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Relative returns

Family companies have historically performed well in times of market stress – but they have their own vulnerabilities
Relative returns
  • Family businesses often benefit from a long-term focus and disciplined investment
  • An intensifying focus on ESG means that there is more onus on maintaining strong internal standards and protecting minority shareholders

The subject of family has pervaded this year’s Covid-19 saga. Virus-induced restrictions have pulled siblings, parents and grandparents apart – unable to laugh, hug, cry or grieve together because of the threat of infection. But for many people, family has also been central to getting through the pandemic – representing a beacon of stability and comfort amid the uncertainty.

Steadiness in tough times is also a trait associated with family businesses, too – underpinned by a long-term focus, alignment between the interests of bosses and shareholders, and prudent capital allocation. And that’s before the propensity of listed family businesses to outperform their peers. Indeed, a recent report from Credit Suisse showed that its database of more than 1,000 family-owned companies had beaten other stocks by an annual average of 3.7 percentage points since 2006.

Moreover, the bank found that such share price outperformance was rooted in strong relative financial returns. Over the past 14 years, revenue growth for family-owned companies has exceeded that of rival entities by more than two percentage points. The cherry on top is that family companies also tend to be more profitable.

 

Challenges and opportunities

It’s easy to see why investors might want to buy into companies with such attributes, particularly in the middle of a major economic recession and unprecedented market volatility.

But family businesses have vulnerabilities, too. They are not immune to the coronavirus crisis, although – as we shall explore – past trends indicate that they might weather major storms better than non-family competitors.

The family-business landscape is also vast, representing two-thirds of all companies worldwide and 88 per cent of the UK’s private sector. Such scale breeds variety, meaning each organisation has its own specific pressures.

At the same time, an intensifying focus on environmental, social and governance (ESG) credentials has prompted greater scrutiny of all companies’ working practices. And while Credit Suisse found that family businesses typically have a slightly better overall ‘ESG score’ than their competitors, they often fall behind on the G factor – governance. For fans of the hit TV show Succession, such an observation will come as no surprise. Family ownership can – in extreme circumstances – elicit bitter rivalries, inter-generational discord and a reluctance at the top to hand over the reins.

There are ample opportunities to dive into well-run dynasties with promising growth prospects, disciplined spending strategies and attractive returns. But the family-business sector, like any other, faces challenges – calling for a judicious investment approach.

 

How the 2016 portfolio performed

This magazine has twice previously constructed an example portfolio of family-owned stocks. Both portfolios have performed well so far. The first, put together in 2010, has seen a share price return of more than 100 per cent over the past decade, while our 2016 selection is up by 80 per cent. For context, the broader FTSE All-Share index is down 10 per cent over the same four-year period.

NameTIDMFamily holding in 2016 (%)Share price on 22/07/2016 (p)Total return(%)Share price return (%)
Accrol GroupACRL15111-56%-58%
AntofagastaANTO65492137%111%
FW ThorpeFTW5622837%28%
FocusriteTUNE52138647%625%
Henry BootBOOT1617161%43%
Hochschild MiningHOC542327%2%
ImpellamIPEL51679-64%-66%
A&J Mucklow*MKLW2039586%63%
SchrodersSDR432,58127%8%
Total98%84%
FTSE All-Share5%-10%
Source: FactSet, as of 23/10/2020. *Acquired in 2019

It is hard to attribute the growth of these portfolios to family-ownership alone. As Investors Chronicle documents every day, companies can be pushed and pulled by any number of factors beyond the composition of their boards and shareholder registers.

 

Volume up

That said, the top performer of the 2016 portfolio was Focusrite (TUNE) – more than a third of whose shares are now controlled by directors and related parties. Focusrite sells audio equipment to professional, commercial and hobbyist musicians and was founded in the 1980s by Phil Dudderidge – former soundman to rock’n’roll band Led Zeppelin. Its shares have soared by more than 600 per cent over the past four years and are up by almost a half since January alone – buoyed by strong trading updates and subsequent broker upgrades.

Another standout stock from our 2016 feature was urban logistics player A&J Mucklow, whose shares leapt last year on a £415m takeover offer from warehouse landlord LondonMetric (LMP). A sign that family businesses can also make attractive acquisition targets despite their distinctive ownership structures.

 

Dampened down

Conversely, one of the worst performers from 2016 was Impellam (IPEL) – a company subject to significant family ownership via the Lombard Trust, created for the benefit of Lord Ashcroft’s children. Impellam is a recruitment specialist and has been badly hit by Covid-19 disruption, although it was already dealing with difficult markets before this year.

Accrol (ACRL) was also a negative contributor. The group’s shares were knocked badly in late 2017 when it warned on profits and still sit well below their former heights. The purveyor of loo roll was listed on Aim in 2016 by its founding family, the Hussains, alongside private equity firm NorthEdge Capital. These days, only the latter group is a shareholder, alongside asset-managers Schroders and Ruffer.

 

Fam-demic returns

Turning to the present, it is impossible to gauge how painful the Covid-19 outbreak will prove for each sector. But history can help us understand how family businesses have historically coped in difficult conditions.

Credit Suisse's own findings are that “family-owned companies tend to have above-average defensive characteristics that allow them to perform well, particularly during periods of market stress”. Furthermore, the bank’s early pandemic data suggests that these companies’ models are “proving relatively resilient” – with return data for the first half of 2020 revealing an outperformance of roughly three percentage points compared with non-family businesses. 

We can speculate on the reasons for that apparent endurance. For example, it may help that some family businesses operate in industries that stand to benefit from longer-term behavioural and demographic shifts – such as communications and healthcare.

 

Weathering the storm

But family control can also motivate bosses to keep their eyes on the future, with a view to safeguarding their own assets and those of the next generation. And that long-term focus should, theoretically, bolster companies’ defences in times of trouble. Such observations go some way to explain why Pictet launched its family-focused fund in late May – at the height of the pandemic.

The fund in question – a "repositioning" of Pictet’s European small-caps vehicle – is global, and uses various filters to identify constituents. Beyond voting-right thresholds, it requires companies in emerging markets to have a minimum market value of $10bn – guided by the fact that there is less information pertaining to governance and financials for smaller companies in these geographies.

Conducting a back-test on its stock universe, Pictet found that family companies outperformed non-family companies by 56 per cent between January 2007 and June 2020 (against the MSCI ACWI). Better margins, balance sheets, lower leverage and higher growth are all cited as important factors. For fund manager Cyril Benier, “this shows that there are clearly attributes of quality and growth for these companies”. And while dividend yields tend to be lower for family-owned companies, Mr Benier notes that such businesses typically reinvest more of their profits.

By comparison, Mr Benier suggests that companies with lower profitability and a weaker balance sheet could see restricted opportunities to invest during crises – potentially eroding their market share.

 

Discipline, diversity and governance

That pattern of investing for long-term growth is generally indicative of tight controls and strong managerial discipline. In some senses, that might make family-run businesses synonymous with good governance and benefiting from years-in-the-making principles that have been handed down like corporate DNA.

But with the spotlight currently trained on companies’ internal standards, family businesses are being asked to prove their structures won't cause problems for outside investors and stakeholders. There is also pressure to move with the times.

For a start, the matter of diversity is gaining traction. As Credit Suisse points out, “diversity in leadership is notably less favourable” among family businesses, and "will only come under greater scrutiny as ESG continues to rise in investors’ agendas”.

Mr Benier also notes that with family businesses “there is a risk [that] dominant shareholders confuse the operational assets of the company with their own wealth”. Succession is a key aspect of a company’s long-term vision.

Then again, new thinking from younger generations might not always marry with the company’s brand. It could even spark conflict. James Murdoch – the son of media mogul Rupert – resigned from the board of family-controlled NewsCorp earlier this year, citing “disagreements over certain editorial content published by the company’s news outlets and certain other strategic decisions”.

 

Monitoring governance

Broadly speaking, it can be difficult to know how to monitor for ESG compliance. Credit Suisse "fully recognize[s] that the ESG scores provided by the leading ESG rating companies are not without shortcomings. Data quality and availability is a key issue as is the uncertainty regarding which ESG metrics are material and how these should be weighted." And governance is arguably difficult to quantify; some ESG tools may not acknowledge the specifics of family-owned companies. Mr Benier says that these can put “too much emphasis on board independence”, despite the fact that family-owned companies are not independent.

Still, there is broad consensus on the need for a minority protection body, alongside independent nomination, remuneration and audit committees. Pictet has created its own customised governance tool, focusing on four pillars: ownership (understanding how the family is constituted), committees, long-term vision and whether there have been any past controversies. Mr Benier says investors in family-owned businesses require an “active approach to understand how the governance works”.

 

2020 portfolio

Following our 2010 and 2016 selections, we have looked beyond UK-listed stocks for our third generation of family business investment ideas. Each has its own traits of family ownership or control, providing a sense of the reach, diversity and nuanced structures of family companies.

NameTIDMSectorFamily holding (%)Share priceMarket cap 
AntofagastaANTOMining651,038p£10.3
DunelmDNLMRetail50.531,487p£3.0
JD SportsJDRetail55822p£7.8
Hikma PharmaceuticalsHIKHealthcare262,549p£5.9
RocheSWX:ROGHealthcare50CHF297.4E254
HermesFR:RMERetail70+E825E8.5
NikeUS:NKERetail*$129.69$204
Source: FactSet, as of 23/10/20. *Nike has a separate 'A' class of common stock, 75 per cent of which is owned beneficially by Swoosh LLC

 

Antofagasta

Chile-based copper miner Antofagasta (ANTO), which appeared in the IC’s last family business portfolio, continues to epitomise ‘family control’ – with chairman Jean-Paul Luksic and his billionaire family still holding a major stake in the group, at roughly 65 per cent.  

Antofagasta was set up in 1888 as a railway company. It diversified into mining and other sectors in the 1980s, after the Luksic Group took control.

Senior independent director Ollie Oliveira noted within the 2019 annual report that “the widely held view is that the substantial controlling interest [of the Luksics] is regarded positively”. He said that shareholders were “satisfied that the interests of the controlling shareholder are aligned with theirs, and appreciative of their understanding of the copper price cycle and market fundamentals, long-term vision of the industry, and well-known conservative operating, financial and growth strategy”. Mr Oliveira acknowledged that such support was conditional on continued compliance with the group’s corporate governance framework.

Copper is seen by bulls as a necessary ingredient in the push towards electrification and a low-carbon world. Together with a drop in copper reserves, this should arguably stand Antofagasta in good stead in the longer run – notwithstanding shorter-term challenges linked to the virus. (Last IC view: Buy, 1,085p, 20 Aug 2020)

 

Dunelm

Home-furniture seller Dunelm (DNLM) featured in our 2010 example list. It was established as a market stall in 1979 by husband and wife team Bill and Jean Adderley. Today, their son Will Adderley is deputy chairman and the family still holds more than half of the group’s shares.

With more of us working remotely in recent months, the group notes that “homewares [have] become even more relevant”. Trading for the first quarter to 26 September was well ahead of Dunelm’s expectations – prompting it to repay money received under Westminster’s furlough scheme, in an apparent demonstration of good governance.

Management isn’t providing guidance while uncertainty prevails. And we can’t ignore the risk that weakening consumer confidence could bite into Dunelm’s income statement. Still, a stronger balance sheet could allow the group to reinstate dividend payments, which were stopped during the pandemic. As broker Shore Capital sees it, “Dunelm remains a well-managed company with a clear strategy and good cash generation”.

Signalling a longer-term frame of mind, Dunelm carried out an external review of the management team during its 2020 financial year – and while the board was found to function well, the group said it planned to increase its focus on succession and to develop its longer-term sustainability priorities. (Last IC view: Buy, 1,451p, 10 Sep 2020)

 

JD Sports

Retailer JD Sports Fashion (JD.) might not be a family-business in the conventional sense – but its top shareholder, with a 55 per cent stake, is Pentland: a family-run investment firm.

Pentland has added various brands to its collection since it started out selling shoes in the 1930s, from outdoor goods group Berghaus to swimwear name Speedo. It acquired a stake in JD Sports in 2005. Pentland says that its strategy is to “grow our portfolio of brands, over the long-term, so that more people, see, buy and love our brand”. From a governance perspective, it notes on its website that “as a privately-owned family business, we believe in doing the right thing, not the easy thing”.

True, Pentland sold a sizeable chunk of shares in JD Sports worth more than £177m last December – but it said that this was done to fund future investments and to increase the group’s free-float “to meet the increasing interest expressed in JD by other shareholders”.

JD managed to keep sales retention at 90 per cent during the first half of 2020, despite the pandemic – although profits took a hit because of extra costs tied to shifting revenues online. These are precarious times for physical retailers and it remains to be seen how well footfall recovers in the coming months. But Pentland’s forward-looking approach and its goal to become a more sustainable business could prove valuable for its investee companies. (Last IC view: Hold, 776p, 8 Sep 2020)

 

Hikma Pharmaceuticals

Hikma Pharmaceuticals (HIK), a leading provider of generic medicines, was founded 42 years ago by Samih Darwazah in Jordan. Today, Mr Darwazah’s family still owns more than a quarter of the group’s FTSE-100 listed shares via a vehicle called ‘Darhold’. It has also remained involved at board level, with Mr Darwazah’s sons Said and Mazen holding the positions of executive chairman and vice-chairman, respectively.

Hikma’s chief executive, Siggi Olafsson, coordinated a detailed succession plan for each executive committee member last year – and the group says that it is well positioned to “move forward with continuity”. Hikma also claims that its board “promotes good governance” within the group, aiming to ensure that it meets its duties to shareholders, employees, suppliers and customers.

In any case, from a performance perspective Hikma should stand to benefit from favourable demographic trends – supported by ageing populations, the rising prevalence of chronic illnesses and loudening calls to bring down the price of healthcare. Generics contain the same ingredients as branded drugs and can enter production when the exclusive patents on drugs expire – meaning that they are typically much cheaper than their branded alternatives.

Hikma has made several appearances in this magazine’s Ideas Farm. (Last IC view: Buy, 2,685p, 15 Oct 2020)

 

Roche

Not many publicly-listed companies can claim to still be under family ownership 124 years after inception. Enter, Roche (SWX:ROG). Today, 45 per cent of the group’s shares are held by descendants of its original founding families, thanks to a shareholder pooling agreement set up in 1948. A further 5 per cent of the shares are held separately by another family member.

Roche has been working hard to tackle the Covid-19 crisis – offering up testing kits to detect the virus, while also striving to fight the symptoms of the disease. Such efforts reflect the group’s leadership in the twin fields of diagnostics and pharmaceuticals – a combination that allows it to sit front and centre of the ‘personalised care’ movement. Mr Benier at Pictet, whose family fund holds the stock in its top 10, concludes that Roche has a “unique business franchise”.

Mr Benier points to a “strong family structure” at Roche with family members on the board including the vice chairman. But the group has an external chief executive and Mr Benier notes that the company “take[s] care also on minority shareholder protection”. He sees Roche as “strong on the business side, very strong on the governance side”. Roche has also appeared in the IC’s Ideas Farm screens. (Last IC view: Buy, 327CHF, 30 Jul 2020)

 

Hermès

French leather goods and clothing group Hermès (FR:RMS) was founded in 1837 by Thierry Hermès. Today, descendants of Mr Hermès collectively hold more than 70 per cent of the shares overall. Family-members decided to create a central, more powerful family holding structure in 2010 in a bid to protect the company after the news that luxury giant LVMH (FR:MC) had been building up a stake.

Like Roche, the group features in the Pictet family fund’s top 10 holdings. Adam Johnson – senior product specialist, developed equities and specialist equities at Pictet – notes that “we would say it’s really at the top of the pyramid in terms of luxury brands with its pricing power to match”. He adds that Hermès has done a “great job of nurturing this culture of product excellence that underpins everything that the company does” – and that the families of Hermès and Roche both "see themselves as the protector of sustainability of the company; they are there for the long term”.

 

Nike

Sportswear company Nike (US:NKE) was set up in 1964 under the moniker ‘Blue Ribbon Sports’ by Phil Knight and Bill Bowerman. Today, the group owns a family of popular brands and is valued at $163bn. But at the same time, the group is, effectively, a family business. Mr Knight was chief executive until 2004. He is now ‘chairman emeritus’. His son Travis has been a director of the company since 2015.

In 2015, Phil Knight transferred his ‘class A’ shares in Nike into a new company called Swoosh – controlled by his son. As of 30 June 2020, Swoosh beneficially owned roughly three-quarters of the group’s Class A stock – and if these had all been converted into class B shares, the commensurate ownership percentage of these shares would be 16 per cent.

Interestingly, Nike explains in its financial statements that provisions in its articles of incorporation provide the board with “a means to to attempt to deny coercive takeover attempts”. Those provisions include the fact that the Class A shareholders can elect three-quarters of the board’s directors. But the group concedes that such provisions could also delay or stop an unsolicited merger of acquisition, which some shareholders might have felt was in their best interests.

The group’s first-quarter results to August revealed a 1 per cent dip in revenues to $10.6bn. But this belied very strong growth in digital sales – ostensibly reflecting a model that can adapt to changing circumstances.