1. Thriving in the Face of Adversity

    Chris Davies, Investment Manager. Third Quarter 2018
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  2. The Munich Olympics of 1972 are rightly remembered for the tragic Munich massacre, which saw eleven Israeli participants killed by members of the Black September group of Palestine. The tales of personal endeavour from the games themselves are thus often left untold. One of these stories recently captured my imagination.
  3. September 3rd, 1972. Ideal conditions for running. The contenders line up for the 10,000 metres men’s final. Among the athletes are the great Mohamed Gammoudi of Tunisia, Emiel Puttemans of Belgium, and the relatively unknown Lasse Viren of Finland. The race gets off to a good start, but when the pack approaches the halfway point, catastrophe strikes. Viren – in fifth place at this point – trips over his long legs and tumbles to the ground, taking Gammoudi with him. The crowd gasps. This would go on to become the defining moment of the race. While Gammoudi stays down, Viren somehow musters enough energy to drag himself up and re-join the race. Trailing and no doubt feeling hopeless, the odds are firmly stacked against him. He desperately wants the medal. Viren strides on, passing his opponents one by one. Finally the only challenger is Belgium’s Puttemans. The Belgian can’t keep pace, and, in defiance of the odds, Viren drives his tired legs over the line to take gold, setting a new world record in the process. 

    Lasse Viren going to ground while racing. © Bettmann / Getty Images.


    Viren’s story is a powerful one. If time had miraculously frozen and the gasping audience somehow polled while both men were down, I doubt many would have bet on either to win a medal, let alone gold. This is often the case in financial markets. When a company stumbles it suffers the wrath of an unforgiving market that finds it difficult to envisage a brighter future. Operational hiccups, mismanagement, or even natural disasters can lead a company to a dark place. With deteriorating sentiment comes a falling share price, and very soon a company can find billions of dollars wiped off its market value.

    Sometimes the market is right. It would have been difficult to envisage Enron rising like a phoenix from the ashes when its skeletons came tumbling out of the closet in 2001. Similarly, the fate of former Global Alpha holding Northern Rock seemed all but sealed as it hurtled towards insolvency during the financial crisis of 2008. Sometimes, however, the market is simply wrong. On countless occasions it has punished companies for short-term problems that are eventually resolved. If Mr. Market were a person, he’d have so much egg on his face he wouldn’t be able to see. Like Lasse Viren, companies can stumble but still power on to glory. For the patient, long-term investor, these situations can be extremely lucrative. The key is to ascertain which stumbles can be overcome, and which cannot.

  4. Like Lasse Viren, companies can stumble but still power on to glory. For the patient, long-term investor, these situations can be extremely lucrative.
    Lasse Viren of Finland winning the final of the 10,000 metres event during the Summer Olympic Games in Munich, 3 September 1972. © Ed Lacey/Popperfoto/Getty Images.
  5. Our approach

    The Global Alpha strategy is designed to have a broad approach to growth. Our four growth categories – stalwart, rapid, cyclical and latent – express the philosophy that there is more than one way to make money in growth investing. Latent stocks are typically out of favour with the market because there has been little or no growth in recent years, but we call them ‘latent’ because we feel that this prevailing negativity is undeserved. This is usually because there are strong catalysts for change in the business that are under-appreciated. As patient, long-term investors, we believe that we are well-placed to benefit from such situations. This is quite different from investing in, say, stalwart stocks, where our insight tends to relate to the pace or longevity of growth; latent growth investing is more about exploiting market behaviour and sentiment. We are looking for companies that can thrive in the face of adversity. In short, in our hunt for latent growth ideas, we are looking for the Lasse Virens of the stock market.

    Success cannot be achieved without catalysts. When we invest in latent growth companies, we are doing so because we believe that the company will improve itself over time and beat sceptical market predictions as a result. That improvement cannot happen unless it is fostered and nurtured.
    It could be that a company has undergone a much-needed management change, or that its industry is improving. Whatever the case, we only invest when we are comfortable that the conditions permit success.

    It’s worth considering some latent growth examples to bring our thinking to life. The first is an idea that has worked, while the second is very much still in progress.

  6. Royal Caribbean Cruises

    The cruising industry hit choppy waters after the financial crisis. Negative headlines became routine, and companies such as Royal Caribbean and Carnival found themselves fighting fires on many fronts (sometimes literally). If the iconic image of the 1972 10,000 metres final was Viren rising to his feet while Gammoudi remained on the ground, its parallel in the cruise industry in 2012 would have been one of Carnival’s cruise ships – the Costa Concordia – lying on its side off the coast of Italy’s Isola del Giglio. The sinking was the latest in a series of unfortunate events, including the recession, painfully high fuel costs, and political unrest in North Africa. It didn’t end with Concordia. Later that year the industry had to deal with more questions over safety as another Costa ship found itself adrift off Seychelles after a fire, and a norovirus outbreak hit Princess Cruises. Both these companies were owned by Carnival, which found itself having to navigate its way through several problems at once. The cruising industry had lost the market’s favour and Royal Caribbean was caught in the crossfire, with its valuation falling to the lower end of its historic range.  

    Costa Concordia cruise ship wreckage off Italy, January 2012. © Kyodo News, Getty Images.


    Despite the challenges of 2012, there were reasons to be positive. First, the general economic malaise holding back cruise demand would not last indefinitely. Second, we viewed the convergence of headwinds as an anomaly: the likelihood of so many negative events occurring at the same time again in the near future felt low. Third, and most importantly, the market was overlooking a major structural improvement in the industry in that consolidation had fostered a much more rational industry structure with two players – Carnival and Royal Caribbean – dominating the market. Beyond the consolidation, underlying management incentives had also changed for the major players following the global financial crisis, with a clear focus on improving returns and therefore maintaining supply discipline. The capital cycle was in action. Royal Caribbean’s historic incentive plan had focused on delivering operating profit growth alone; the new plan was based on return on invested capital, and increased customer satisfaction. The cruise companies suddenly wanted to generate returns, not grow for growth’s sake.

    Royal Caribbean set itself some ambitious targets. Christened ‘the double-double’, its plan involved a doubling of earnings per share and return on invested capital between 2014 and 2017. It achieved this through a combination of better pricing and selling more on-board goods and services. The strength of its brands remained pivotal. As we hoped, the bad news went away, demand recovered strongly, and capacity discipline became the new normal for the industry. In 2014, we reclassified holding from from latent growth to cyclical. Royal Caribbean sailed through its double-double targets, and by the fifth anniversary of our purchase the share price had risen over three and a half times. Our investment in Royal Caribbean began to bear fruit.

  7. A.P. Moller Maersk

    From one ship operator to another: conglomerate A.P. Moller Maersk, one of our current latent growth investments. With a market capitalisation of over $25 billion, this is no small pleasure boat. Like Royal Caribbean in 2012, Maersk recently suffered its own moment of crisis as the oil price crashed in late 2014, taking its oil business with it. While this caused a tough 2015, worse was to come as Maersk’s container shipping business – Maersk Line – hit an iceberg as overcapacity met lacklustre demand. In 2016 Maersk Line made over $20 billion in revenue, but reported a loss of $376 million. Maersk was in crisis. At the same time, its valuation saw a sharp compression, with the price/book ratio falling from 1.3x at the end of March 2014, to under 0.8x two years later. Maersk began to look cheap on multiples of profit too. 

    The catalysts started to emerge. The company – spurred on by its family owners – began a strategic review in June 2016, the results of which were announced three months later. This was a once-in-a-generation event which resulted in the decision to divest all energy assets and focus on building an integrated transport and logistics business that would surpass the value of the container shipping business on its own. Significant progress has already been made here with the sale of Maersk Oil to Total for $7.5 billion, and the sale of Maersk Tankers. Concurrently, the shipping industry has seen significant consolidation with a wave of mergers taking the share of the top ten carriers to 77% by the end of 2017, but with the current outstanding deals, it should rise to 82% (though there is probably more to come). One of the biggest problems the industry has faced is overcapacity. At times capacity has grown twice as fast as demand. A more consolidated, rational industry should help improve returns and profits, similar to the cruise industry in 2012. Maersk has also decided to focus on less capital-intensive growth in freight forwarding, a highly fragmented but growing market. This makes it look much more like a growth business, something that is not reflected in the share price. 

    A gantry crane moves a container in Gwangyang, South Korea. © SeongJoon Cho/Bloomberg, Getty.


    We are at the beginning of our Maersk voyage. We could be wrong. It could be that industry discipline fails, or that Maersk is unable to compete against established freight forwarders like DSV or Kuehne & Nagel and therefore struggles to become the growth business we hope it could be. Right now, Maersk is much like Lasse Viren in that it has stumbled and is trying to drag itself to its feet. We hope this is the beginning of a fundamental, positive transformation that should provide patient shareholders with strong returns in time. 

    Latent growth investments tend to share certain characteristics. What’s most important with all of them is the prospect for significant, constructive change. This may take several forms, including structural improvement in a company’s industry, positive change in the way a company is run, or even big shifts in the way a company is structured. Our typical latent growth investments will also be companies that are regarded with a prevailing negativity by market participants. This negativity may be caused by recent stumbles, but where others choose to extrapolate the bad times into the future, we may take a more positive view. There are therefore two potential sources of return when our latent growth investments work: improving operational performance and an upward shift in the valuation of those earnings.

  8. Summary

  9. Risk Factors and Important Information

    The views expressed in this article are those of Chris Davies and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions. 

    Potential for Profit and Loss 

    All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.

    Stock Examples 

    Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style. 

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  10. Chris Davies

    Investment Manager

    Chris joined Baillie Gifford in 2012 and is an Investment Manager in the Europe Team. He graduated BA (Hons) in Music from the University of Oxford in 2009 and went on to gain an MMus in Music Performance from the Royal Welsh School of Music and Drama in 2010 and an MSc in Music, Mind and Brain from Goldsmiths College in 2011.