Many of the companies in the AFIC portfolio are based in Australia or New Zealand but are operating globally and are generating a substantial part of their earnings offshore. They include James Hardie, ResMed, CSL, Sonic, Carsales.com, Reece, and Macquarie Group, among others. Portfolio Manager David Grace and Investment Analyst Nga Lucas recently visited the United States to obtain a greater understanding of what's happening in this major market for some of these international businesses.
In the US, we met with the management teams of several of our key portfolio holdings. These companies exemplify the characteristics we seek in our investments, as we aim to hold them over the long term to generate superior returns for our shareholders. During our visit, we focused on companies that have significant growth opportunities in the US.
We wanted to ensure that we have an on the ground view of the various businesses, and through the insights that can only be obtained through face-to-face contact with senior management. We feel it is important information because operations in one country are not necessarily exactly the same as another. By visiting the US, we can better assess industry structure (including conversations with competitors) and consider if each company is well positioned in that context.
More generally the visit also provided insights into what is currently happening in the US economy.
The employment market in the US remains strong but is set to change. Cost pressures seem more acute, and companies are looking to reduce costs as economic conditions slow down. Also, working from home appears more pronounced in the US compared to Australia, with companies speaking of the difficulties in getting their staff back into the office. That said, quality businesses such as those we include in our portfolio, find a way to navigate through this changing environment.
Reece has an enormous opportunity in the US
Plumbing distribution company Reece bought a plumbing business called MORSCO in the US in 2018 for around $1.9 billion. We caught up with the local CEO of that business, saw Reece’s new store format, looked at their competitors, and got a feel for the lay of the land.
We believe that Reece has bought a very good business in MORSCO and has an enormous opportunity in the US market. We were pleased that the company is seeking to grow in the US in a measured way, mostly through organic growth. The company has also been able to differentiate its offer from those of its competitors.
Another key point is that the MORSCO business is based in the ‘Sun Belt’ (18 states in the southeast and southwest) of the US, which is an area experiencing significant population growth.
In contrast to other Australian companies that have made US acquisitions but struggled to gain momentum, Reece has bought a business that is of reasonable scale but not overly large and in the four years since the purchase, has been refining its go-to-market strategy.
Reece’s asset base in the US is very strong and well located, and the company’s strategy is well considered and appropriate.
Carsales.com can grow in the US
Carsales.com is Australia's leading used car online classifieds business with a dominant market position in Australia. It continually invests in technology innovation to help dealers sell more cars. The value created for dealers translates to strong cash flow generation for the business.
The business has successfully expanded overseas via several acquisitions, including Encar in South Korea, a 30 per cent stake in Webmotors in Brazil, and more recently, Trader Interactive in the US. We visited Trader Interactive in the US and met with the local CEO and senior managers.
Trader Interactive has a dominant market position in the US in the RVs and power sports classifieds market and is a close number two in trucks and equipment. We believe the business has an opportunity to accelerate market penetration and grow in the US through new products and technology, whilst leveraging the Intellectual Property and knowledge from the Carsales.com management team here in Australia.
James Hardie’s growth outlook in the US remains strong
James Hardie is the market leader in the manufacturing of fibre cement cladding, where it currently holds about 90 per cent market share. This business has operations in the US, Europe, Australia, New Zealand, and Singapore. We attended the investor day in the US recently and met with senior management.
The core market is US residential homes, particularly the renovations market.
Since 2005, fibre cement has more than doubled its market share of US homes with all alternate materials either stable or declining. Fibre cement has several superior attributes compared to other cladding materials – namely wood and vinyl.
It is lightweight and has a similar look and feel to wood, however, requires less regular painting than wood, and lasts significantly longer than its nearest competitor, vinyl.
James Hardie’s R&D pipeline has led to the recent launch of new lightweight panel brick products, competing with heavy construction materials of stucco and brick.
Capital allocation has been strong with the company generating a return on invested capital well above its cost of capital while maintaining a strong balance sheet.
We believe the growth outlook for James Hardie remains strong despite short-term cyclical headwinds.
ResMed as market leader has significant opportunity
ResMed is the market leader in the treatment of obstructive sleep apnoea (OSA). OSA occurs during sleep and results in a temporary narrowing or closing of the airway. Since foundation in 1989, ResMed has evolved from a small industry player to now having more than 50 per cent market share.
Our visit to the US gave us even more confidence that ResMed will continue to win market share as their key competitor, Philips, struggles with a major product recall.
ResMed employs over 8,000 people and sells products in more than 140 countries and we like the fact that ResMed generates consistent and strong free cash flow. The company also invests heavily in developing market-leading products and raising consumer awareness of OSA.
Long-term industry growth rates are forecast at around seven to eight per cent per annum, and the opportunity for ResMed as the market leader remains significant.
We also rate the management team highly as they have developed a long and successful track record of capital allocation, driving return on invested capital higher for the business.
The US trip help reinforce our view of these companies as good long-term investments. These companies have what we seek in all our investments for the long term: strong management teams, strong balance sheets, competitive advantages that we believe are sustainable into the future – all often underpinned by long-term secular growth trends.
As a long-term investor in quality companies, we have low portfolio turnover which make our returns to shareholders more tax efficient.