Scottish Oriental Handbook: Part 3
Avoid: Businesses with poor growth prospects available at “cheap” valuations
The handbook
Our investment approach is aimed at preserving capital and growing it sensibly. This approach has remained steadfast since the Company was established in 1995. In the fast-growing Asian region, there are several exciting stories or popular themes prevailing at any point of time, which promise attractive returns. These themes rarely stand the test of time and investing behind such opportunities comes with the risk of permanent loss of capital.
Therefore, our investment process starts by determining what we will not do.
Avoid: Businesses with poor growth prospects available at “cheap” valuations
We often observe that as a business matures, its owners or management may lose their desire to continue driving growth. They are happy to collect their annual dividends, which can be invested in other ventures. The earnings growth as well as return on capital of these companies decline over time. We noticed such trends in several companies with operations in economies such as Singapore, Malaysia or Hong Kong a decade ago.
These businesses had performed well in previous decades when the countries in which they operated were benefiting from strong growth. As their categories matured, their promoter families began to use the cash flows from dividends they received to fund other interests, with limited focus on the listed entity. Their earnings per share were declining and the returns on capital employed was deteriorating. These risks were justified by their “cheap” valuations, which were substantially lower than past levels. We avoid such value-traps. Businesses with declining earnings power only become more expensive over time. Comparisons to historical valuation levels hold little merit, given the lower returns and growth prospects. Management teams can also make poor capital allocation decisions such as expensive mergers and acquisitions during such periods, to mitigate this lack of growth.
Our focus is to own smaller companies which have the potential to emerge as much larger businesses in future. These operate in under-penetrated categories in large markets, which offer a long runway for growth. As these categories grow with steadily rising per-capita income levels, these businesses are likely to be the large businesses of the future.
Case study: Philippine Seven
Leading the 7-Eleven convenience store market in the Philippines
Philippine Seven is the exclusive franchise operator for 7-Eleven stores in the Philippines. The company is majority owned by President Chain Stores, which has successfully built the 7-Eleven convenience format into a large retail network in Taiwan. Its management is led by Jose Victor Paterno, who comes from the founding family of the business in the Philippines. Under his leadership, Philippine Seven has built a dominant position in convenience stores, with over 4,000 stores across the country and 58 per cent market share, which is over twice as large as its nearest competitor.
The management has also broadened its product offering to serve the evolving needs of consumers, such as fresh coffee and meal options as well as basic financial services. Despite the strong growth, convenience store penetration is still below 10 per cent of total modern retail sales in Philippines, compared to 30 per cent to 70 per cent in other regional markets such as Thailand, Taiwan and Indonesia. As per-capita incomes grow and customers prioritise convenience, this penetration of convenience stores is expected to rise consistently. With its clear market leadership which its management is strengthening further, Philippine Seven has the potential to emerge as a much larger business in the coming years.
Risk factors
Capital at risk. The value of investments and any income from them may go down as well as up and are not guaranteed. Investors may get back significantly less than the original amount invested.
Important Information
This document has been prepared for informational purposes only and is only intended to provide a summary of the subject matter covered and does not purport to be comprehensive. The views expressed are the views of the writer at the time of issue and may change over time. It does not constitute investment advice and/or a recommendation and should not be used as the basis of any investment decision. This document is not an offer document and does not constitute an offer or invitation or investment recommendation to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this document.
Net Asset Value (NAV) performance is not the same as share price performance and shareholders may realise returns that are lower or higher than NAV performance.
This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy, or completeness of the information. We do not accept any liability whatsoever for any loss arising directly or indirectly from any use of this information.
References to “we” or “us” are references to First Sentier Investors.
In the UK, issued by First Sentier Investors (UK) Funds Limited which is authorised and regulated by the Financial Conduct Authority (registration number 143359). Registered office Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB number 2294743.
Scottish Oriental Smaller Companies Trust plc (“Company”) is an investment trust, incorporated in Scotland with registered number SC0156108, whose shares have been admitted to the Official List of the London Stock Exchange plc. The Company is an alternative investment fund and has appointed First Sentier Investors (UK) Funds Limited as the alternative investment fund manager for the Company. Further information is available from Client Services, First Sentier Investors (UK) Funds Limited, Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB or by telephoning 0800 587 4141 between 9am and 5pm Monday to Friday or by visiting www.scottishoriental.com. Telephone calls with First Sentier Investors may be recorded.
First Sentier Investors entities referred to in this document are part of First Sentier Investors a member of MUFG, a global financial group. First Sentier Investors includes a number of entities in different jurisdictions. MUFG and its subsidiaries do not guarantee the performance of any investment or entity referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk including loss of income and capital invested.
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