Ben Needham, Portfolio Manager at Ninety One, a global asset manager with emerging markets roots and a commitment to developing specialist investment teams, spoke to us about the opportunities and threats facing UK businesses.
HOW HAS THE CURRENT ECONOMIC BACKDROP IMPACTED THE LARGEST COMPANIES IN THE UK?
The performance of the FTSE 100 index, representing the largest 100 companies in the UK, is broadly flat so far this year in sterling terms. That does, however, belie the significant variation in performance we have seen between individual stocks and sectors and the volatility in the index as a whole over that time. In 2023, we have had record rampant interest rate increases in the face of persistent inflation, conflict break out in the Middle East and developed world growth start to creak. A rising oil price in the third quarter helped UK energy stocks such as Shell outperform. Rising yields have benefited banks such as HSBC and larger cap stocks more broadly, relative to growthier mid-cap stocks with longer dated cash flows. They have, however, simultaneously provided a headwind to more defensive parts of the market perceived to be more bond-like such as healthcare and consumer staples. The latter sector has also been impacted by an increasingly uncertain consumer backdrop.
HOW IS AI DISRUPTING THESE BUSINESSES?
For many businesses, AI can act as both a disruptor and an enabler. Arguably one of the most exposed UK large cap businesses to developments in generative AI is the data and information company, RELX. Its legal information platform, LexisNexis, is a good example of how generative AI can actually have a significantly positive impact when the underlying content is proprietary in nature. LexisNexis provides a comprehensive collection of historical court rulings, laws and accompanying commentaries without which subscribing lawyers cannot do their job. Around 10 million legal documents worldwide are uploaded onto the platform every week and all of LexisNexis’ proprietary legal data is protected and ringfenced in the cloud. The company’s new AI product, Lexis+AI applies Large Language Models to allow users to easily search their library of content and generate immediate, comprehensive and accurate responses to specific queries. There are also additional helpful functions such as “draft email to client” and “Brief Analysis”, the latter of which allows lawyers to upload documents and use AI to highlight relevant legal arguments. Extensive testing of Lexis+AI found lawyers saved hours of time every week completing their usual tasks, enabling RELX to price the product at a premium and further enhance their competitive advantage.
WHAT ARE THE OPPORTUNITIES?
In my opinion, high quality businesses with strong competitive advantages will continue to generate steady levels of free cash flow, which creates more optionality in challenging times. In a world where money is no longer free and the economy is rockier, differentiation, pricing power, strong balance sheets and free cash flow generation will really matter and there remain significant opportunities in attractively valued companies with these attributes.
WHAT’S THE BIGGEST RISK TO THESE TYPES OF COMPANIES?
The biggest risk remains higher discount rates. This risk is somewhat mitigated for quality companies by three main factors: the first is pricing power, which enables quality companies to pass on higher costs to the end customer in an environment of persistent inflation; the second is balance sheet strength, where high-quality companies have lower debt levels and correspondingly lower refinancing risk; and the third is low capital intensity, where these businesses have less of a drain on their cash flow in an environment of capex inflation. Together with a reasonable starting valuation, these factors should help protect these types of companies should we continue to see higher discount rates.
WHAT TYPES OF COMPANIES ARE YOU MOST EXCITED ABOUT
OVER THE NEXT 12 MONTHS?
Our quality universe is looking as interesting as it has for quite a while with a number of shares having de-rated on the back of concerns related to both higher discount rates and slowing economic growth. Around 90% of our portfolio holdings reside in companies with revenue persistence, i.e. consumer staple companies (Unilever and Reckitt Benckiser), medical device companies (Convatec and Smith+Nephew), companies with high subscription revenues (Sage, Kone and Partners Group) and companies with high retention ratios (AJ Bell and Compass Group). Revenue persistence has not been in favour in recent years but against an increasingly uncertain and challenging macro environment, we think it will be a characteristic that could well come back to the fore.
NEW YEAR’S RESOLUTION?
To bite the bullet and buy the family home despite believing property values are still woefully overvalued, particularly compared to the Ninety One UK Equity Income Fund!