Luc Bauler is managing the American equities fund BL Equities America at BLI - Banque de Luxembourg Investments since 15 years. The investment outlook for the US Equity market remains attractive, especially when companies with major competitive advantages are favored.
Could you start by summing up your management process?
The fund is managed according to the principles of Business-Like Investing. This stock-picking approach means that each investment is considered as taking a stake in a company, with a long-term investment horizon. So we focus on high-quality companies which have a clear competitive advantage that enables them to generate a high return on capital invested and strong free cash flow. Over the long term, this kind of company is expected to create value for its shareholders.
Stock-picking and investment decisions are primarily based on a detailed fundamental analysis of each company’s activities. Drawing on Business-Like Investing principles, this in-depth analysis leads us to a close study of each company’s business model and industrial positioning, its capacity for free cash flow generation, and its capital-allocation process. Then, before investing, the company's valuation must be attractive and its share price offer a safety margin against the fair value of the business.
How would you sum up 2018?
After 2017, a year marked by historically low levels of volatility, the equity markets saw a return to volatility in 2018, especially in the last quarter. At the beginning of the year, the US equity markets were still buoyant, benefiting from US companies’ strong earnings growth, helped in part by Donald Trump's tax reform. By the end of the year, slowing economic growth around the world, rising interest rates in the United States, and the US-China trade war weighed on the financial markets. The US large cap equity index, the S&P 500, fell at an annualised rate of 14% (in USD), with a 9.2% slump in December alone, the worst monthly performance for a December since 1931.
On the positive side, following the market correction in the fourth quarter of 2018, and given the sharp increase in US corporate earnings, the valuation of the US market is now back in line with its historic average for recent years. With corporate earnings having increased by an average of over 20% in 2018, and a market in retreat, valuation multiples have been revised downwards by around 25%, which represents a historically significant adjustment. In the current economic environment, which is showing some signs of slowing but is not about to go into recession, the outlook for the US equity market remains positive.
Breakdown of S&P 500 performance in earnings growth and expansion/contraction of valuation multiples
What are your top convictions?
We continue to be particularly positive about Microsoft, Visa and Mastercard shares. These are the fund's top three positions and have been in the portfolio for several years.
Since the arrival of Satya Nadella as CEO of Microsoft in 2014, the group's competitive position has been considerably strengthened. Along with Amazon Web Services, Microsoft has become one of the leaders in cloud computing. The group's future is now axed on the Azure platform (combining all Microsoft’s cloud computing services), Office 365 and LinkedIn, as well as profiting from smaller segments such as Xbox and Gaming, Surface and Dynamics. On the back of very favourable sector trends, Microsoft should be able to continue to post earnings growth rates of around 15% for the coming years. Given the solidity of the group’s balance sheet (surplus cash in the region of USD 50 billion), a high return on capital invested and strong free-cash-flow-generation capacity, a valuation of around 23 times forward earnings for fiscal year 2019 (year ending June 2019) still seems reasonable and attractive in the current financial context.
Visa and Mastercard are the main beneficiaries of the rapid expansion of the payment markets. These two companies are continuing to develop their business model and strengthen their competitive advantage with the geographic proliferation of their offer and the expansion of e-commerce. Although the macroeconomic environment could turn out to be more difficult in 2019 than previous years, Visa and Mastercard are posting post double-digit earnings growth. Both companies should continue to reap the rewards of strong secular trends, while more specific catalysts will come to fruition in 2019, such as a better pricing policy for Visa Europe and market share gains for Mastercard. At the same time, the valuation of Visa and Mastercard shares has become more attractive again following the market correction in the fourth quarter. Both shares are currently trading at around 25 times forward earnings for 2019.