The year to April 2014 was the worst year for High Quality Growth (HQG) since inception four years ago. While most stocks in the basket upheld the HQG criteria, i.e. strong organic growth, margin resilience and attractive cash generation, this was not a scarcity in the period as the market was expecting. We actually had the reflation (that we saw coming in April 2013) and many of the raw material headwinds non-HQG stocks previously suffered actually reversed in many cases. FX was a particular problem too for HQG, given EM is where they source their above average growth. With the beauty of hindsight, the US yield curve predicted early in 2013 that HQG underperformance should come – it did, effectively giving up just over a third of the alpha generated over the previous three years. It’s worth mentioning the US yield curve last week gave a signal to expect HQG outperformance ahead. So it’s timely to review the basket of names again. There are 40 stocks again, 27 repeat entrants (8 from the original basket four years ago) and of the 13 new entrants there’s a return of an old favourite and 8 from the HQG ‘bench’. The selection criteria are unchanged, based on consensus Y2, at least 4% sales growth, 5% FCF yield or higher and a resilient and generally rising margin profile.
The new basket of names are:
Aberdeen Asset Management, Aeroports de Paris, Anheuser-Busch Inbev, Aryzta, Babcock International, Bayer, Brenntag, Compass Group, Danone, easyJet, Edenred, Experian, Fresenius SE, GEA Group, Givaudan, Halma, Hargreaves Lansdown, Henkel, Hugo Boss, IMI, Ingenico, Kering, Kerry Group, Kone, Legrand, Linde, LVMH, Meggitt, Next, Reckitt Benckiser, Roche, SABMiller, Safran, Sanofi, SAP, Schindler, SES, Sodexo, Symrise, Unilever.
‘Promotions’ out or too expensive on FCF (8 stocks)
Every year we have promotions out, where stocks rerate beyond the FCF yield hurdle rate of 5% or more on consensus Y2. The genuine reratings are Assa Abloy, Telenet Group (both now out after three years) and Wartsila. What is different this time is there are several names where they are now too expensive, not just because of a rerating but more because FCF expectations have been downgraded. These are adidas, Richemont, Dassault Systemes, Swatch (out after four years and one of the ‘originals’) and Syngenta. The margin profiles of the stocks is not greatly impaired.
Growth hurdle not met (4 stocks)
Just like last year, four stocks do not make the 4% Y2 sales growth cut-off. This year they are Heineken, GSK, BAT and Pernod Ricard (all names above 5% FCF yield Y2 note). This does not spell the end of HQG for them, note how Next is back in the basket owing to consensus Y2 growth estimates being too low.
Margin profiles not proving resilient enough (one stock).
Every year there are stocks in the basket where the market changes its view on the resilience of the business. HQGB4’s standout flop was Technip.
Full note to follow.
