Julian Fosh

Buying Bunzl – how its market position could strengthen during the crisis

Julian Fosh

Companies in possession of barriers to competition are likely to have better-than-average ability to trade through a crisis and emerge on the other side. This means that they are often able to enhance their market position – taking share from weaker competitors who have suffered more or ceased trading altogether.

We have no special insight into how this pandemic will play out but, having invested through previous crises, we’ve designed our investment process to direct us towards the kind of stocks we are happy to hold during turbulent times. We look for businesses that have strong barriers to competition, attractive market positions and a history of high returns. While these characteristics should prove valuable across the economic cycle, they can be particularly beneficial against a tough backdrop.

We were recently able to add a stock to the UK Growth Fund that we think will emerge from this crisis in a sound competitive position: Bunzl. Following April’s addition of IMI, this is the second quality cyclical we have been able to buy for the Fund since the Covid-19 crisis began.

FTSE 100 constituent Bunzl provides outsourced procurement and distribution of essential everyday items for customers that operate on a local, regional, national or international scale. Its possession of a core Economic Advantage intangible asset comes in the form of its distribution network, which stretches to over 30 countries and comprises 3,000 sales specialists and 2,600 customer services specialists.

While Bunzl owns some of its brands and distribution fleet, this is not where its network generates benefits for its clients; the majority of goods are fulfilled using third-party brands and channels. Bunzl’s value-add rests on its ability to provide benefits of scale and expertise in the sourcing, storage and distribution of goods. This allows customers to concentrate on their core business, reduce working capital and benefit from economies of scale.

The company specialises in providing sectors with goods that are not for resale such as packaging, labels, cleaning & hygiene products and personal protection equipment.

Bunzl’s mix of markets suggests it is a quality cyclical, albeit one with moderate rather than pronounced cyclicality. Its largest market is foodservice (c.30% of revenues), where it supplies non-food consumables such as food packaging, disposable tableware and cleaning products to hotels, restaurants and contract caterers. It also supplies the retail sector which, along with foodservice, is significantly challenged by Covid-19 contained measures. But this is balanced to some extent by more stable sales to other key sectors such as grocery and healthcare.

At the point we bought into Bunzl, with the shares trading at around £18 in May, we thought the market had overestimated the extent to which Bunzl is threatened by weakness in the global economic, presenting what we considered to be an attractive entry point.

As with all stocks added to the Fund, there must be evidence that Bunzl’s theoretical Economic Advantage is translating to a tangible financial advantage. Its credentials here are very strong: only once – in 2009 – has its cash flow return on capital failed to exceed its cost of capital. Bunzl’s line of business could be unkindly described as rather dull, but this kind of financial profile is why it excites us as an investment; it is exactly the kind of quiet long-term compounder of growth that our investment process looks for. 

It also met our requirement to be priced at a discount to the market on at least one of five measures, meeting the criteria on three of them: price/earnings (18.5x vs 19.8x for FTSE All-Share), free cash flow yield (4.7% vs 3.9%) and enterprise value/sales (0.9x vs 1.5x).

Its financial risk profile is one of the most stable we’ve seen, underpinning our decision to target a sizeable overweight position versus its FTSE All-Share weight.

Bunzl does have some customer concentration risk as its largest customer accounts for c. 10% of revenues, but the top 40 overall only account for 30%.

It also carries some acquisition risk, owing to the number of deals it strikes, but this is at acceptable levels given the extent to which acquisitive growth forms a key part of its strategy. Since 2004, Bunzl has made 160 acquisitions, at an average annual cost of £215m. Its management team believes that the outsourced procurement market is still very fragmented, leaving lots of room to grow organically and through further acquisitions. Because of this, we think Bunzl may even strengthen its market position during this economic downturn as the sharp recession may lead to some business owners having to sell at distressed prices. This could benefit operators like Bunzl that are robust enough to survive and have the capital to consolidate the market.

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Liontrust Insights

 

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Some of the Funds managed by the Economic Advantage team invest primarily in smaller companies and companies traded on the Alternative Investment Market.  These stocks may be less liquid and the price swings greater than those in, for example, larger companies. The performance of the GF UK Growth Fund may differ from the performance of the UK Growth Fund and will be lower than its corresponding Master Fund due to additional fees and expenses.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product.  Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Wednesday, July 29, 2020, 1:01 PM