American Tobacco is at
the forefront of developing the
next generation of reduced risk
tobacco products called heat-
not-burn (HNB). The technology
heats rather than burns tobacco
to release a vapour with a taste
similar to that of a conventional
cigarette with significantly less
toxicants. This gives the benefit
over e-cigarettes of providing the
same nicotine hit and flavour
as a traditional cigarette. It also
means that the same barriers to
entry of supply and distribution
remain for the big tobacco
companies. Soon the product will
evolve with the technology used
to heat the tobacco stored within
a filter, meaning the delivery
mechanism will match the size
and feel of a traditional cigarette.
£m
Despite this investment and
growth potential, British
American Tobacco’s shares have
been lacklustre against a strong
market in 2017. The valuation
is attractive, with the company
trading at a significant discount
to the consumer staples sector
and also offering investors a 4
per cent dividend yield which
continues to grow.
As an income investor, it’s
hard to own the disrupter. Those
companies typically are in a
growth phase and reinvest in
their business rather than paying
out dividends to shareholders.
I t’s important to remember,
however, that management
teams of the disrupted
companies won’t necessarily
stand still and the good ones will
correctly balance investment
to protect their businesses with
dividends successfully. 
JOHNSON MATTHEY’S INVESTMENT
IN R&D VERSUS RETURNS
250
ROIC (RHS)
%
25
R&D Spend
50 20
150 15
100 10
50 5
0
2013
2014
2015
2016
2017
0
Source: Company Accounts, 31 October 2017
Notes: R&D = Research & Development, ROIC = Return on Invested Capital
None of the above stock examples are to be taken as advice and are for illustrative purposes only
Before investing in an investment trust referred to in this document, you should satisfy yourself as to its suitability and the risks involved,
you may wish to consult a financial adviser. [Past performance is not a guide to future performance]. The value of an investment and the
income from it can fall as well as rise and you may not get back the amount originally invested. [Tax assumptions and reliefs depend upon
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(Brand Management) Sarl and Janus International Holding LLC.
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