Rathbones’ Thomson bugs out on pest control
“The good thing about bugs and insects is that they don’t care about the state of the economy,” Rathbones’ James Thomson told Portfolio Adviser in relation to Rollins, a US-based pest control conglomerate.
The firm, which owns myriad US brands including Critter Control, PermaTreat and Western Pest Services, is a holding in the manager’s £3.6bn Rathbone Global Opportunities fund.
It contributes part of a 20% allocation to what Thomson refers to as “weatherproof stocks”, which are less economically sensitive, offer resilient business models and tend to fare relatively well during times of economic hardship.
“Pest control businesses in the US are considered an essential service, because of the warmer climate – particularly in the south. It is the perfect environment for bugs to thrive in,” he explained. “It’s a repeat service and, if customers don’t continue with that repeat service, the bugs come back.”
He adds that customers typically remain loyal to their pest control service of choice, which creates recurring revenue – particularly among commercial customers.
“Restaurants or food manufacturers simply can’t have a pest control problem. So, they are a very sticky customer base. This company has been in the fund for almost ten years now.
“As a business it has proven very resilient, has strong pricing power and boasts real customer loyalty. And, it really is considered a vital service in the US.”
Another weatherproof sector across the pond, which is less likely to be considered as an investment opportunity in the UK, is waste disposal.
Thomson has an allocation to Waste Connections, which is headquartered in Texas and is one of the largest waste collection providers in North America.
“People living in the US pay around $40 (£31.78) a month for their garbage collection. And, as with pest control, things have to become pretty bad for people to turn off their garbage collection service – particularly for commercial customers.
“Even in a difficult economic environment, where a restaurant has fewer covers and creates less waste, their garbage still gets collected whether their bin is half full or not.”
The manager added that rubbish collection businesses in the US are “de facto monopolies granted by the states”, meaning they don’t have to worry about competition from other firms.
“There are a lot of attractive qualities to this sector, which is probably why the Mafia loved it so much all those years ago. But now, it is a legitimate, profitable and successful business opportunity within the private sector,” Thomson explained.
“I could have never imagined, at the beginning of my career, investing in these kinds of stocks. But in time you realise the beautiful qualities they add to a portfolio; they sit perfectly alongside Amazon and Nvidia, because they offer resilient qualities that perhaps those other businesses don’t.”
JOHCM prescribes health stocks for value investors
It is possible for value-focused investors to reap the benefits of a burgeoning healthcare sector, contrary to popular belief, according to JOHCM’s Robert Lancastle.
Lancastle, who has co-managed the £548m Ireland-domiciled JOHCM Global Opportunities fund with Ben Leyland since its launch in 2012, holds “several” healthcare names in the portfolio. This is despite the fact healthcare stocks are stereotypically viewed as expensive, alongside other fast-growing parts of the market such as technology.
Meanwhile, Lancastle and Leyland adopt a value-focused approach to investing, seeking out companies they believe are being underestimated by the broader market.
See also: Beneath the bonnet: The case for L’Oréal, Salesforce and LVMH
“We have six or seven healthcare names in the portfolio, and five of them are in the US,” Lancastle explained.
“But to be frank, in the US, I could give you three different buckets even within the healthcare space. That shows you how wide-ranging the market area is.”
Overall, healthcare stocks account for 18% of the 39-stock portfolio. Its single-largest holding is Henry Schein, which distributes dental supplies and comprises 4.1% of the overall portfolio.
Lancastle said: “Anytime you go into the dentist, pretty much anywhere in the world, these guys will be providing most of the products that are being used.”
Alongside distributers, the fund managers hold ‘life science stocks’ – companies that operate in the research, development and manufacturing of biotechnology, pharmaceuticals and medical devices.
“We have a holding in Thermo Fisher Scientific, which is involved in the testing and development of new drugs, Covid testing, ectetera. Things had been going well here, although it has recently been facing some headwinds,” Lancastle explained.
Alongside a 3.3% weighting in Thermo Fisher, the fund also has a 2.4% allocation to European life science firm Merck.
The third healthcare bucket the fund has exposure to, according to the manager, is managed care organisations (MCOs), which typically provide managed care to clients and charge a set monthly fee.
“These are effectively medical insurers,” he said. “We don’t have that market in Europe or the UK, because there is generally more of a public healthcare system. But in the US, you need insurance.
“These companies provide that insurance if you’re privately employed, but they also provide healthcare support for either the elderly, or the poor, through various different packages.
“We hold two of these types of companies. One is called UnitedHealth and the other one is Elevance Health.”
Generally speaking, Lancastle said the fund’s healthcare holdings are “demonstrably advantaged businesses” trading on “very sensible multiples”.
“Those latter two companies, for instance, were growing somewhere between 10% and 15% last year. They come with a certain amount of political risk, because obviously politics and healthcare can become intertwined.
“But that is partly why we don’t just put all of our eggs in one basket, we have a number of [healthcare stocks].”
Irrespective of the political landscape – particularly the US ahead of this year’s election – the manager said the long-term fundamentals powering healthcare companies will remain in place.
“There is a need for healthcare. I don’t think any party in the US wants there to be no healthy people. Whether this is done privately, or through the Medicare and Medicaid system, there will be a policy.
“It will get tweaked and can change throughout the electoral process, but this shouldn’t actually affect the business models that much.
“All of our healthcare holdings have an average growth in high-single digits and are trading on mid-teens multiples. They’re just not growing as fast as Novo Nordisk or Eli Lilly.”
Gym Group: A place for the many not the few
In the wake of Covid-19, people are slowly trading their Joe Wicks living room workouts for a trek to the gym to step on the elliptical trainer again. And this time around, Castlefield’s David Elton believes a new cohort of people will have the opportunity to join the masses through a subscription to Gym Group.
Gym Group is the second-largest player in the affordable fitness market behind PureGym, and offers 24-hour access to gyms across the UK without a contract. As of 31 December 2023, it had around 850,000 members.
Elton, who runs the Castlefield Sustainable UK Smaller Companies fund, invested in the company in 2017, attracted by its accessibility.
“It opens gym membership to people who may have historically not been able to afford a £50-60 monthly fee. This is good because health challenges around obesity in the western world are something we need to tackle as a society,” Elton said.
“We feel Gym Group is playing its part in that. The fact it is open 24/7 provides access to people who historically may not have had it. If a gym is only open from 9am until 8pm, then someone working shifts in the day wouldn’t be able to get there.”
The past five years, however, have proved difficult for Gym Group, as shares fell by over 45% after weathering the pandemic. While the price recovered momentarily in 2021, the past few years have led to slips again.
But in Gym Group’s annual report to 31 December, revenue increased by 18% while free cashflow increased by 62% from £16.7m to £27m. As of 20 March 2024, the stock had returned 23% in the past year with a share price of 119.75p. Its five-year peak was 308p.
Elton remains positive about Gym Group’s outlook, citing the company’s plans to open between 10 and 12 new gyms this year, and 50 in the next three years. He also noted the change of management this September 2024 as Will Orr becomes CEO.
“It’s encouraging to see they’re getting back on that more normalised rollout track now. It’s a very cash-generative business, which is what we look for. The gyms they manage are low-cost to the customer, but they’re also low-cost to run,” Elton said.
“The beauty of the model is that they can offer lower fees as they don’t have things such as steam rooms, saunas and swimming pools, which are very costly to run. It’s more stripped back in terms of its approach, but still high quality, clean and well maintained.”
While investors have held little faith in UK small caps, Elton said this makes it a “stockpicker’s market”.
He added that another issue in the UK small-cap market is takeovers. Eight of the companies within Elton’s portfolio have been bid on in the past 18 months at a premium average near 40%, with fives sales made. “It can be bittersweet to see businesses get taken over, but there are plenty more fish in the sea.”
This article first appeared in the April issue of Portfolio Adviser magazine
