Nike, Starbucks

This means that they are much more likely to survive a torrid patch. Take airline online booking system specialist Amadeus – they flew into a very stormy patch last year but were cushioned by interest cover of 32 times.

How have you chosen your recent consumer brand targets?

I will start with Nike. As the world’s largest sportswear apparel retailer and the market leader in trainers by a considerable margin, this is the 800lb gorilla in its space. It is also extremely well adapted to online markets. Nike has been right at the forefront of e-commerce for some time, so it was clear that the firm would power through last year’s disruption and even benefit from it.

The brand also has one of the key characteristics that we like – it is becoming a virtual business. Just as Coke and Pepsi do not make their own drinks anymore, so Nike no longer manufactures its own shoes. As such it can focus on marketing and distribution, which is how it commands huge brand loyalty. This should enable Nike to generate strong returns on capital and future growth. Next, Starbucks. They were hit hard initially by the pandemic, as city centres closed, and office workers started operating from home. However, they have counterbalanced that with their drive throughs and kiosk businesses, which are more profitable. The traffic jams at their sites in places as diverse as the US and Kuwait are testament to this. They have also done well in China, in part because their biggest rival turned out to be a fraud.

Then there is LVMH, which is all about luxury goods. In short, we have long sought the right exposure to accessories, apparel, designer goods, jewellery, watches and the like and we did not think we were going to get a better opportunity than last year to invest in this global leader.

Which sectors do you avoid?

Plenty! We do not own any banks, insurers or real estate companies and we also avoid highly cyclical sectors, such as engineering, construction, and heavy manufacturing. We also don’t buy utility firms, or any of the asset exploiters, so we own no mining, minerals or oil and gas companies. We steer clear of transport too, which rules out airlines. In short, quite a large chunk of the stock market is not of much interest to us and has not been so for some time.

The reasons differ but there is an underlying theme. Look at the first category I mentioned, retail banking. The core business model is simple – taking deposits, lending money and enabling payments – which is why it is under attack. Established payments firms, such as Mastercard, Visa and PayPal are encroaching further into their territory as are starts-ups, such as Square and Revolut. Meanwhile in lending, a chunk of their business is being taken away by peer-to-peer operators. Couple that with expensive premises and old, legacy systems and you have an unattractive commercial proposition. Worse, their leverage makes them heavily cyclical. Even the return of inflation will not help them much beyond the short-term – banks had a grim time during the inflationary 1970s and could do so again. As such, they are typical of the kind of “old economy” stock we tend to stay away from.

What do investors get wrong most often?

Firstly, market timing. Let’s say in January 2020 I had predicted a pandemic, the global economy going into recession, and America suffering a 9.5% fall in GDP in a single quarter. What would you have done? Anyone who chose to stay invested in the broad US market made an annual return close to 12%, whereas those who panicked and sold up would have lost out. My point is that to successfully time the market, you not only need a crystal ball when it comes to what will happen next, you need a second one to tell you how the market will react. It is therefore a fool’s game. The other big mistake people make is confusing quality and price. Whilst valuations are not unimportant, they are secondary. The key question I ask myself is, “do I want to own this business forever?” For almost any rolling 10-year period for, say, the MSCI and its sub-sectors, quality has beaten value. So, I always focus on the former much more than the latter.

What book would you recommend to a young investor?

Robert Hagstrom’s “The Warren Buffett Way”. It offers a clear insight into how one of the world’s greatest investors thinks and operates. Another good read is Buffett’s annual Berkshire Hathaway shareholder letter. Over the years his wealth and sense of humour have grown in tandem, making them increasingly entertaining as well as hugely informative. ●

Jumping yields

Mateusz Malek

Head of Bond Research

Mat analyses the sudden rise in government bond yields earlier this quarter and assesses the outlook for investors.

Government bonds have been hitting the headlines this year, with prices falling and yields rising sharply (at the time of writing). The key questions are why and whether investors should be worried.

The changing global economic outlook is certainly a key part of the explanation. With vaccine rollouts happening at pace across the US and UK in particular, markets have started demanding higher bond yields to reflect renewed growth prospects. Furthermore, the unprecedented level of US fiscal stimulus, arriving in conjunction with the potential release of excess household savings, as economies reopen from lockdowns and consumers are free to spend again, has stoked speculation about a spending splurge. Rising commodity prices have also added to this picture of recovering demand (see page 6). If higher inflation is the result, it could spell bad news for bond prices as it reduces the return from fixed coupons.

Digging down

So how far have yields risen? At the time of writing, the 10-year US Treasury yield is up by over 75bps so far in 2021 and has breached the psychologically important level of 1.5%. Meanwhile, the 10-year UK gilt yield has quadrupled to 0.82% (see chart). Although German government bond yields have generally remained negative, they too have moved higher since the beginning of the year. This has impacted prices. Noting that they move in the opposite direction to yields, the UK 10-year government bond has lost 5.7% year-to-date, a truly awful performance from an instrument that at the beginning of the year was offering a yield-to-maturity of just 0.2%. Even this, however, pales in comparison to the performance of the longestdated gilts, some of which have fallen steeply since the start of the year.

US Treasury and UK gilt yields

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 10-yr UK Gilt Yield 10-yr US Treasury Yield

2016 2017 2018 2019 2020 2021 Source: Bloomberg Finance.

This data is a stark reminder that although UK government bonds remain some of the safest in the world, they are not immune from duration risk. And although the market’s correction has been largely triggered by the ‘reflation trade’, rising inflation expectations have only partly offset the broader government bond sell-off – even the 10-year UK government inflation-linked bond is down so far this year at the time of writing. Since corporate bonds are generally priced relative to government bonds, they have been affected too, particularly those with longer maturities. Indeed, only the high-yield part of the bond market, which tends to be much shorter dated, has not cost investors money so far.

Looking back

To put this in a historical context, we need to go back nearly a decade to find an example of another meaningful government bond yield retracement – 2013’s so-called ‘taper tantrum’. Back then, the 10-year gilt yield increased from 1.8% to 3.0% over the course of the year, or by twice as much as it has so far in 2021. The difficulty with this comparison, however, is that there are not many other similarities between the two periods. The 2013 sell-off was initially triggered by fears of the Federal Reserve implementing monetary tightening prematurely. This time, central banks are being careful not make the same mistake, which is why the current forward guidance remains that quantitative easing and ultralow interest rates are here to stay. This is reflected in some relatively small yield increases amongst shortdated maturities. Indeed, with the current alignment in yields seemingly consistent with expectations for an economic recovery, the Federal Reserve and the Bank of England have not pushed back on the recent rises. Fed Chairman Jay Powell has said that he would only be concerned if conditions become “disorderly”.

Closing out

Investors mulling whether further rises in yields will have an adverse impact on their bond portfolios may note that yields are still very low by historic standards. For example, despite a sharp rise, the 10-year gilt yield is only back to the pre-pandemic levels and is still well below the Bank of England’s inflation target. Meanwhile, globally nearly 14 trillion dollars’ worth of negatively yielding bonds remain in issue.

Assuming we see a strong economic recovery from the pandemic, keeping average durations short may still look like a sensible strategy, as it reduces a bond’s exposure to rising yields. Further, for a portfolio consisting mainly of bonds that are approaching their respective maturities, an environment of rising yields is likely to create improved reinvestment opportunities. ●

Peter highlights three shares that should benefit from a post-lockdown consumer rebound. Please note that these are not covered by Killik & Co research.

In the last edition of Confidant, we focused on transportation-linked companies that we think are well positioned as the economy unlocks. They were Redde Northgate, DFCH, Halfords and Cambria Automobiles. This quarter, now that we have an exit timetable from the government, we are widening our remit to consider firms that will benefit from a broader consumer spending revival. In the cases of Jet2.com and Restaurant Group, we foresee a fundamental shift in the competitive landscape as the pandemic fades, which will create the scope for both companies to generate accelerated earnings for quite some period. We also include our updated thoughts on Redde Northgate, as it remains a standout value play.

Jet2.com – booking revenue

Jet2.com is a leisure travel company that has grown over the last decade to become the second largest tour operator in the UK. In the wake of the pandemic, it may even overtake TUI to claim the number one spot. However, in common with the rest of the sector – and indeed any business that relies on the movement of people – it has been in a state of hibernation for some months due to the wide-ranging travel bans imposed after the coronavirus outbreak. Having raised equity once during this crisis (in a deal which we backed for clients at the time), it came back to the market on 12th February to raise a further £422m at a price of 1180p. This was a prudent move, as it removed the need for the firm to rely on government-backed loan schemes. In the near-term, we would expect the share price to be driven largely by sentiment, as plans to unlock travel become clearer with late May currently looking promising. However, our investment case is not predicated on any great level of trading this year. Instead, we are looking ahead to Summer 2022, which falls into Jet2’s 2023 financial year. By then we expect earnings to have done more than just recover, as we think an excellent management team should be able to generate super-normal profits for a number of years. Our view is underpinned by several factors including; reductions in industry capacity as weaker players retrench, improved pricing opportunities as pentup consumer demand is released, and better overall margins as Jet2 drives its product mix towards package holidays. So, what might earnings look like once the firm has recovered fully from the pandemic? If we use 2020 as a base, we note that the group generated £3.75bn of revenue and around £265m of profit before tax, without reaping any benefit over the summer season from the collapse of Thomas Cook (which failed in September 2019). Whilst we have no crystal ball, we would like to think that, in a post-Covid world, the structure of the market in which the firm operates supports a materially higher profit number. Jet2 could even become the “category killer” in the UK packaged holiday industry thanks to the fragility of both the competition’s customer service levels (for example, when it comes to processing refunds) and constrained funding models.

Roaring back

Peter Bate

Portfolio Manager

Restaurant Group – feeding growth

Restaurant Group is a casual dining chain with around 400 outlets across the UK. The Group’s main brands are Wagamama (which accounts for 37% of the ongoing estate) and Frankie & Benny’s (about 26%). In addition, the company has a portfolio of rural & suburban pubs (representing about 19%, most of which trade under the Brunning and Price brand) plus a small concessions operation (9%). The remainder is made up of a handful of other brands, the most noteworthy of which is Chiquito (about 6%). Our investment case has two broad elements. The first is that the pandemic has spurred the company to accelerate plans to exit from a very large proportion of its loss-making leisure sites, specifically the combined Franky & Benny’s and Chiquito estate. The management team had already outlined a five-year plan that would see the firm relinquish many of these sites organically, by not renewing leases as they expire. However, last year’s events effectively forced their hand, such that they have entered a company voluntary arrangement (CVA) across 128 sites. The net result is a reduction in the previous leisure estate of around 60% with a commensurate 30% drop in the group’s overall lease obligations. This process is delivering a higher quality business that offers a more concentrated exposure to the differentiated, highly-rated Wagamama