One of the things I’ve learned from writing a stock screening column for nearly a decade is that sometimes screens need to adapt to survive. That’s certainly been the case during the Covid-19 crisis when much of the fundamental data I use to screen stocks has received a substantial one-off hit. While Covid has forced me to alter many of the screens I monitor for the first time, it is nice to be reviewing a screen this week which has profited from change in the past: my High Quality large-cap screen. Hopefully the changes I’m having to make to it this week will prove as advantageous as the changes made previously.
The screen has had a storming 12 months (see table) helped by investors flocking to quality shares. This builds on strong returns in the prior eight years that I’ve run the screen. The cumulative total return since 2011 now stands at 392 per cent compared with 69 per cent from the FTSE All-Share. While the screen results are intended as a source of ideas for further research rather than off-the-shelf portfolios, if I add in an annual 1.25 per cent charge to reflect real world dealing costs the cumulative total return drops to 339 per cent
12-month performance
| Name | TIDM | Total return (2 Sep 2019 - 4 Sep 2020) |
| Games Workshop | GAW | 100% |
| Spirax-Sarco Engr. | SPX | 28% |
| Hikma Pharmaceuticals | HIK | 21% |
| Safestore Holdings | SAFE | 17% |
| Reckitt Benckiser Group | RB. | 15% |
| Halma | HLMA | 11% |
| Big Yellow Group | BYG | 2.7% |
| Marshalls | MSLH | -7% |
| Glaxosmithkline | GSK | -11% |
| Relx | REL | -12% |
| Diageo | DGE | -28% |
| FTSE All Share | FTALLSH | -15% |
| HighQualLargeCap | - | 12% |
Source: Thomson Datastream
The previous changes I’ve made to the screen were designed to stop it from focusing on value. This was necessary because the increased popularity of quality shares had caused the old valuation criteria to become nonsensical. However, the big hit from lockdown means it is now very hard to find companies that meet the screen’s requirement for signs of consistent improvements in quality metrics. In fact, this year only one company from the FTSE All-Share managed to meet the screen’s old criteria – consumer goods group Unilever (ULVR).
To adapt to the circumstances, I've adopted the changes I made to the High Quality small-cap screen, which I ran in this column last week. Essentially, the changes involve tightening up the quality criteria, while removing the requirements for sustained improvement in quality metrics. The forecast growth tests have also been loosened to look out over a 24-month horizon, by which time economic activity will hopefully be back towards more normal levels.
In all, 12 shares pass the screen based on the amended criteria. Due to the overlap between All-Share and Small Cap constituents, one of the picks – Medica (MGP) – is a company I looked at in last week’s column when I ran my High-Quality small-cap screen. It’s fair to say I wasn’t overly enamoured with Medica’s quality credentials due to its falling margins, although for those willing to take on its company-specific risks, an argument can be made for the shares based on value and growth. The stock I am looking at this week seems to me a far more impressive quality play, and for those prepared to look beyond Covid, its shares’ rating does not seem challenging.
12 high quality large-caps
| Name | TIDM | Industry | Mkt Cap | Price | Fwd PE (+12mths) | Fwd PE (+24mths) | Fwd DY (+12mths) | EBIT Margin | ROCE | Fwd EPS grth FY+1 | Fwd EPS grth FY+2 | Fwd EPS grth +24 mth | 3-mth Mom | 3-mth Fwd EPS change% | Net Cash / Debt(-)* |
| Polymetal International Plc | POLY | Precious Metals | £9,262m | 1,963p | 11 | 10 | 5.9% | 41.6% | 23.2% | 61.9% | 21.5% | 67.9% | 22.4% | 12.6% | £1,398m |
| Persimmon Plc | PSN | Homebuilding | £8,596m | 2,695p | 12 | 11 | 6.4% | 26.0% | 27.1% | -20.9% | 10.2% | 13.7% | 13.8% | 14.1% | -£796m |
| Medica Group Plc | MGP | Medical/Nursing Services | £147m | 132p | 17 | 13 | 1.8% | 22.0% | 22.6% | -29.9% | 50.9% | 43.5% | -0.9% | -9.1% | -£4m |
| Moneysupermarket.com Group plc | MONY | Other Consumer Services | £1,657m | 309p | 19 | 17 | 3.7% | 29.9% | 53.7% | -23.9% | 22.3% | 15.0% | -10.8% | -20.8% | -£8m |
| RELX PLC | REL | Miscellaneous Commercial Services | £33,315m | 1,725p | 19 | 17 | 2.8% | 24.7% | 24.8% | -10.1% | 14.5% | 53.1% | -9.3% | -5.7% | £7,633m |
| Unilever PLC | ULVR | Household/Personal Care | £52,970m | 4,533p | 20 | 19 | 3.4% | 19.4% | 26.1% | 1.0% | 5.3% | 20.6% | 5.2% | -2.2% | £20,770m |
| Croda International Plc | CRDA | Chemicals: Specialty | £7,793m | 6,046p | 32 | 29 | 1.6% | 23.6% | 22.6% | -4.8% | 12.0% | 28.9% | 16.4% | -1.3% | £577m |
| FDM Group (Holdings) plc | FDM | Information Technology Services | £1,160m | 1,062p | 34 | 29 | 2.9% | 17.8% | 63.1% | -23.8% | 8.9% | 4.9% | 14.9% | -5.6% | -£36m |
| Rightmove plc | RMV | Internet Software/Services | £5,696m | 652p | 38 | 31 | 0.9% | 69.6% | 539.8% | -40.7% | 65.7% | 36.6% | 10.8% | -9.6% | -£39m |
| Experian PLC | EXPN | Miscellaneous Commercial Services | £26,002m | 2,836p | 37 | 33 | 1.3% | 24.2% | 20.1% | 20.6% | 13.0% | 45.5% | 0.6% | -3.0% | £3,323m |
| Games Workshop Group PLC | GAW | Recreational Products | £3,010m | 9,210p | 42 | 36 | 1.4% | 27.5% | 54.6% | -2.8% | 14.5% | 15.6% | 17.2% | 22.6% | -£21m |
| Spirax-Sarco Engineering PLC | SPX | Industrial Machinery | £7,739m | 10,495p | 40 | 37 | 1.2% | 19.9% | 20.2% | -9.1% | 11.9% | 24.0% | 7.3% | 2.0% | £363m |
*All FX converted to £
Source: Factset
RELX
Relx’s (REL) business is focused on selling data and content, and associated added-value services. It generates very impressive profits and cash flows from doing this and also has a good approach to creating value for shareholders through a mix of investment in growth and cash returns.
Key to the competitive advantage that supports the group’s growth and consistently high levels of profitability, is Relx’s vast archives of data and niche content along with technology that can draw insights from it. It has designed systems that are able to make sense of over 3 petabytes of unstructured data - equivalent to more than 14bn books or 60m four-draw filing cabinets full of text.
This is not the kind of thing competitors can hope to easily replicate and the company is focused on using its data and technology to create products that its customers cannot easily do without. The high margin and ROCE shown in the above table stand testament to the success of this model.
Relx is focused on four areas: peer-reviewed scientific, technical and medical (STM) content (35 per cent of sales and almost two fifths of adjusted operating profits); data-driven risk and business analysis (RBA) tools (29 per cent of sales and 35 per cent of profit); legal publications (21 per cent of sales and 13 per cent of profit); and face-to-face events (the remaining 16 per cent of sales and 13 per cent of profit).
Much of the group’s STM and legal revenue is recurring and reliable with subscriptions accounting for just over half of group sales. Much less reliable in times of social distancing is the face-to-face business which has been decimated by temporary cancellations of planned events. Legacy print publications and transaction-based income, which account for 62 per cent of RBA sales, have also suffered as a result of the pandemic. This showed up in a 10 per cent top-line decline in the first half.
The company's success in generating returns for shareholders is based on a combination of: reinvesting profits into organic growth, with capital expenditure historically averaging about 5 per cent of sales and underlying operating profit growth of between 5 to 6 per cent over the last five years; bolt-on acquisitions with spending averaging about £400m over five years; and cash returns based on buyback of £500m to £700m per annum over five years and dividends, which in cash terms, amounted to £842m in 2019. The dividend was held at the interim stage.
The company has managed its spending and cash returns to keep net debt excluding leases and pensions at between 2 and 2.5 times cash profits (Ebitda), although the impact of Covid on earnings has caused the ratio to temporarily go above this level. Meanwhile low interest rates and the willingness of lenders to finance such a quality operation has also allowed the company to refinance and reduce borrowing costs over the last five years from 3.8 per cent to 2.2 per cent.
The high level of profitability boasted by Relx has raised the question of whether margins can be maintained. This is especially the case in regard to the STM business. Universities have made a lot of public fuss about the price of subscriptions to the STM research library. That said, academic subscriptions only make up about two fifths of STM revenue. What’s more, there is little denying Relx adds value to academic publishing with its network of 23,000 editors and 1m reviewers along with its impressive record at attracting citation in terms of both quantity and quality. Indeed, its price per article looks good compared with peers. And while the volume of complaints is likely to remain high, the value of the content and the extra tools Relx continues to develop means the threat to pricing may remain limited.
That said, many of the sectors Relx serves, including academia, are likely to find themselves under financial strain for some time which could slow sales growth. This was the case during the first half on the transactional sales from the RBA business, although the division still managed 3 per cent revenue growth. It is also uncertain when exhibitions will be up and running again. Recent dollar weakness is also a consideration given 56 per cent of sales come from North America.
That said, demand for all of Relx’s activities looks likely to remain strong in the longer term. Changing working practices also mean face-to-face events could ultimately take on added importance once Covid is out of the way. On that basis, it is encouraging that Relx has been continuing to acquire businesses with £720m spent in the first half. It also has not sought to aggressively cut costs. This is the kind of long-term thinking that is characteristic of a quality play.
Given Relx’s activities and the strong competitive advantages it boasts - especially from its data collection and processing abilities, and niche content - it seems worth looking beyond Covid when assessing the company’s investment merits. The accusations of “profiteering” from academic research are a concern, but the actual risk to profit seems lower than the volume of the complaints. Looking out 24 months, the valuation looks attractive given the long-term quality and potential of the business.
