Public Markets

Firstly, the company designed a manufacturing process based around 300mm wafers (while the rest of the industry remained on 200mm). Secondly, it incorporated immersion DUV (Deep UV light with 193nm wavelength) when other competitors found this too complex to implement. Finally, in 2019 it sold the first chip that used EUV lithography (Extreme UV 13.5nm wavelength), which marked the culmination of a c. 20-year R&D project. Each step has been championed by TSMC, which has led to massive advantages in manufacturing, and enormous gains in market share. The first of the next generation EUV ‘High NA’ chips will likely be sold in 2025 and could fundamentally alter the process of semiconductor manufacturing.

Semiconductor equipment is usually a feast or famine sector, and the post COVID years were certainly a feast. It appears that 2023/2024 are more likely to be famine years, but we believe that EUV High NA has the prospect to drive a new cycle of innovation in this sector. Over the last 5 years ASML has grown revenue by 17% p.a. and EPS by 22% p.a., with an EBIT margin of 35%, and a ROIC of c. 50%. We are happy to own ASML while we await the EUV High NA cycle.

We have renewed confidence over the strength of Search after various events that have happened in the last 3 years – 1) being unaffected by the changes in ‘privacy settings’ on iPhones, 2) being unaffected by the launch of Microsoft Bing AI, and 3) details being released in the Google vs. DOJ lawsuit. We believe Google Search is a self-re-enforcing differentiated product enhanced by the scale of the end user base. For Android we like the indirect monetization model of having Google Search pre-loaded and charging 15%/30% payment processing fees in the Play store.

We expect Google to keep growing at roughly the rate of e-commerce, which continues to take market share from regular commerce. Over the last 5 years Alphabet has grown revenue by 21% p.a. and EPS by 22%, with an EBIT margin of 26%, and a ROIC of 35%. We are happy to own Alphabet while it trades < 25x NTM EPS.

Over the last decade it has grown revenues faster than any comparable, but the shares have performed the worst. This is due to the peers starting a decade ago with c. 40k employees, and slimming down to c. 20k, whereas CNI began with only 20k employees – so its backwards looking earnings growth has been weaker. However, in 2023 all the North American rails began with broadly similar margin structures – so revenue and volume growth will become more important.

We expect CNI to keep growing at about the rate of GDP, returning all the cash to shareholders. Over the last 5 years CNI has grown revenue by 5% p.a. and EPS by 8% p.a. (both in USD), with an EBIT margin of 40%, and a ROIC of 12%. We are happy to own CNI while it trades around c. 20x NTM EPS.

To date Danaher has spent about USD 80bn buying businesses in Life Sciences. The aggregated combination of these businesses serves the biotech industry as their primary client. Within the R&D spend of its customers, Danaher is mostly exposed to Biologics and Cell/Gene Therapy solutions, which are taking market share from small molecule pharmaceuticals.

We expect Danaher to keep growing in line with the rate of pharma R&D, at around 8% p.a. Over the last 5 years, excluding COVID sales and profits in 2022, the revenues of the Life Science divisions of Danaher have grown 14% p.a. (50% of which has been acquired), with EPS growing 22% p.a., as EBIT margins expanded from 16% in 2017 to 21% in 2022. The ROIC is low at only 10%, a result of many recent acquisitions, but should improve as the company grows organically. We are happy to own Danaher while it trades at c. 25x NTM EPS, as despite the low ROIC, the cash conversion of earnings is excellent (before M&A spending).

We consider that the management team is excellent and recognize that the key variable in luxury goods is restricting supply, meaning that Ferrari does not exhibit volume cyclicality like the rest of the auto industry. Special models are released for sale, available only to loyal customers, which increases brand affinity and exclusivity over time. Ferrari is also alone as a large luxury brand to have such a low penetration to China. As the line-up evolves with some bigger cars, and electrification, we believe the appeal to the high-end Chinese consumer will increase (as Porsche successfully did with the Cayenne).

We expect Ferrari to keep growing faster than global GDP. Over the last 5 years Ferrari has grown revenue by 7% p.a. and EPS by 11% p.a. (both in USD), with an EBIT margin of 24%, and a ROIC of 25%. We are happy to own Ferrari while it trades around c. 35x NTM EPS.

We hope that the luxury sector will be less cyclical than other parts of the market, as was the case during the GFC, while exhibiting above GDP growth in the longer term. The LVMH group has just come off a huge COVID boom, so it may take a while for the financial results to settle down, but we feel the valuation is attractive enough to own the shares. We especially like LVMH as it has the most balanced geographic exposures of the luxury peers, while some of the competition has become overly reliant on specific geographies.

Over the last 5 years LVMH has grown revenue by 9% p.a. and EPS by 21% p.a., with an EBIT margin of 27%, and a ROIC of 17%, despite being highly acquisitive. We are happy to own LVMH while it trades < 25x NTM EPS.

Since c. 2016, under the tenure of new CEO Satya Nadella, the company changed its focus to offer ‘the best and most accessible’ software solutions to use on any device. When used in combination with Microsoft Azure (cloud services), customers were paying much less to upgrade to the newest, best performing software. The relationship Microsoft has built with Open AI should allow a gradual increase in prices to customers in return for enhanced productivity.

We expect Microsoft to keep growing in excess of the rate of growth of IT services for the near future. Over the last 5 years Microsoft has grown revenue by 14% p.a. and EPS by 20% p.a., with an EBIT margin of 40%, and a ROIC of 45%. We are happy to own Microsoft while it trades < 30x NTM EPS.

The largest is the Ratings business, in which two players lead the market (an issuer usually must have one of S&P or Moody’s, preferably both, for institutional investors to buy the bonds). The growth of the ratings business is a function of the total size of the debt market in USDtn – as the debt market overshadows the equity market and has grown much faster than nominal GDP growth, so should S&P ratings. However, as a consequence of rapidly rising interest rates in 2022/2023, combined with outstanding loans with long maturities (issued during low interest rate COVID years in 2020/2021) debt issuance has been very subdued lately, resulting in S&P ratings revenues being flat over 5 years. This is due a cyclical upswing as bonds mature.

We expect SPGI to keep growing in excess of nominal GDP. Over the last 5 years SPGI has grown revenue by 13% p.a. and EPS by 11% p.a., with an EBIT margin of c.45%. On a Pro-Forma basis, assuming it owned IHS Markit since 2017, this would be Sales growth of 5% p.a. and EPS growth of 9% p.a.. The current ROIC of 8% is heavily distorted by the acquistion. We are happy to own SPGI while it trades < 30 NTM EPS, due to the high cash conversion of earnings and the current cyclical downturn in ratings.

Since the 1990’s, as a result of changes in legislation, the traditional insurance underwriting cycle disappeared, making US health insurance a predictable steady growth industry. We no longer see 2–3-year peaks and troughs in underwriting margins, accompanied by flow of capital in when margins are high. UNH has been the most active Insurance company in buying healthcare assets to serve its insured population, this gives it the most control over (hopefully) positive outcomes, at acceptable costs. In areas of America where UNH has critical scale it can offer the most comprehensive and attractive packages under Medicare Advantage, ensuring that it maintains and expands its 25% market share nationally.

We expect UNH to keep growing in excess of the growth in Medicare Advantage. Over the last 5 years UNH has grown revenue by 10% pa and EPS by 17% pa, with an EBIT margin of 9% (the insurance EBIT margin is regulated), and a ROIC of 20%. We are happy to own UNH while it trades around c.20x NTM EPS range.

While merchant acquirers have been blowing up their margin structures trying to win market share in what VC thought was an infinitely scalable business, the net take-rate that Visa and Mastercard keep in digital payments is relatively low, and most importantly stable, even if their profits are very high - resulting in a more measured competitive dynamic.

Mastercard has historically been a big beneficiary of the faster penetration of digital payments in Europe, where it has been relatively stronger, but now we believe it is Visa’s turn to excel with its enormous market share in America – at c. 70% in debit card spend, and c. 60% in credit card spend.

We expect Visa to keep growing faster than the US economy, driven by the strong tailwinds of increasing digital payments. Over the last 5 years Visa has grown revenue by 10% p.a. and EPS by 17% p.a., with an EBIT margin of 68%, and a ROIC of 30%, despite spending c. USD 15bn buying Visa Europe in 2016. We are happy to own Visa while it trades around c. 25x NTM EPS.