The star fund manager underperformed his benchmark in the first six months of 2023, but says there are lots of reasons to be optimistic.
Terry Smith underperformed in the first half of the year, as a post-pandemic slowdown in laboratory equipment hurt the share prices of Waters and Mettler-Toledo, and cosmetics group Estée Lauder reported poor growth numbers.
The T Class accumulation shares of his Fundsmith Equity fund trailed the MSCI World index in the six months to the end of June, returning 8.5% compared with 8.9% for the index.
However, the fund has returned 15.6% a year since launch in 2010 compared with 11.3% for the global shares benchmark. It is a member of interactive investor’s Super 60 investment ideas list.
Writing in his half-year letter to investors, Smith said: “Waters and Mettler-Toledo have both been affected by the slowdown in laboratory expenditures post the pandemic. In neither case are we bothered by this. In fact, we hope it presents an opportunity for us to buy more.”
But Smith said he was concerned about the performance of Estée Lauder, whose shares dropped about 20% over the reporting period due to poor sales figures and inventory build-up in Asia.
He said: “While domestic travel has returned, it seems that Chinese consumers are buying watches, handbags, and other luxury goods first which it was harder to shop for online during the lockdown. It has revealed some severe weakness in Estée Lauder’s supply chain with no manufacturing capability in Asia.
“We hold Estée Lauder as a complementary cosmetics company to L'Oreal SA (EURONEXT:OR), with strength in America, prestige and traditional distribution channels in contrast to L’Oréal’s strengths in China, mass market and online. We await to see how the recent debacle is handled.”
On the sale, Smith said that the immediate cause of it was concern over potential capital misallocation.
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While he was initially confident that new Amazon CEO Andy Jassy would manage the firm’s investments well, the evidence did not stack up, according to Smith.
Smith said: “It is always easier to talk the talk than it is to walk the walk and the CEO’s pronouncement that he wanted Amazon to seek routes to get bigger in grocery retail ran counter to all these principles. In our view, grocery retail has none of these characteristics and Amazon has already stubbed its toe in this sector with the Whole Foods acquisition.”
He adds: “Where companies choose to invest outside a powerful core franchise in which they already have expertise we believe they are likely to destroy value, and especially so where they are entering a sector which already has poor returns.”
Amazon's CEO told investors last year that grocery is an important area for the business, but it would approach the sector differently from established supermarkets.
He said: "We're continuously refining our store formats to find the ones that will resonate with customers will build our grocery brand and will allow us to scale meaningfully over time. As such, we periodically access our portfolio of stores and decided to exit certain stores with low growth potential. We continue to believe grocery is a significant opportunity, and we're focused on serving customers through multiple channels, whether that's online delivery, pickup or in-store shopping.”
On a more positive note, Smith said that his healthcare and consumer stocks were performing well on an underlying business level.
“In the healthcare sector, businesses like Stryker Corp (NYSE:SYK) continue to benefit from pent-up demand after Covid which drove revenue growth in the company’s most recent quarterly results of 13%, several points above its historical run rate. Others like Coloplast or IDEXX remain metronome-like in their reliability and generated revenue growth of 8% and 10% respectively. Novo Nordisk A/S ADR (XETRA:NOVA) meanwhile was also an extremely reliable business growing at around 10% that has now been transformed into one growing at 25%, courtesy of its weight loss drug Wegovy.”
Nevertheless, Smith noted that rising input costs were putting pressure on profit margins.
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“Thus Procter & Gamble used to ‘make things’ for $0.50 and ‘sell them’ for $1.00, but now it costs $0.53 to make them. McCormick used to make things for $0.58 and sell them for $1.00, but now it makes them for $0.63. Estée Lauder used to make things for $0.20 and sell them for $1.00, now it costs $0.28 to make them.
“This still leaves our companies’ gross margins way above those of the market average, which means their bottom lines are better protected, but they cannot completely offset these headwinds.”
Smith said that he would not alter his investment approach based on macroeconomics and geopolitics.
“While we await the outcome of these economic and geopolitical conundrums, we will seek to continue to do what we set out to do. Which is to assemble a portfolio of high-quality companies and hold on to them so that their inherent ability to compound in value will determine how we perform over the long term.”
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