The Contrarian View Of Small-Cap Industrials by Steven McBoyle, CPA, CA – Royce Funds
Portfolio Manager Steven McBoyle describes the attributes of quality-oriented industrial companies he currently finds attractive: high-moat businesses with high returns on capital that have the capacity to reinvest back into the business.
Watch the video here.
Steve Lipper: So industrials are a big focus for us in a number of the portfolios. Some investors are pessimistic about that. What’s your outlook there?
Steven McBoyle: So the industrial complex is a very diverse set of companies and we truly have been able to find a large group of companies that meet all our attributes. Again, these are high-moat businesses, high returns on capital, where we feel we can build conviction in the sustainability of those returns, and perhaps most importantly, of late, have the capacity to reinvest back into the business.
Now, I certainly can agree that one can paint a pessimistic brush when one looks at industrials. We can worry about the high dollar, we can worry about pockets where supply outstrips demand; we have long-term commodity deflation, but having said that, these are macroeconomic concerns that create microeconomic opportunities. And we have identified a group of companies that we think are premier in nature and where this pessimism is obviously creating a value opportunity.
Steve: So there are several companies that are well positioned with a network effect, that the moat is that they’re in the center in a particular micro industry that’s benefited well despite the pessimism around industrials. Can you give some examples of that?
Steven: We’re trying to identify business models that are secular in nature versus cyclical and so we have had great success in being affiliated with companies that have the network effect, as you allude.
For example, we own and we continue to like the largest auction internet platform for salvaged cars in the U.S. Currently this is a business that is benefiting from a number of attributes. We have high frequency, high severity of accidents in the U.S., and we have high miles being driven.
This is a business model that classically fits into what we’re looking for: high returns, high barriers to entry, and has the capacity to reinvest back into the business.
They have the ability to grow through a period where others may not given the secular forces that they have at play.
Steve: So we’re involved in another auction business within the industrial space, which is not as cyclical as some people might expect. Tell us about that.
Steven: We have owned and continue to do so, the largest physical auction provider of heavy equipment. It is, as you rightfully point out, more countercyclical than people expect because again, when you are faced with these cyclical forces, the outcome, actually is surplus equipment and dislocation in the marketplace.
That drives transactions and at the end of the day, that is volume to them. So this market leader is actually extending the channels to which they serve beyond their normal base reserve auction platform into alternative channels. Here they have the ability to create and grow their addressable market. Again, that is exactly the type of company we want to be aligned with.