Killick & Co Investment House: A Thematic Approach To Stock Selection

In 2021 there seems to be a theme for everything, and an associated investment vehicle to match, whether the underlying thread is cryptocurrencies, rising levels of global obesity, or even the space economy. However, whilst not wanting to totally dismiss them, we nonetheless feel that investors should not underestimate the risks of investing into what are, in some cases, nascent industries where the underlying companies have no clear path to profitability. Instead, our approach is built on looking for themes that have a relatively high level of predictably.

We therefore spend time on ‘Big Picture’ thinking combined with detailed research and analysis, a strong pairing that makes a substantial contribution to our investment performance over time. Once we have found a theme that we like, we then look for businesses that stand to benefit from secular tailwinds that should provide lasting opportunities for growth in revenue, earnings and free cash flow. We keep the old investing adage in mind that, “a rising tide lifts all boats” even if the tide in our case is not the overall economy or a specific pocket of it, but a broad theme that we want to tilt towards.

The businesses that we select must therefore be able to plan and invest for the long-term, whilst demonstrating the means to withstand any short-term volatility in their end-markets or regions. As such, we are focused on high quality companies that can offer significant scale, balance sheet flexibility, strong brands, and robust growth opportunities.

As we enter the final stage of our re-emergence from the pandemic, here are two examples of key global challenges that demonstrate how the thinking outlined above, positions us to deliver superior risk-adjusted investment performance.

The first is our Future Healthcare theme. The cornerstones of our investment case are several seemingly unstoppable global forces, which include a rising population and increasing need for, and access to, healthcare in emerging markets.

The UN predicts an extra 700 million people on the planet by 2030.

This will create a wall of demand as not only are people living longer, but they are also becoming less healthy. That combination implies a higher incidence of chronic conditions, such as diabetes and heart disease which, in turn, are expected to place a greater strain on an already overburdened global system (in 2017, it was estimated that over one in seven dollars of spending in the US went towards treating diabetes alone). These drivers strongly suggest to us that global healthcare spending will continue to rise consistently over the next decade and beyond.

Given the inherent uncertainty in developing new therapies or medical devices, it is often difficult to accurately predict which companies in this space will be able to deliver the next round of solutions. However, what we are convinced of is that all healthcare companies, both existing giants and emerging upstarts, will have to spend significant amounts of money as part of an important global effort. But rather than taking what we would see as undue levels of risk in buying companies facing uncertain success around their future products, we prefer to ride the existing wave of research and development (R&D) spending in the healthcare industry, alongside long-standing trends towards greater outsourcing.

As such, Danaher and Thermo Fisherare two of the top names that help healthcare companies to research, develop and commercialise products across a wide range of end-markets. Both are geared to traditional spending as well as promising future markets (including cell and gene therapies, for example). We believe that both companies can grow annual revenues in the mid-to-high single digit range over the medium to long term, underpinned by excellent commercial execution and the aforementioned secular growth in healthcare R&D.

The case for investment in water is quite simple: it is the finite, essential resource needed to sustain life.

Further, the world needs to secure greater access to it in a useable, clean state in the face of some persistent, growing challenges. Water demand is being driven by a rising global population, coupled with climate change and the associated variability in weather patterns. In developed markets, ageing infrastructure presents a significant barrier to overcoming these issues.

Across the US, for example, it is estimated that the national average age of pipes has risen from 25 to 45 years between 1970 and 2020, largely as a result of underinvestment. Creaking infrastructure not only leads to greater leakage and pollution, it is also less efficient and more costly to run than its upgraded equivalent.

In emerging markets, meanwhile, water infrastructure is still non-existent in some countries and regions. The UN estimates that over four billion people lack access to basic sanitation, whilst over two billion are deprived of safely managed drinking water. Gaps in regulation around pollution, combined with a lack of adherence to existing ones, further complicate the picture.

Against such a backdrop, spending on water technology must continue to grow steadily over the coming decade.

To improve existing infrastructure and meet these growing challenges, this combination of solutions is what our favoured water technology companies are all about. However, there is also the potential for a significant separate boost in spending across developed markets from the $110bn earmarked for water infrastructure as part of President Biden’s $1.9tn proposed government spending plans.

Our approach to this is nonetheless conservative – whilst we have confidence in the eventual increase in spending needed, there can be no certainty about its timing and extent beyond the headlines.

Despite a growing awareness of environmental and regulatory issues, several decades of underinvestment have already passed, increasing our reluctance to assume that this time will be any different. So, rather than baking a significant step-up in spending into our forecasts, we prefer to remain circumspect.

Should a significant new infrastructure replacement programme materialise in the medium term, this will likely boost our investment case. If not, the challenges facing this crucial industry will remain. Our thematic work suggests the sector will generate attractive opportunities for investors regardless.

For now, our favoured way to invest is via Xylem, the world’s largest pure-play water company. With a product range spanning pumps, meters and treatment, plus data and analytics, it is geared to the replacement and upgrade cycle in hardware (mainly pumps), as well as the newest and smartest connected solutions aimed at reducing waste and improving asset efficiency.

Killik & Co’s Global Sustainable Equity Service helps you invest directly into companies that make a positive impact on our world. To find out more visit: www.killik.com