Egerton Capital was co-founded in 1994 by John Armitage. Since then, the firm has yielded huge profits for its investors. Some estimates put the total value of investing earnings at over $20 billion, making it one of the most profitable hedge funds of all time.[bufffett]
John is the Chief Investment Officer and portfolio manager for the firm’s equity long/ short and equity long-only strategies. He recently presented two of the firm’s top ideas at this year’s Invest For Kids conference. The CIO of Egerton gave one long idea and one short.
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CIO of Egerton Capital on his favorite long
The co-founder began his presentation by stating that he believes Covid-19 has “accelerated” the trends that were already in place before the crisis, particularly concerning the “new digital economy.”
In this new digital economy, Armitage continued, it’s “very hard for businesses to achieve pricing power” because technology is “hugely disruptive and very damaging for the prospects of most businesses.”
To be able to succeed in the digital economy, companies must be a “special business.”
A firm that Armitage and team believes falls into this category is Alibaba. This is one of China‘s “most innovative and successful companies,” he explained.
There are two “interesting” points about this business, in particular, the fund manager continued.
“Alibaba invested very, very heavily to build an ecosystem of companies, which reinforces its business. And there’s range from gaming, to payments, to offline retailers, which are digitising, to digital supply chain business, which is helping mom and pop stores, to in fact, new factories now, which are helping arcade manufacturers produce for the new online world music, video.”
The second exciting thing, the speaker added is that “the retail sector in China has basically leapfrogged the 150 years of development it’s had in the West.”
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This means there are no large competitors such as Walmart, which are such effective competition to Amazon in the US.”
Instead, Alibaba is competing with “new startups” and “mom and pop stores.”
As well as the company’s e-commerce platform, which Edgerton believes has the potential to expand at a rate of 20% per annum, the fund is also excited about Alibaba’s expansion into the cloud computing market.
The firm’s cloud division could become the “AWS of China,” the speaker noted. It’s growing at 60% per annum and should benefit from the Chinese government’s decision to throw “its weight behind the application of the cloud and the digital transformation of the economy.”
The hedge fund estimates the firm’s growth will average the “low 20%s over the next fours year,” and is likely to be higher as “cloud will arguably do a lot better than we than we are factoring in.”
After Alibaba, Armitage moved onto his favorite short.
The short position Shiseido
Japanese multinational personal care company, Shiseido is “pretty challenged,” the speaker noted.
The firm has been highly reliant on domestic sales, but Japan’s economy has a heavy reliance on tourism, and “those sales have really collapsed.”
While the group does have some international businesses, they are” consistently unprofitable as they “lack scale” and are “dependent on licensed brands on which the company pays heavy fees.”
“The company would say that it’s US and EMEA sales are structurally chronically unprofitable,” Armitage explained.
These issues are “quite intimidating,” he continued.
Shiseido lacks the sale of its larger international peers. It has just three or four $1 billion brands, and “L’Oreal has got 12.”
“That means the company lacks tremendous scale, the scale economies that the company like L’Oreal and just makes good profitability, kind of hard to achieve,” the speaker continued.
Further, Shiseido has “done far, far worse than L’Oreal and Estee Lauder in this downturn. And that is with a huge rise in inventories, which are essentially about the company putting costs onto its balance sheet.”
More worryingly, the company’s inventories have “risen by about 50% every two years.”
“That means the company has essentially been over producing,” and at some stage, it will either have to write these assets off or sell them at a discount.
This “bloated” level of inventory suggests Shiseido’s “sales have been too high.”
Put simply, Egerton believes that this Japanese cosmetics giant is “chronically unprofitable, very expensive, and we think we’ll have a slow recovery.”
This article first appeared on ValueWalk Premium.