Pearson, value traps and positive change

Many investors would like to profit by investing in out of favour stocks, but doing this successfully is easier said than done. Alex Savvides, manager of JOHCM UK Dynamic (GB00BDZRJ101), aims to do so by backing companies going through some form of positive change.

"We look for companies that are [rethinking] certain aspects of their strategy to simplify, de-risk and [decide] whether to continue investing in assets, for example, that aren't generating the expected return," he explains. "They then use the capital that was allocated to those divisions, business lines or services to reinvest in parts of the business that are generating good returns and have competitive advantages, high market share and a differentiated position."

When it comes to success stories, the transformation theme spans various sectors. Savvides cites medical technology company ConvaTec (CTEC) as one name that underwent a management and strategic change in the past. Current positive change stories include Vodafone (VOD) which is "going through similar thought processes about simplification," and communications and advertising company WPP (WPP). Examples lower down the market cap scale include engineer Ricardo (RCDO), business information publisher Euromoney Institutional Investor (ERM), and personal hygiene and beauty products producer PZ Cussons (PZC).

For the manager, much of the momentum behind positive changes can come from management teams. "Change is typically driven more whole heartedly when there is fresh strategic insight in companies, so we invest where there is a new set of managers – typically a new chief executive, chief financial officer and chair of the board," he says.

However, like any backer of unloved stocks, Savvides may find holdings that divide opinion. One name he views as a positive change story is Pearson (PSON), the beleaguered education company whose shares plunged between 2015 and 2020. Pearson has long been known as a difficult holding. Lindsell Train’s Nick Train, who sold down his stake earlier this year, told the IC that bringing digital technology to the education industry had “proved more challenging than in other segments”.

By contrast, Savvides sees potential for improvement, arguing that the company has installed new managers, and simplified by selling non-core assets and reinvesting the proceeds in its core global education business. It has "set up a platform which so far has been quite successful and brings the best of Pearson's educational content curation skillset direct to consumers on an app for a reasonable monthly price which has been quite successful", he adds.

Beyond value

If he favours unloved companies, Savvides still wouldn't necessarily describe himself as a value investor.

"I don't think it's good enough for me just to rely on value," he explains. "Value characteristics at the beginning are very interesting but have to be accompanied with plus factors. A company trading on a traditionally low valuation metric relative to its history and the wider stock market, where there is board commitment to significant improvements of the right metrics is very interesting. Where those transitions have been successful and there is a reasonably high degree of certainty that the business will become more of a growth company because of good capital allocation decisions, we would typically hold onto the stock. Although we always have an eye on high valuations so that there's a limit to the price-to-earnings ratios we might be willing to pay, we've been successful in transitioning with our companies from value to growth because of our focus on 'value plus.'"

Savvides and his team tend to favour companies with established track records, reasonable market shares, and a differentiated position, service and business line. Similarly, they like businesses in "structurally sound markets that are not going to decline". Notably the fund will also only hold companies which pay dividends or are likely to start doing this within 12 months. "Good cash generating companies that reinvest but know when they can afford to pay a dividend generate good long term returns," Savvides says.

It can nevertheless be challenging to distinguish a future success from a company in decline. “It’s very difficult to identify a ‘value trap’ when you’re in it,” says Savvides. “This is why it’s important not just to buy value for value’s sake.”

One example of an investment he got wrong and which was in a structurally struggling industry was local newspaper company Johnston Press, which went into administration in 2018.

"Print local newspapers have had a challenged 10 to 15 years and Johnston Press didn't meet the challenge as quickly as they needed to," says Savvides. "Much of that challenge had played through in the share price, and there was management and strategic change to try and switch to digital and get the best out of that. We were attracted to that, but while it was a very cash-generative business the balance sheet was a bit imbalanced in favour of debt. And in the end the decline in print press accelerated rather than stabilised and they just couldn't move quickly enough. We sold those shares before they disappeared." 

Savvides and his team consider selling out of positions if they are worried about a company's capital allocation decisions, including plans to make acquisitions or invest in a business or a product line that has questionable return characteristics.

"We would firstly ask the management team why they are doing this, why they believe the returns are going to be acceptable and over what time frame," he says. "If we can't get the right answers to those questions we might sell. There are many examples of where we take a differing view of what the management team should do over capital allocation – a recent one is Hyve (HYVE) in the events space. They've been very acquisitive and haven't focused enough on what the returns on capital might be."

Sector preferences

JOHCM UK Dynamic's largest sector exposure is financials, which accounted for over a quarter of its assets at the end of June, partly because the UK market is heavily weighted to the sector. 

JOHCM UK Dynamic holds Barclays (BARC) and HSBC (HSBA) which "have been effecting quite a good turnaround and are on low valuations", says Savvides. But he prefers asset managers to banks.

"Man Group (EMG) took a long time to deliver value but the patience has paid off materially," he says. "Some accused us of having a value trap but its markets were sound and service offering was good – it just took a long time for the wider stock market to see it."

Private equity company 3i (III), meanwhile, is "the most successful investment in this fund's history," although more recently it has detracted from returns. Savvides commented that in May it was "pulled lower on a negative read-across from profit warnings at Walmart (US:WMT) and Target (US:TGT) to its stake in Dutch discount retailer Action.

“The management team moved quickly to rebut any negative comparisons, noting that Action is trading well ahead of budget in the year to date and has seen recent trading deliver strong like-for-likes. Action is one of the fastest-growing European retailers. It has taken material market share, [but] the wider stock market is concerned that inflation is having a knock-on effect on consumer ability to buy discretionary products.”

JOHCM UK Dynamic's sector allocations provide one explanation for its substantial underperformance of the FTSE All-Share index and Investment Association (IA) UK All Companies fund sector average return in 2020. Although it has outperformed its sector and this index in 2021 and so far this year, the fund's returns still lag the FTSE All-Share over one, three and five years.

"A few companies that gave us problems in 2020 were perceived as [not being] beneficiaries of lockdowns and staying at home," Savvides explains. "There was a cyclical element to these companies, and a bit of retail and office exposure. And we didn't have enough winners in in the stock market such as tech disruptors and biotech companies that captured attention in 2020. But 2021 saw a partial reversal of that and 2022 [too]. We were very adamant that by being patient through 2020, stocks in the portfolio at that time would be the ones that would lead us out of any performance issues and support performance going forward.

"That's exactly what's happening – we've had some material share price recoveries and improvements, but also takeover activity. Between August 2020 and August 2021, 10 companies out of a portfolio of roughly 40 were bid for. Material interest in the kind of stocks that we invest in has meant outperformance over the last 12 to 18 months. That takeover interest has continued this year. We've had a bid for Pearson by Apollo, a private equity company. We've had a bid for Euromoney - a position that we had increased materially over the last 18 months because it had underperformed through that Covid-challenged period in 2020, taking a long term view." The fund also held Daily Mail and General Trust and Morrisons Supermarkets, which have been taken over and delisted in the past year.

"We haven't had exposure to many cyclicals or consumer discretionary stocks that have been under pressure," adds Savvides. "We have had more exposure to defensive revenue streams, [and] companies going through strategic restructurings and turnarounds [which are] more in control of their own destiny, and that has supported the performance of the fund over the past 12 to 18 months."

Alex Savvides CV

1996-1999

Astaire & Partners

1999-2002

Teather & Greenwood

2002-2003

Numis Securities

2003-2008

Analyst/fund Manager JOHCM UK Growth

2008-Present

Senior fund manager JOHCM UK Dynamic

Fellow of the Securities Institute, Securities Institute Diploma, BA (Hons) Politics, University of Nottingham

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