Playing the long game

Jason Pohl

In Australia and around the globe, companies face escalating costs, high inflation, tight labour markets, and dwindling consumer demand. The spectre of a recession looms as well. But the companies that are focussing on building resilience in the face of these challenges are those that will ensure competitive excellence through these cycles and emerge successful on the other side.

On a recent investor trip to the US and UK we were impressed by the lengths some companies are going to, to position themselves for this future outperformance. We were also reminded of the uniqueness of our approach – by focusing on the quality of a company’s fundamentals, while appreciating longer-term opportunities we can withstand short-term volatility.

A year of normalisation

Industries that did well out of Covid, like food and deliveries or online luxury goods, have experienced a pullback as the world returns to ‘normal’. However, companies that have managed to take advantage of the increase in customer numbers, and the higher retention rates of those customers, are positioning their business for long-term growth.

During this time, many are taking advantage of this pull back in activity to reinvest in new systems and processes, while others are withdrawing from less successful areas and focussing on profitable lines of businesses. Instead of hiring new workers, they are looking to where they can most effectively deploy their existing workforce. Or perhaps they may be considering new Enterprise Resource Planning (ERP) systems that can improve efficiencies and reduce costs. Efficiency and productivity are key.

One positive we picked up from our investor trip was that consumers overseas are quite resilient. Compared to what we read about consumer sentiment in the US and UK, what we saw was actually quite positive. Something as simple as the US offering 30-year fixed mortgage rates means many Americans don’t have the same financial strain Australian mortgagees have.

Firms are realistic and many are expecting a recession by the end of this year. But the companies we like are those that are forward thinking and strategically preparing for such a situation by, for example, analysing their customer base and focussing on more profitable or loyal customers. Those that are doing this well have been able to take market share from their competitors during this period and have accelerated their competitive position.

Customer loyalty

One of the great takeaways of the post-covid world has been the importance of customer loyalty. We notice this in Australia but observed it during our investor visits in the US and Europe to a greater extent.

Customers have always wanted to feel valued and appreciated. Using loyalty as a tool to enhance the customer experience helps companies manage the reduced market demand more effectively.

Companies who can do this, and centre their business model around the loyal consumer, are also finding it benefits the bottom line.

We observed the distinct prevalence of loyalty programs during our travels. Across the board, companies that have been able to understand and home in on their core customer through these programs, and other means, have experienced substantial improvements in profitability.

These programs need to offer more than just points and provide the loyal consumer with reasons to keep using the company’s services or products again and again.

Poster children

PWR Cooling (ASX: PWH)

Australian listed automotive cooling company PWR Cooling (ASX: PWH) supplies cooling products around the world. In 2015 it acquired US-based cooling and fabrication company C&R (now known as PWR North America). PWR North America now supplies to US motorsport markets, aftermarket, and now aerospace and military markets.

We were able to spend a considerable amount of time at their new factory when we were in the US. While we have been invested in this company since its IPO in 2015, being able to observe their activities on the ground further confirmed to us the rapid growth in their business. PWR is one company that exhibits the hallmark traits of companies we seek to invest in – focusing on their niche core competency, continually reinforcing their competitive advantage, and growing their economic footprint sustainably over the long term.

They have been incrementally investing in the business’ competitive advantage to the point that they’re now on aerospace and military contracts. They are also exploring opportunities in electric vehicles (EV) and providing electronic cooling solutions for EVs.

By visiting their facilities, we were able to better understand their growth options. Their expectations for growth in the aerospace and defence space became obvious through observing the sheer size and scale of that facility. We believe there will be an explosion of opportunity for PWR over the next two to three years.

We also like what they are doing with regards to labour retention. Faced with difficulties in finding appropriately skilled workers, they have implemented programs to train workers to the right skill level. They have initiated grassroots talent development initiatives and are working with schools to develop apprentices.

Domino’s Pizza Enterprises (ASX: DMP)

Domino’s has experienced a few hiccups in Australia over the past 12 months. Post-covid inflationary pressures have impacted franchisee margins and profitability, and disappointing first-half earnings saw a 23 per cent drop in the share price in February this year.

Domino’s Australia has a large exposure to Europe but even though Domino’s US and Domino’s UK are quite separate businesses, the insight from the international perspective is a return to franchise profitability. The US, for example, is also doing very well out of its loyalty program, with their 30 million active loyalty members delivering improved engagement and order frequency.

Looking at Europe specifically, we are observing some food and energy costs stabilising, leading us to believe the business will return to growth. This all gives us comfort that the outlook will improve while the company repositions itself through this year of normalisation and its operational improvements take hold.

Final word

Our message to investors for this year would be – don’t be put off by flat or declining growth and instead look out for companies making smart strategic decisions that position them for growth past any short-term disturbance.

Our US and UK trip brought home to us the importance of identifying companies with clean balance sheets, loyal customer bases, and management teams that understand their value proposition and competitive advantage. As the year of normalisation passes, quality companies will strengthen their competitive moat, providing opportunity for the long-term investor.

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By Jason Pohl, partner and head ESG officer