FTSE Friday: Supermarkets, House Builders And Words Of Wisdom From Terry Smith

13th Jan '23 by Megan Boxall

12 comments 2811 reads

There has been plenty of juicy content for private investors to seek their teeth into this week. Announcements from retail sector continue show (or at least make it appear) that ‘everything is ok’, weakness in the housing market is being reflected in the numbers from some listed companies, and a profit warning from Robert Walters hints at trouble in the employment market.

But I would argue that the most useful content to grace the internet this week is Terry Smith’s annual letter to shareholders. As ever, it is fabulously written, but runs to a length of 19 pages so I would recommend finding a quiet moment over the weekend to sit down with a cup of tea and maybe some snacks and digest the full thing properly. Here are my key takeaways:

The era of easy money has been caused by economists and central bankers looking to patch over crises. Now that seems to have come to an end the poorly run companies which relied on this so-called easy money will not survive. That shouldn’t worry investors who only seek high quality businesses.
The sector allocation of certain companies should be taken with a pinch of salt (something that BnB also noted in my article earlier in the week).
The structural challenges facing the tech sector (beyond over-hyped valuations) could force a retreat from over-ambitious investment projects (not necessarily a bad thing).
Fundsmith itself is a very high quality business which generated a return on capital employed (ROCE) of 32% last year (double that of the FTSE 100). Note: This isn't the return of the fund's holdings which were down 13.8% in 2022.
Mr Smith is not all that optimistic about the growth outlook for his portfolio companies this year (”If 1% growth worries you it may be wise not to read next year’s letter”).
High quality businesses shouldn’t be afraid to disclose mistakes and listen to their long-time investors (and virtue signalling is pointless).
Removing non-cash items from non-GAAP accounting (e.g. share based payments and depreciation) not only gives investors an unrealistic picture of performance but could also cause management to make poor investment decisions.

It is, of course, worth noting that fund managers’ letters to their shareholders are generally used as marketing material and, we can’t all invest like Terry Smith with enormous sums of money. (And even if we could, it wouldn’t…

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Rusty2

13th Jan '23

Megan, which Fundsmith figures are looking at? The Fundsmith fund was -13.8% in 2022. Terry Smith made a big mistake with Paypal which was one his largest holdings.

Food revenue going up 6% does not look that good considering food price inflation. Aldi and Lidl were up around 27%.

Megan Boxall

Hi Rusty2,

With the ROCE (32%) figure I am talking about the metric if you were to assess Fundsmith as a company i.e. the return of the 'company' dividend by its assets-current liabilities. You are right, the actual performance of the holdings was very poor - PayPal was a problem and I would also argue that Meta has been a big mistake (which the fund still holds).

I have now clarified that figure in the article.

Thanks Megan, I understand what you mean. I do have a holding in Fundsmith.

David52

Is it possible to break out the number of EVs sold and the margin achieved on those by each of the big car companies? Just for an alternative perspective!

BnB

You are right, the actual performance of the holdings was very poor

To be fair to Mr Smith, many of the holdings held up very well and the fund did not significantly diverge from major indices after 10 years of consistently knocking them into a cocked hat. Is that so bad?

He was certainly guilty of holding onto PayPal and Meta for too long - as was I. But the fund did what I says on the tin - buy and hold, ideally indefinitely- which means through thick and thin. I admire that he is a business owner, not a position jumper from short term opportunity to another. And far from hoping to be right 55%-60% of the time, his selections are almost universally successful. It’s the macro that bit growth stocks, not the company performance (apart from the two mentioned above).

Lucky dip

14th Jan '23

Diversification is the mantra for every investor.

Not only in holding various asset classes but also holding the best and the worst (most disliked)sectors.

For me the housebuilders are currently in the latter category. Almost all the known unknowns are known about the sector. Rising interest rate, rising cost of living, expectations of big house prices drop and so on.

adding to all of that no one is recommending the sector as a buy for 2023!

It has its place in a diversified portfolio.

Harry Hindsight

On carmakers.

Apparently on average electric vehicles cost a third more than a comparable ICE.

The Ford F-150 Lightning EVs sell for $84,868, compared to $65,173 for a comparable gasoline F-150.

It takes nine years for the buyer of an electric vehicle to recover the price premium through lower fuel and operating costs. By then the battery is dead or under-performing so a big replacement cost or its written off.

That said the direction is clear despite vehicle cost inflation.

The Chevrolet Bolt and Nissan Leaf come in at a more affordable $30,000 and qualify for purchase subsidies with GM launching a similar level Equinox. Tesla is looking to build a cheaper Model 2 for us less affluent.

The current Teslas will be premium brands competing with Porsche and Audi etc and the Mustang E.

Tesla will struggle in Chinas big market due to Mr Musks activities and the internet connectivity through his Starlink satellite system - but suspect the chip can be replaced with the Chinese state equivalent to monitor your every transgression and pump propaganda at you on your journey.

Expect taxes to rise and subsidies to be removed as the income from ICE vehicles declines making them even less affordable for the masses. And who want's to risk buying a second hand battery. Used to kick the tyres, take for a test run and that's it - now probably need some kind of diagnostic equipment. All comes back to cost of metals and batteries.

I always thought hybrids were the way to go but believe they are very heavy and do not give the overall mpg benefit from a good diesel.

As for driverless cars I don't think GPS, 4G, 5G etc are robust enough on our congested roads - ok on Route 66 maybe but Hanger Lane - two hands on the wheel and foot near the brake, not watching netflix.

They all need Dr Copper so Freeport-McMoRan (NYQ:FCX) Glencore (LON:GLEN) Atalaya Mining (LON:ATYM.

Recycling is another area supporting the revolution and like Steel Dynamics (NSQ:STLD).

TOYOTA MOTOR (NYQ:TM) are going the hydrogen route I believe and if anyone can plus probably the most reliable cars available. Currently a value trap but not sure the usual stocko metric applies to a £158bn company.

Badgersbrook

Terry Smith's letter is a very entertaining, and also informative, read. Most entertaining is the section on Unilever:

"Returning for a moment to Mayonnaisegate, amongst the outpouring of comments last year were a number of apologists for Unilever who were at pains to point out that the Hellmann’s brand has been growing revenues well and this was proof that ‘purpose’ works. Of course there is no control in that experiment; we don’t know how well it would have grown without the virtue signalling ‘purpose’. It also confuses correlation with cause and effect. There may be a positive correlation between stork sightings and births but that doesn’t prove that one causes the other. Maybe Hellmann’s would be growing as fast or even faster without its ‘purpose’.
To further illustrate the point, this year we are moving on to soap. When I last checked it was for washing. However, apparently that is not the purpose of Lux, the Unilever brand, which apparently is all about ‘Inspiring women to rise above everyday sexist judgements and express their beauty and femininity unapologetically’. I am not making this up..."

topvest

Thanks - Terry Smith's annual letter is always worth a read. I particularly liked the Unilever LUX comments.

The grocer updates were very interesting, but I agree that volumes vs. price mix was very unclear. The overall picture was quite positive - Sainsbury, Tesco and M&S all holding up and actually doing quite/very well. M&S turnaround seems to be working. Waitrose and Morrison were the two losers, both of which had a sales decline. With inflation of c10% that was a dreadful performance and shows that their proposition is not good enough versus the aggressive competition of the rest and Lidl and Aldi in particular.

On carmakers, very interesting.....is it possible that EVs are the wrong technology and Toyota will win with Hydrogen vehicles? EVs just appear a problem buy unless you have solar panels and don't travel more than 100 miles given the high purchase cost, lack of infrastructure, high electricity prices (caused by gas) and battery life of less than a decade. Hybrids are sensible and Toyota led this foray. However, long-term, hydrogen vehicles may just be the winner if this can use the petrol station infrastructure already insitu.

Anyway, Tesla (NSQ:TSLA) price reductions now mean that their cars are commodity products, as cars have been for well over a century. There is no recipe for making high ROCEs in the car industry, which is why thousands of car manufacturers have folded over the last 100 years. The TSLA price is in a stage 4 downtrend which doesn't appear to have finished in my opinion. The graph here indicates it could at least half from here to get to a sensible valuation versus other more established car manufacturers.

There is no recipe for making high ROCEs in the car industry

Look at Ferrari. Not high by software standards, but certainly up there with quality industrials

Thanks BnB - yes, agreed on Ferrari, albeit niche high premium. c50% gross margins and c20% net margins at Ferrari - quite impressive!

1James1n1

15th Jan '23

He sounds like he would fit in well in a series of "Grumpy Old Men". The caution is, has he lost touch with a changing world and is ranting like a grumpy old man, or is he genuinely putting his finger on something that needs calling out? A thin line I would suggest...

FTSE Friday: Supermarkets, house builders and words of wisdom from Terry Smith

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Megan Boxall

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