Long-Term Investing Ideas in a Volatile Market
Simon recently spoke with a $35 billion global asset manager about how they're navigating the market volatility. The key takeaways are to think long term, tune out the noise...
Comgest's Portfolio Managers describe their long-term investing approach and the most compelling global opportunities.
May 25, 2023 – By Simon Erickson
We as investors often suffer from “home court bias”, where we’re most interested in the opportunities who are based in the country that we live in. We’re familiar with the culture and the currency, so it’s easier for us to invest closer to home.
Yet the business world stretches to all corners of the globe, and investing is similarly an global phenomenon. Astute investors who are willing to put in a bit more research are often rewarded by the opportunities offered by other countries.
So where are those opportunities today? Are there certain countries that are particularly lucrative for investors? Are there specific companies who are winning on the global stage?
To answer those questions, we’re welcoming back two of our favorite guests. 7investing CEO Simon Erickson recently spoke with Comgest’s portfolio managers Rick Mercado and Richard Kaye about international investing. Comgest is an independent global asset management firm based in Paris, who manages $30 billion and has a knack for finding long-term growth opportunities.
The three kicked off the conversation by sharing perspective on the global macroeconomy. Interest rates are rising and threats of a recession are looming, yet bottoms-up research and stress-testing of companies still shows that the fundamentals of most businesses are still sound and attractive. Tech companies like Microsoft (Nasdaq: MSFT) appear well-positioned to benefit from AI, while the membership-based Costco (Nasdaq: COST) appears resilient to an economic downturn. Perhaps surprisingly, high-end consumer discretionary names like Louis Vuitton Moët Hennessy (OTC: LVMHF) and Ferrari (NYSE: RACE) have similarly shown a resilience to the challenging macro.
Richard then discussed investing in Japan. He points out that Japan’s growth rate is amongst the highest of OECD nations, yet its market valuation multiple is among the lowest. Several under-the-radar companies like Ibiden (OTC: IBIDF) and Advantest (OTC: ATEYY) are manufacturing the equipment necessary to manufacture the microprocessors to support high-performance computing. Due to the rising popularity of AI and machine learning inference, those are seeing a dramatic increase in demand. Rick and Richard together described how sometimes a country’s equity markets could be a springboard for it’s companies to enter other markets.
Simon and Rick then dive into the computing industry, specifically about ASML’s (Nasdaq: ASML) dominance of lithography. They discuss whether rising geopolitical tensions between China and Taiwan could disrupt the semiconductor supply chain and the impact that might have on ASML.
The three then discuss India, where mega-conglomerates with close ties to the government often “write the script” of emerging industries. One example is Suzuki, who is working with the government on the rollout of electric vehicles. Similar situations have happened with renewable energy and telecommunications. This can often make it challenging (and messy) for international companies like American Tower (NYSE: AMT) to compete in countries like India. But it can often also backfire, as seen recently with Adani Group’s troubled financial statements.
In the final segment, the group discusses investing in 2023 as compared to 2022. “Earnings matter now”, as fundamentals and good quarterly reports are increasingly being rewarded by the market. Rick and Richard close out by discussing their approach to valuation, especially using a long-term mindset.
Publicly-traded companies mentioned in this podcast include Adani Group, Advantest, American Tower, Apple, ASML, Costco, Don Quijote, Ferrari, HDFC Bank, Ibiden, Intel, LaserTec, Louis Vuitton Moet Hennesy, Microsoft, NVIDIA, Orax, Reliance Industries, Softbank, Suzuki, Sysmex, and Taiwan Semiconductor. 7investing’s advisors and/or its guests may have positions in the companies that are mentioned.
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Simon Erickson 00:00
Hello, everyone, and welcome to this edition of our 7investing podcast where it’s our mission to empower you to invest in your future. I’m 7investing CEO Simon Erickson and you can learn more about our 7investing long term investing approach at 7investing.com and also see our favorite stock market opportunities each and every month. I’m really excited to talk about the investing world that we’re living in today. It’s an interesting one out there right now, you’ve certainly seen technology is being embraced by America’s largest tech companies. We’re seeing a focus on large language models that are built upon artificial intelligence. And it feels like GPT is taking the world by storm right now. But of course, behind the scenes, there’s also some complicated silicon chips that are used for the computing and processing that’s required for those AI models. And a lot of these are fabricated in Taiwan, where more than half of the world’s custom silicon for high performance applications is actually produced. Of course, Taiwan has had rising geopolitical tensions with China, who has had trade tensions with the United States, who has tensions with the Ukrainian conflict going on in Eastern Europe. My point in setting the scene for all of this is that we’re living in a very interconnected world where pieces are delicately fit together, and there’s a lot to interpret for individual investors. As such, I’m very excited to welcome back to two guests to our show today. Rick Mercado and Richard Kaye are both analysts and portfolio managers with Comgest. Comgest is a global asset management firm based in Paris, France, they manage more than $30 billion globally. And they also share our long term investing approach. Rick and Richard, I’m so glad to have you back on the 7investing podcast. Welcome back to the show.
Richard Kaye 01:40
Again, thanks so much, Simon.
Simon Erickson 01:43
We’ll jump into a kind of a bunch of the different themes that we kind of alluded to there at the beginning. We have some individual companies we’ll get to chat about for a little bit. Perhaps the first thing worth pointing out is that we are, it’s lost for anyone who’s listening to this rather than seeing the video, but we are located all around the world. It’s 8am for me in the morning, here in Houston, Texas. Rick, I know that for you out in Paris, I believe it’s 3pm. And it’s got to be somewhere in the middle of the night for you out there in Japan, Richard. But on average different time zones are well represented for our for our call here today. Perhaps let’s start with the macro, though. Rick, let me let me key you up with this one first. And then Richard, if if you’d like to take it as well. But you know, it’s we always want to be long term investors. I know that you guys have the quality growth, investment philosophy, you’re very long term investors with conscious which I love that. But it’s hard to tune out a lot of the stuff that’s going on out there, right, interest rates are rising quickly. We’re trying to constrict the economy, maybe just a 10,000 foot level question, Rick, you know, how are you looking at the macro right now? And how is that influencing your investing approach?
Rick Mercado 02:51
Yeah, it’s a really good question. Thank you, Simon. Macro is always very interesting. It’s difficult to forecast, everyone’s got a view on our investment philosophy always comes back to the fundamentals. So from the perspective of whenever the market is focused on macro event, a shock, something like COVID, and so on, you tend to always get opportunities where valuations and fundamentals disconnect. And that’s typically what we saw in 2022. So, from a bottom up perspective, we are always doing scenario analysis. We definitely don’t have our heads in the sand. We want to stress test our companies for interest rate environments, for recessionary environments and so on. But ultimately, I believe that over the long term, despite what may happen in the short term, share price performance ultimately converges to fundamental and earnings performance. And I think the start of this year has been quite encouraging last year was certainly volatile and tumultuous. Earnings were generally good for most of our companies all throughout last year, but this year, finally, it seems that the market has put earnings and fundamentals back at the forefront and the bond yield environment devaluation environment has taken a backseat to that. We’ve seen that over our 30 year history. It certainly hasn’t been the first time this has happened. But we feel like we’re now in an environment, which really sees our style of investing start to resonate.
Richard Kaye 04:15
Go ahead, Richard, what are you seeing in Japan? Very similar comments to Rick, on the global stage there. We believe that all the track record we’ve we’ve gotten, we’ve been doing our fund for about 20 years, just on Japan here, all the track record we have proves that profits are the ultimate determinant of share prices. You’ve got to stick with a story. You’ve got to allow that story to develop. You’ve got to allow company’s profits to be again reflected in share prices. The macro economic noise gives us opportunities just like Rick said. And they’ve been of course, global and Japan specific events which have greeted that noise for our stocks here in Japan. And we’ve used those events as opportunities. To add to positions, one of the major questions that especially non Japanese foreign investors have advised about Japan for the last two years is will there be a change in monetary policy? And that macro question has almost dominated the debate on Japanese equities, the Japanese markets for two years. We don’t think that’s a major question, actually. The whole inflation story is quite different in Japan. And we have many companies which grow independently, regardless of even a small percentage potential rising rates. And so we are very much encouraging investors to look at stocks specific stories and move away from these big macro debates, very much like Rick said, on the Global’s sphere. Similarly for us in Japan, we’ve started to see share prices reflect good earnings numbers, especially in this last month or so we’ve had companies giving guidance for the coming fiscal year, fiscal year closes in March in Japan. And we feeling that’s a much more germane environment for our type of investing.
Simon Erickson 06:04
Yeah, certainly. And we we share the interest in looking at individual companies that are influenced by the macro. We’re not investing based on what the chart of CPI shows every quarter every year. But it does have an influence. I’m going back to what you said, Rick, we’re looking at company fundamentals, we’re looking at earnings per share growth that’s sustainable over time. We, at least in the United States, have certainly seen this impact to the tech industry. We’re used to kind of zero interest rate policy for decade. Money was cheap, if not a very, fairly valued stock price, you could immediately issue equity equity, you could put that into projects, you could go out and hire a lot of people, like we saw a lot of our large tech companies doing. And there’s also a huge trend right now, right AI is kind of the two letters that that stick with everybody. But the large language models, I just got back from MIT last weekend saw how comprehensive those are, and how basically every company is trying to do the same thing and trying to build a layer that everyone else will build upon for for company specific models. Rick, back to the point, though, that you made about, you know, we’re looking at fundamentals. earnings, it seems like are being rewarded, at least in this earnings season, where they perhaps didn’t matter last year, because everyone was just so depressed about the macro. Are there pockets of of companies that you’re seeing that are really outperforming or taking advantage of all of its influence from the macro right now that you that you really find appealing as an investor?
Rick Mercado 07:20
Yeah, absolutely. So a lot of good things to touch on. Just in that comment that you made, Simon? Certainly AI is something that we’re looking at in a lot of detail. It’s still early days. I would compare that if you look at Tech over the last 10 years, you’re absolutely right, we’ve had tailwind spiders, a low bond yield environment, pretty much a everyone winning everyone stay in their own sandboxes. Whereas today, I think the environments somewhat different, we certainly don’t have zero interest rates. And we have seen more competitive incursions upon each other’s normal environment. So that’s something we need to be aware of, I think it speaks to, we need to be much more selective. And again, it really speaks to being a stock picker in this sort of environment. So you take a name like Microsoft, to your point, AI was mentioned over 50 times just in the last earnings call. So certainly did get a lot of detail 1% of the growth in so so they got into 26-27% revenue growth 1% of that was already attributed to AI related services. So given how nascent that is, that’s pretty impressive. Now, if you look across the landscape, typically these models, this shift to AI, it’s going to cost a lot of money, it’s going to incur a lot of CapEx, and then you have to ask yourself the question of how do we monetize that? We think Microsoft, so a name that we’ve had, since 2008, is very well placed. If you look across to Microsoft, they have a broad suite, they have obviously offers, they have GitHub for coding, they have cloud and so on. But they’re actually able to say, Well, if you switch to our highest priced tier of office, for example, you get access to all the AI copilots. So they’re able to say, well, I can actually monetize this AI opportunity. You know, if they take share from the from Google on search, they also get to monetize that. Whereas if you look across the other companies, most of them are going to incur a cost but they have limited means by which they can actually price and monetize that. So we think Microsoft is very well placed from that perspective. Certainly looking into that theme. And then to your point across our entire portfolio. We’ve seen really compelling performance whether it’s in insurance, luxury goods, data, obesity, so Novo Nordisk, and Eli Lilly doing very well on that front. It’s quite comforting to see that a lot of our portfolio is constructed on on an idiosyncratic basis. And we’re seeing that they’re playing through from different places, different themes, different sectors, and so on.
Simon Erickson 09:57
One company we chatted about last time, Rick was called Costco, you know, I know that you guys are looking for winning business models, sometimes that are resilient no matter what’s going on with the macro economy. We mentioned Costco at the time, a retailer, which you might think would be super inflected by, or super impacted by inflation. But because they’ve got that membership model, it actually kind of has some resilience against that. Do you still like Costco? And do you think there’s still opportunities in retail, even in the environment we’re in?
Rick Mercado 10:22
Yeah, we certainly do like Costco. To us, it is one of your highest quality consumer related names. That membership model that you spoke too, it’s incredibly resilient, they haven’t put through their price increase, they typically do that every five or so years. So that’s certainly something that should help in terms of earnings growth, we are watching valuation, and it has remained resilient throughout this time. And naturally, as part of our processes, competition for capital asset has remained resilient, some other names have not done so well. So we naturally start allocating away from Costco into those ones. On the flip side, luxury names LVMH has been very good for us. So we’ve gone from staple li to pure consumer discretionary, that consumer base obviously is more resilient, they’re well off, they don’t see the economic fluctuations so much as the rest of the world. Again, valuation comes into play. It’s done well for us, but we need to start thinking, Are we at peak luxury? Is valuation maybe becoming a little bit too stretched? And we think not at this point, but it certainly does play on our minds.
Simon Erickson 11:28
Our reports on Ferrari, we mentioned that one last time. That’s definitely the ultimate consumer discretionary. But it seemed like they had a pretty good backlog last time we talked.
Rick Mercado 11:35
Yeah, Ferrari is a phenomenal brand. One of the best brands there is out there. It certainly has been forming. They sold out of their pure Sunway SUV model that was recently released. Obviously, earnings were quite good last quarter. To us. The key question, especially from the global perspective is what happens when we see that switch to EV? Obviously no one’s driven a Ferrari EV vehicle. And as we have regulations and consumer tastes shifting to an EV world where does not sure about whether or not that makes sense from a long term asset ownership perspective. We think they probably will be successful. But you know, the luxury we have from a global perspective is we can play into a number of high quality brands without that level of uncertainty. So probably, I think the brand resonates, it probably will do well. But we can look at other ways of playing it like LVMH, as I said.
Simon Erickson 12:31
Absolutely. Let’s get back and talk about Japan. A little bit more here, Richard, because our conversation last time blew my mind when he pointed out to me that Japan’s growth this was in about I think it was November or December of 2022. Last time we spoke. And you said at the time, you know that Japan’s growth rate was amongst the highest of OECD nations in 2022. It’s aggregate PE ratio, and you look at the company as a whole was far less than other countries. The exchange rate between Japan and the United States was at a 30 year low and yet its inflation was still less than 4%. Even though buybacks and dividends are at an all time high. I think we’re not paying enough attention in Japan. That sounds like the ultimate investing checklist out there. Are you still as optimistic about the country’s possible prospects?
Richard Kaye 13:11
No, I’m actually more optimistic. I’m actually more optimistic than we were even in November. Because it’s funny, a number of the things you said just now I’ve already gotten quite a lot better. Inflation is actually lower than when we last spoke. It’s come down to 4%, around 3% to the high twos percent. The currency has strengthened somewhat against the dollar, but it’s still the multi year low. The macro economic figures, the GDP figures that consumer figures are all picking up. And going back to what Rick was just coming to you, and you were discussing Simon, on the luxury side and the consumer. Remember that the entire Asian consumer world is is waking up right now, from from the COVID lockdown, and that includes Japan. Japan entered its emergency states much later than the US and Western Europe. We only had what they call the recategorization, the downgrading of COVID, something like last week. And China you know the story very well. People were literally removed from isolation weeks ago. And they’ve spent the last few days, last few weeks, the Lunar New Year holidays on trains and planes visiting relatives they couldn’t see for three years. They will now start to consume. And a lot of that consumption in China actually, as well as reopening of Japan actually is great for Japanese companies, because they supply the brands. We don’t buy Ferrari maybe but we do supply luxury brands here in Japan, which Chinese consumers love and Chinese consumers are buying and right now we’re seeing those numbers. Uniqlo you know very well the clothes company it’s sort of default brand almost in Japan had their biggest month of sales ever in China in March. And we don’t know the April figures yet but it’s probably something quite similar. So yes, the macro story is you mentioned some money’s not only good, it’s actually getting better. And the fact that we’re getting our reopening right now in Asia, and Japan is a major provider of that is great news for us. If I can segue back real quick to the Changi be destroyed the AI story. We had Sam Altman, actually in Japan a few weeks ago, meeting the Government of Japan, talking about the opportunities there. And it’s a fascinating theme for two major reasons. One is you’ve got an awful lot of, if I can put it in efficient workflows. In Japan, it’s been a somewhat traditional conservative culture. There’s a lot of scope for workflow optimization, and guess what? AI is perfect for that. And at the same time, we’re running out of workers. So why can’t we get software to do things? There’s another major reason why the whole AI story is huge for Japan, it is that the people who make the equipment for AI are mostly in Japan, people make the semiconductor equipment that designs the NVIDIA chips. A lot of that is in Japan. So we had a company called Ibiden, it’s the world’s biggest maker of the packages that go into Intel or Nvidia microprocessors. Those guys announced a very large three year capital expenditure plan really targeted AI chip packages. These are the arms producers in a way for the the AI revolution on the hardware side, and a lot of those are in Japan. You mentioned earlier TSMC and the geopolitical risks. Yes, yes. Where TSMC is building new factories right now. It’s in Japan, as well as the US and Japanese companies. We met one just three weeks ago, actually down in Kyoto. Japanese companies and making the equipment that goes into those factories. So the whole AI story is massive for Japan, because it needs it and it surprises. So for all those reasons. Yes. To your points. The macro is great. And the specific company stories that play into that. And these themes are very exciting. And they’re mostly not being watched right now. So you can get them at great prices in our view.
Simon Erickson 17:05
Could you repeat the name of the company? You mentioned there one?
Richard Kaye 17:07
Yeah, sure. It’s a little company called Ibiden, IBIDEN. And they have their stock code for those who watch these 406. It’s just a great little company that makes the organic resin packages, which go which package Intel and Nvidia micro processes. That business actually is a global duopoly. There’s one other little Japanese company that does that. And all of the growth in the volume of microprocessor sophistication is great news for this little company. That’s why just last week announced a major expansion of capacity for that business.
Rick Mercado 17:50
Simon, your reaction is exactly the sort of reaction we get from many investors where Richard mentioned a company and people would never have heard of it. And I always find like Japan, you know, our colleagues in China are super helpful when it comes to this sort of dynamic where you can uncover super high quality companies that aren’t even covered by the sell side at times will have very poor or low coverage. Richard Santana, the team in Tokyo, they get to meet with these companies all the time and provide such a level of insight that we just simply don’t see on the sell side. So yeah, to me, it’s a fantastic opportunity to look at. Yep, Japan and other markets.
Simon Erickson 18:26
That’s perfect. And that’s actually a perfect segue to the question I wanted to ask, which is exactly that. We hear so much about China, we talked about, you know, purchasing power increasing, people moving to cities, you know, billion people and everything else. It feels like sometimes the investing world is not paying enough attention to Japan. Richard, as we close out this segment where we’re talking about Japan, what’s one misconception of the investing world about Japan out there? What’s something that you see, and a lot of headlines are that people tend to think about Japan, that just isn’t really what you see out there?
Richard Kaye 18:54
So people think that we’re an old country with a dying population, massive sovereign debt problem. And so you don’t want to go near Japan. And I’m saying, that’s completely the wrong perception. You’re not investing in the Government of Japan, or the population or the country of 20. You’re investing in specific Japanese companies listed in Japan. But with global business opportunities. Rick is actually getting on a plane to come out and meet me in Japan in a few weeks. And we’re going to visit a lot of these companies together. Because although he’s very nice to our team here in Japan, he actually done a lot of work on these little Japanese companies himself. And taking away that perception of Japan leaving a slow and negative demographic structure and remembering the great little companies here who will lead us in many niche areas. That’s the big opportunity that Rick has found in Japan investing globally. And of course, we capture in our Japan fund.
Simon Erickson 19:47
A contrast. A company you mentioned in the last conversation we had were Don Quixote, which was a discount retailer in Japan. And then I believe LaserTech which was contributing some of the equipment for for high performance computing are there Are there other companies you’d like to leave our listeners with, we should be paying a little bit more attention to in Japan?
Richard Kaye 20:03
Certainly evident. We mentioned just now on the package side at Simon, a company called Advantest. 26857, I think is the stock code. So I’ve been doing this market too long. Everything is four or digit codes for me now, which is advantageous is the world’s biggest semiconductor tester maker, an enormous opportunity again in AI chip testing, because of the complexity of the algorithms that have to be tested Advantest for a variety of reasons, including a multi decade relationship with Intel is best placed for that business. Another company I think is very important that he had earnings out just a few hours ago and we were watching the presentation, Softbank. Because Softbank is, you know, who owns ARM. Which is you know, is the major architecture supplier of a lot of the chips that we’re talking about here, as you know is going to list shortly, and that will be a major opportunity for Softbank not just because the one off ideal gains but because arm will remain a consolidated part of SoftBank business. If I can make the very quickly you mentioned the last one, Simon 6861 is the code for the for the watches, they’re a major player in the AI and machine learning space, specifically in the area automation equipment, and getting factories to work more efficiently. Not so well understood. They don’t say very much, but they’re a great company and just look at their numbers what they’ve done. You ideas there.
Simon Erickson 21:34
Oh, my goodness. Yeah. So much opportunity in Japan right now. Thanks very much for the context on that Richard. Rick, let me bring it back to you. Some of the elements we just chatted about. We have to get back and talk more about AI. It’s such a key theme right now. We talked about Softbank, we know that Masayoshi Son has got a 300 year plan out there. Right. We talked about Sam Altman before. I mean, Sam Altman says that OpenAI is going to be the most expensive company in the world when it IPOs because of the capital costs required to deploy GPT and so many different applications it’s got out there. But Rick, you and I last time, I’d really like to hear your global perspective on this, right? We’re not just looking at how this is going to impact the US. This is this giant interconnected beast that is computing, that is software. That is hardware, that is production. It’s all interconnected. And there’s a lot of delicate relationships. Right now we chatted last time about ASML. And the lithography equipment that’s required to produce, you know, these super, very small transistors that are out there right now. Can you talk about maybe just 10,000 foot to set the scene on this? You know, how do you view the the evolution of computing that we’re in right now, we know that it’s very expensive to train these AI models and a lot of the NVIDIA chips and everything else like that they’re very effective, but they’re also very expensive for a lot of companies. Are you still as bullish in the companies we mentioned before? And what is your opinion about the relationship between the US and China and Taiwan?
Rick Mercado 23:02
Yeah, that’s a good question. Even more bullish today? I would say. So certainly, all of the same headwinds are in place. And our view is that they are cyclical, it’s very hard to say that we believe well, it’s very hard to find people that would say that the proliferation of the cloud, or, you know, going into more advanced nodes is something that is going to take a step back from this point, we see that as a one way trend. And the reason why I would say, and sorry for the French sirens in the background, there’s probably a protest or a strike taking place somewhere.
Simon Erickson 23:39
It was the World Cup last time, guys. [laughs] I was hoping something was gonna come up.
Rick Mercado 23:43
Exactly. Yeah. So we think we are nearing to closer to the point where we’re seeing that cyclical trough. The end point, a structural story hasn’t changed and valuations are still quite compelling. I think Richard spoke to this last time, but typically the market tends to price six to nine months in advance. Certainly since last time we spoke, we’re probably close to that point. So yes, we are watching all these things. But we don’t think the story has changed much. The geopolitical tensions, certainly something to look at. If you remember from that call, we think it ends up with more and more ASML equipment being used. The world is concerned about security of supply. So that means a plant in Europe, a plant in Japan, a plant in the US. Well guess what that just means more and more ASML machines located around the world. We need to temper that with what is actually taking place in terms of political, I guess policy. So obviously, the Netherlands came out saying that they would restrict sales of their advanced DUV equipment to China. We’ve estimated that that’s a quite a small proportion of revenues that it’s going to be at risk. The way these DUV machines work is that use the same power source. To use the same numerical aperture, you can swap out your most advanced models, the components are modular, you can swap them out and replace them with the equipment that’s used in the lower models and then ship them out. If at the same time demand continues to be about 20%, greater than supply at this point in time. So we think that they’re quite well placed. And certainly it should be something that they can navigate quite well.
Simon Erickson 25:26
Great points in there Rick. You know, a little bit of context for anybody who’s catching up with everything that was just said there. He’s saying the deep ultraviolet machines that are allowed to sell to China right now, there has been a exclusion list where actually the United States has said, the US sells components into the extreme ultraviolet machines that are banned from being sold to China by the Netherlands based ASML. There’s certainly some geopolitical tensions to say the least in these relationships. But we know that machinery is a it’s a monopoly. EUV is something that is absolutely necessary for the most cutting edge chips. I agree with you, Rick, that that’s not going away anytime soon. There is definitely a lot of IP and know how that’s in ASML machinery. Could you tell me just a little bit more on one of the comments you said there about the machines are going to be built in other countries? So we’re starting to see a lot of interest in domestic supply. Right? Not only the US is wanting Taiwan Semiconductor to build plants in Arizona instead of the island of Taiwan now. But it seems like Germany and other locations across the world are similarly interested. And Japan, to Richard, is interested in kind of setting up their own fabs. Is that, just like you said, there’s going to be more machinery for ASML more fabs for Taiwan Semi? Any other maybe second level things we’re not thinking about that this is going to impact? I mean, there’s 10s, if not hundreds of billions of dollars at play with these fabs?
Rick Mercado 26:50
Yeah. It’s a good question. So yes, certainly we see proliferation taking place. We think you need to watch out for a little while ago, there was a little bit of tension between TSMC and the American government. About the profit sharing, and so on. So obviously, as with most things, the devil is in the detail, we need to watch that. I think in terms of secondary impacts, we need to look at, well, ASML is a super high quality, it tends to be recognized. So we need to start thinking around all the other companies in the supply chain, can we get the same level of quality and perhaps a more attractive valuation that we need to consider? We also need to consider labor. So it’s only a I guess, a rumor. But obviously, it’s not just TSMC that’s building in America. All these other countries, you have Intel also increasingly at capacity. Samsung and so on. But we’re starting to hear some indications that people are poaching each others’ stuff. So we need to be aware of that. What are the repercussions for supply, for cost, and so on. So that’s one thing that we’re keeping an eye on, but certainly not enough to delay it significantly, or to say the plans not going according to plan. But there’s always you know, a million different things that we just need to be aware of.
Simon Erickson 28:11
And one last question for you, as we close out this chapter on the chip war here, is your thoughts on Intel? There’s polarized opinions about Intel out there. Some people are raging bulls, say they’re going to grab it a ton of share as they open up foundry services to others. Others say that Intel is doomed. Perhaps there’s a lot of middle ground between those two extremes. But where do you fall on the spectrum when it comes to thoughts about Intel as an investment, or as an opportunity?
Rick Mercado 28:37
Yeah, it’s a good question. So certainly, we come back to the idea that we’re long term investors, we want to have an asset ownership mentality. For me, I would say that Intel’s lead is too far extended, when you look at how much needs to be invested, how far behind they are in requires that they can execute extremely well. And they need to invest as well. And I emphasize that execution point, because what we want are companies and business models. Where actually, execution isn’t the main thing. This is a company that will defy gravity, its industry structure, its IP lead or so on. would be in that, you know, ideally not, but you could get, you know, a mop and running the company and it will still continue to do extremely well. The fact that we need to have all those things fall into place for an Intel, it tends to say that when we adopt that quality, first asset ownership mentality approach, it probably doesn’t cut it for us. Yeah.
Simon Erickson 29:30
And, Rick, I think I heard you say that you’re still bullish on ASML. Any other players in the space that you’re really bullish on as an investment in semiconductors?
Rick Mercado 29:38
Yep. So we select TSMC. Certainly there are geopolitical issues that we need to be aware of, but valuation is quite compelling. Certainly, it seems, for similar reasons. This is not a company that is going to be displaced. We mentioned this last time that LaserTech also in Japan. So Richard, I don’t know the stock code off the top of my head. But it’s essentially a monopoly as well, the last time we spoke, I had said that it is on our watch list. Were waiting for valuations come in, it’s pretty close to the point that we feel like it’s it’s looking attractive. Not quite there yet, but we’re watching that one quite closely as well.
Richard Kaye 30:22
Yeah. Yeah, it’s funny, because we’re just talking to LaserTech, literally two days ago. And we went to see them with with some European investors that in our Japan fund that we’re here in Japan, about two weeks ago, as well. And the next conversation is exactly like your conversation right now. Do I watch Intel? Do I watch TSMC? Do I watch Samsung? Who’s going to be the one with the most focus on design, rule, evolution, UV leadership. And by the way, all the great things Intel is trying to do, which I think as Rick indicates, we we need to watch although it’s not maybe clear, everything to do with microprocessor diversity multilayer designs, fascinating. It’s good news for LaserTech and some of these other local companies like Ibiden on packaging, because they make the equipment that enables those technologies. Think about Japan and the equipment space, especially in Japan, you don’t have to figure out who’s going to win the chip war, either the country or the company. Because these people supply everything. And so some of these companies we’ve spoken to, we’ve spoken about LaserTech, Ibiden, Advantest. They’re making all of these. They’re enabling all of these processes.
Simon Erickson 31:35
Chris Chris Miller, the author of the chip war, the book that I referenced just a moment ago, and what he was presenting last week, and he said exactly the same thing, Richard, the wrong question that’s being asked is who wins the chip war? The actual answer is, there’s a lot of inputs that are all interconnected. And there’s going to be a lot of winners, and perhaps even a couple of losers in this next evolution of it. Fascinating, fascinating story behind the scenes of semiconductors so complicated. Chip producing is so complex and complicated. And a lot of it hinges on Apple and the smartphone, it’s not to be understated for anyone listening that just how complex Apple’s designs are, and how they really move the bar. Apple alone accounts between 20% and 25% of Taiwan Semiconductor’s total revenues every year. Just as they’re always in the front of the line for the most cutting edge chips that they can possibly design. And the process technologies, as Rick was alluding to earlier in the call, are always cutting edge. I think we’re down to two or three nanometer nodes for the transistors that are going into the most cutting edge chips. And those find their ways and other applications over time. Yeah, the segue that I want to use for that is that Apple is also very interested in India right now. We saw Tim Cook go out there kind of do a campaign, you know, trying to promote, they now have a physical presence. They have an iPhone, an iStore and iPhone store, Apple Store, I guess the whatever the right nomenclature is for but it’s really focusing on India for consumer market for Apple as it should be right now. And there’s also a lot of discussion about India as a manufacturing hub as a lot of other companies that support the supply chain. It’s not just for semiconductors, but for a variety of industries are considering India as a way to get away from some of perhaps the geopolitical risks of China right now. Are you all investing in India? If so, what companies or sectors are on your radar right now? Perhaps we’ll start with with Richard on this, and then I’ll open it back up to Rick too.
Richard Kaye 33:27
Yeah, India is huge for Japan, believe it or not, Simon. It’s something that Japanese scenario that Japanese companies talk about all the time, after they finish talking about China. China is of course a major opportunity for the consumer and for the technology opportunities, which Japanese companies can service. But India is the next horizon. And I was speaking to a company just this afternoon, it’s only season. So it’s been a lot of companies right now, which is developing a fascinating renewable energy storage technology. And I was intrigued by what they’re doing. They’re using solar power to shift a whole bunch of water up into a reservoir, which then has potential energy, so it can fall down using hydroelectric power to generate energy when it’s needed. So the waste they figured out how to store solar power to chemical green coal and the Japanese company that owns it is called Orax, ORAX. They’re intrigued by the needs of India for New Energy, the potential of India with its technology. And this is one clear example of of investments they’re doing which is actually moving the dial on the whole business of RX FANUC. The robot coming to everybody knows about has Indira Gandhi’s, excuse me Mahatma Gandhi’s granddaughter, as the Chairman of its India operation, which shows the importance that they attach to India for themselves and the symbolic presence that they want to have in that country. We have in our portfolio and it’s worked very well for us. Some know the Japanese car company called Suzuki and Suzuki wouldn’t believe it is getting 130% of its profits from India. Because it owns Maruti Suzuki out there and Maruti Suzuki makes more money by far than the Suzuki parent company makes in Japan and the growth of the Indian middle class the growth of rural populations who want their first car, that answer that that issue is addressed by Suzuki, which has said has been a great investment for us. And Softbank, we talked about earlier also has numerous investments in India. In rideshare, in cashless payment infrastructure, and that’s an area they talk about all the time. Forgive me, I’m droning on about a bunch of names, but Unicharm Pidgin, which are consumer, baby care, feminine care names. We’ll also talk about India the whole time as their next horizon. So yes, India is a place that Japan has been looking at very seriously. And the best companies already there are doing great things. And they’re answering we think that the needs of India’s of India’s tomorrow, in a way.
Rick Mercado 36:09
Yeah. Yeah, yeah, certainly. So I spent five days in India, soon after the Adani short report came out, actually. And there are a few key takeaways from that, I would say. So one, it is undeniable that the current opportunities, you go around Mumbai, where I was there for a conference, it is almost like one huge construction site. There is so much development, there is so much construction, there is so much growth taking place in that country that it is quite unbelievable. Now, the things that we as global investors struggle with, so we do like investing in India, but primarily through the main set Richard just alluded to, we have one directed Indian investments. So that’s HDFC Limited, which is merging with HDFC Bank. They play into obviously, that mortgages literally penetrated India, the property market is starting to take off after a 10 year decline, the quality is incredibly high. So in India, you typically pay off a loan in five to seven years, which means that your equity component is very high. So if you ever needed to write off a mortgage, you recoup the loss pretty quickly. On the same token you’re taking share away from your government institutions you’re staying around banks are typically on trade when it comes to implementation, culture, cost base and just commerciality. So we think that’s a very high quality play of playing the Indian growth theme. Now, on the flip side, part of the trip was all about trying to understand Are there any other opportunities that can take advantage of all of these current themes that you’ve alluded to? And sadly, the answer is probably not. We just struggle to find companies listed in India that have quality dynamics, you know, we’re comparing them to a Microsoft or ASML. So we don’t see that. So funnily enough, you know, the Adani situation, the short report had just come out there were obviously a lot of things that were in that report that were quite negative. I spoke to everyone about Adani, I spoke to the banks, I spoke to investors I spoke to on the sell side, I spoke to random people on the Street, just asking them about what do you think about the whole Adani situation. And generally, people said, The only surprising thing about the Adani situation is the fact that the rest of the world was surprised about it. Everyone had known that there were issues around them. The banks themselves stopped lending to the Adani group due to what they were seeing. So I think that’s quite telling, when it comes to about the quality behind some of the business that we see that you need to really have, you know, a deep, intimate relationship with the company. So know that everything checks out, you need to have strong governance, it’s quite hard to live into that growth theme, with the quality dynamics that we’re looking for.
Simon Erickson 39:05
It’s a tricky one. Right. Like you mentioned, I mean, Adani, these massive conglomerates. We’re going to name a couple, you know, Tata Group and Reliance Industries. They’re massive, they’re huge. They’re multi billion dollars, they’ve got perhaps some challenges for a lot of these companies with internal controls and the governance and that certainly flows to the entire economy, not just the largest of corporations in India, but it’s something you have to be mindful of certainly as an investor. A bit of optimism too. You know, I recently spoke with Pulak Prasad, who’s Singapore based. He has a fund out there that invests in Indian equities. And he said that his average position in India has that they have an ownership stake and has a 41% return on invested capital. There is certainly profitable businesses that can exist alongside those those mega conglomerates. Can we chat a little bit about the relationship with the Indian Government too? It seems like the government is very progressive in India. You mentioned renewable energy just a moment ago, Richard. I believe it’s the Gujarat province that had just a ton of funding for solar projects and just progressive policies like these. But then also, it seems, if I’m reading everything correctly, that it’s complicated for international companies sometimes to get in and get embedded in India, because there’s things that appear later on. American Tower was one example of this. They were going out, they’re investing billions of dollars in cellular infrastructure in India. And then only to find that they kind of had some unexpected taxes that came up that they had to get paid. That weren’t part of their original business plans. How do you think about that? Maybe Rick, the question’s first for you. Richard, chime in if you’d like. But, you know, how do you think about the relationship between publicly traded companies you might want to invest in and the government? Is it just complicated? Are there certain pockets of this that are really advantageous?
Rick Mercado 40:56
Yeah, it’s complicated. So certainly, when we look at the emerging world, one of the questions that we have to ask ourselves, whether it’s China, whether it’s India is, is this company aligned with or at least not opposed to government ambitions? Generally, if the answer is positive, it certainly counts for a lot. Now, on the flip side, things can change quite quickly. And also, like you look at the Adani situation, things can go too far, where pretty much anything that Modi puts forth, Adani puts a bid in. And it tends to win in these sort of bids. So it’s a bit of a sticky one. It’s almost more straightforward in China, where you do have alignment, you have state ownership, and so on. And it’s just a little bit easier to navigate, you know, what the policies are. What the long term objectives are. I think some of the things…you know, your example about American Tower and unforeseen taxes and so on these sort of dynamics. They’re a little bit more messy to navigate. So we tend to just err away from these sorts of dynamics where we can.
Richard Kaye 42:06
What one solutions that were that we found works well is simply that when you can be in a position to sort of write the scripts if I can put it that way. We talked about Suzuki and cars. Suzuki has worked with the Indian government since the inception of the car industry in India. Suzuki is now working with the Indian government for electric vehicle rollouts. Deciding what kind of infrastructure you need to have theoretically 100% electric vehicle sales by 2030, and often considered to be an excessively ambitious project. But that’s what they’re talking about. What do you do about charging stations? What do you do about electricity generation in the first place? Well, these people are at Suzuki actually writing the script with the government. And I think that’s an indispensable way to survive in a political context, which can be volatile by any by any definition. Another thing is, very quickly and Rick alluded to this, I think the idea of investing in a country from another country using another country’s equity market as a platform to capture the growth of an interesting country where perhaps the political context is complex.
Rick Mercado 43:48
It’s a very good point, that idea about writing the script, you can also do it as an investor. So you take a name like so it’s a Chinese name, but Inner Mongolia Yearly, their dairy producer. Back in, I think it was 2010, our analyst/Portfolio Manager Bai Jin based in China, in Hong Kong. So she was used as a sounding board about why does Nestle care about. It is like, why do you all care about this thing that we’ve never heard about? And from that perspective, we’ve had a very long relationship with a company, we’re able to help influence some of the views around why these things matter wide creates value over the long term. Similar to HDFC. We’ve been going with HDFC since 2009. So it was around on the Indian fund back at that point. And certainly you do find that when you take this partnership approach to the companies that you invest in, you get to have one some influence, but you also get a lot of insight. So you go to the COVID period. On the Global Fund, we hadn’t actually owned HDFC. When followed for a very long time. Valuations came down. We said we would love to speak to the CEO. We got to speak to the CEO in a matter of days, but because he had known that we were long term holders, we’d had this history of engagement. So having that influenced by being a long term investor, so it accounts for a lot. And it does provide you with some comfort around, well, maybe India doesn’t have the best in terms of corporate governance. But when you’ve spoken to this company, when you’ve seen them execute, when they said what they’re going to do, and they do it, and they pass all the tests in different economic environments and different situations, that can give you a lot of conviction. And it is sort of speaks back to that point that we were saying that Richard and his team, they find phenomenal opportunities in Japan, this interaction that they have, Richard has mentioned so many meetings in this call. That helps a lot in closing that information cap and providing comfort.
Simon Erickson 45:44
Yeah, ESG. I mean, it when you have a progressive democracy, like India does, and these kind of bigger picture goals that they’re trying to achieve, it’s really important that you have alignment, like you said, between the corporations and even from tobacco companies. You know, they think of ESG in a very optimistic light. In India, I’m certainly optimistic as an investor, it sounds like there’s a lot of opportunities, a lot of bigger trends. We talked about large population purchasing power, they’ve got the digital payments that we mentioned right there. And certainly mortgages is certainly an important trend that you can invest in. Do you guys have thoughts on on HDFC Bank? Or, you know, certainly one of the most successful stories as an investment? And are you bullish on this one? That’s when we chatted about on the last conversation?
Rick Mercado 46:25
Yeah, I think so. So I would say that HDFC HDFC Bank has generally done very well have a great reputation, they have great risk management, there was a period of some mis execution when the new CEO came on board. It resulted in them having a moratorium on new credit cards, and they certainly gave some shear away to, I think it was ICIC. I think. So that says to me that there’s probably more execution risk compared to the mortgage world. Now, what’s happening is that HDFC Bank and HDFC limited are merging together. And it means that the limited company gets to access the funds from deposits and HDFC Bank, they’re very cheap, you don’t pay very much on them. And yet, they get to lend them out and make a good spread when they’re accessing the mortgage product. By the same token, you have this workforce, that are now able to cross sell across the company. The opportunity for cross sell is huge, you don’t actually have a big overlap between your mortgage company and your banking company. So when I was over there meeting, we think it’s super important not just to speak to the management teams, but to go to a branch, speak to the head of sales, speak to the branch manager, and so on. And I think it was quite telling that normally, in the sort of integration, merge situations, people are nervous or worried about losing their jobs. Everyone was so excited, they were saying that, you know, we don’t have this overlap. And no one’s worried about losing the job, the message they continue to get as they need to hire more and more people, they need to have more and more branches in order to get this product out there. So it’s quite telling when you get stay on the ground, just that level of excitement, and that concept behind company strategies and so on, I think you can get a lot of detail from reading an annual report from speaking on the phone, and so on. But actually getting out there and meeting with the people who are actually doing the business, it’s quite a nice thing to do.
Simon Erickson 48:24
As we close this out, I’d like to ask one final question, to hear both of your perspectives on this. And that’s the question of valuation. We know that you guys are long term investors. It’s very clear to anyone who’s listening to this show, how thorough you are and how deeply you vet each one of these companies. Which is one of the reasons I love having you on the show so many times. How do you think about the layer of valuation on this? You know, it’s so easy to invest in a bull market, when it seems like everything is peachy and everything’s rainbows. And of course, through studies and back testing and everything that’s 2020 hindsight, sometimes the best time to buy companies is when it’s a little bit more challenging, and you’re getting a much more attractive valuation. How do you feel about valuation? And a lot of the companies you’re investing in right now? Is it a good time to be a long term investor, even with everything going on the macro?
Rick Mercado 49:13
Yeah, I certainly think so. I think 2022 was even better. It is quite something. So you can be a long term investor, you can be incredibly smart, and then you can see it all fall apart if your behavioral setup doesn’t match with that. I think 2022 was quite drone. You know, fundamentals were good and stocks weren’t performing. But you really got tested in were you willing to act on that conviction? So I think certainly 2022 was incred year to be, I guess, securing alpha for the future years. Even today, like there are names. We have Alcon for example, on a next 12 month basis, so they sell contact lenses and intraocular lenses. It doesn’t look cheap. But the story is not about next year. It’s about what happens in three, four, or five years time. So they’ve got medium term target saying that they’re aiming for 25% margins by 2025. When you if you believe in that. And I think there’s a good case to have confidence in that there are still some risks around that. But if you believe in that the valuation equation does look pretty attractive. So making sure that we’re building the valuation around, what are our long term outcomes? Do we have conviction behind that, when you take that approach, there actually are quite a lot of good opportunities.
Richard Kaye 50:31
I mean, I use very much the same language as Rick. Which is unsurprising. I mean, we look at the same companies a lot, we share models, we have the same approach. Theoretically, we have a five year approach, we lose, you make numbers five years out, and we base our valuations off of that. The reason I say theoretically, is in reality, we look further than that. We’re not just investing for five years now, some of these things we’ve held for over 10 years already. And we may keep on holding them for that long if we think the story is out there. And so valuation when he has to be seen in that way. For a long term investor, someone who really wants to make money, by the time of let’s say, retirement, five years, 10 years, or whatever it is, 20 years out, that is the way to proceed. Get an image of what the company will look like in five years, 10 years time and base, whatever multiple use price earnings. Okay, EBITDA. We actually use a discounted dividend model. More or less, it’s a discounted cash flow model in our valuation. But it’s got to be based on a long term perspective of that company’s value. Rick’s got a whole bunch of amazing companies he’s looking at globally. Obviously, we’ve talked about some in Japan, and he looks at those with us as well. There’s a company that I just have to mention real quick, in this context, because it felt like 60 or 70% during 2022, and it hasn’t recovered that much. And guess what, we’re finding it a very exciting one, right? It’s a little cold chemicals company called Sysmex. Yes, it’s a it’s a hematology equipment, company blood testing equipment, company rates, which also has pioneering technology and Alzheimer detection. Everyone’s excited about the new technology that’s been authorized in in pharmaceutical space. For Alzheimer treatment, while these guys are working on a similar thing, but in detection. And there’s so much information in studies at universities, institutes about what Sysmex is doing in that field, which gives us confidence that the earnings potential in Alzheimer detection will be at least as big as what they currently have in blood detection, blood analysis, and none of that’s in the champers. And when we do our earnings work, we tried to figure out how those stories will actually pan in the numbers. And the valuations are extraordinarily compelling. I think anybody really knows that story. And we’ve kind of known that company. We’ve known the CEO for over 13 years, I think, or even more now. Really, I think couldn’t be anything but persuaded. And so of course, the evaluation on this long term perspective is giving us great opportunities right now. And yeah, Rick knows that story. Well, and we it’s one of many ideas that we think are very compelling at this time.
Simon Erickson 53:20
Well, for those that are following the Chinese zodiac last year was the year of the Tiger. It was a time that had some sharp claws out there required strength and bravery. We’ve moved on this year to the year of the Rabbit, which is characterized by longevity, peace and prosperity. Those are some good traits for long term investors and certainly was a lot of fun. Once again, having Rick Mercado and Richard Kaye. Both from Comgest on the program. Gentlemen, thanks for being on the 7investing podcast here today.
Richard Kaye 53:47
Thank you, Simon. Simon, great, great to speak to you again.
Simon Erickson 53:50
Please follow along with Comgest, a global asset manager doing some incredible work. And if you’d like to follow up on this podcast and see all of the companies in the tickers that we mentioned you can follow along at 7investing.com/podcast. So that’s a wrap for this episode. We appreciate you for tuning in. We hope you have a great week and we’re here to empower you to invest in your future. We are 7investing!
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