Fri, 7 Jun 2013
A retailer's attractive pricing and a health-care firm's favorable prospects create solid growth opportunities for Jensen manager Eric Schoenstein.
Greg Carlson: Hi there. My name is Greg Carlson, and I'm mutual fund analyst with Morningstar on the active funds team. I am joined here today by Eric Schoenstein, the comanager of Jensen Quality Growth. Thanks for joining me today, Eric.
Eric Schoenstein: Thank you, Greg. Good to be here.
Carlson: I know you've done a couple of videos for us over time. Just to remind folks of the strategy with Jensen Quality Growth, it's a little bit unusual, in that you are only investing in companies with a 10-year track record of at least a 15% return on equity each year.
Schoenstein: That's correct. The reason for that, or I guess the power behind the universe, if you will, is that it helps for us and for our investors then to be able to mitigate business risk as well as pricing risk in their investment portfolios. When you can have a company that performs at the kind of track records that we are looking for, that high level of return on the business that's theoretically above cost of capital for 10 consecutive years at a minimum, then that has a strong likelihood of mitigating any business-failure risk that could potentially exist. Then from there, once we've established that strong universe of companies, then it's our job as investment advisors to then try to select the ones that we think are of the highest quality, or perhaps even more consistency than the universe broadly.
Carlson: Right. You screen for that annually along with a minimum market cap of $1 billion.
Schoenstein: That's correct.
Carlson: And that yields a fairly select universe.
Schoenstein: Yeah, we recently went through the fiscal 2012 measurement of the universe. Today the universe measures about 180 companies. That's up a little bit from where it's been in the past, and actually that's been a good thing we've been happy to see. We had a couple of years where the universe did shrink somewhat because of the downturn in the economy in 2008-09, not unusually so, but it was something that you keep an eye on. And we've seen it now recover back up. I think we are up about a net 15 or so companies in terms of additional opportunities that have shown a 10-year track record, proven themselves over that longer term, and that just gives us more things that we can potentially look at in our investment process.
Carlson: This may be reaching back too far for both our memory banks, but in terms of going back to, say, the pre-2008 peak, was that somewhere around the same level, 180 companies?
Schoenstein: It is actually just about back to where the high peak was. I think the last time we had a high peak before the downturn was like 183 companies, so we are within two or three companies of really being at the all-time peak we've had. The good news, I think, to the more important perhaps aspect to that is, it hasn't been driven based on market-cap movements, and sort of the rising market being a reason why more companies are coming into the universe. It's been truly about more of the fundamentals of longer-term successful business models, which for us is the more important aspect to see.
Carlson: And at the bottom, I think in 2008-09 that number reached, about, 140?
Schoenstein: In the low 140.
Carlson: So it's come up quite a bit.
Schoenstein: Yeah, it's come up quite a bit, but it was never something--again, we are a concentrated manager, 25-30 names in the portfolio. So even when we had only 140 or so names, we had plenty of additional opportunities to continue to research and look to, and now we just have more so.
Carlson: Just perhaps as a broader barometer, I think it's probably a little encouraging for the economy?
Schoenstein: Absolutely, absolutely.
Carlson: So let's talk a little bit more about the portfolio. As you mentioned, it's only a 25- to 30-stock portfolio. You are buying and selling at a pretty gradual pace usually. So oftentimes there may be no transactions or just one transaction per quarter, and we talked a little bit about your most recent purchase, TJX Companies, the retailer.
Schoenstein: Yeah, we added TJX back in December, a retailer, which perhaps is a little different from some of the typical areas that we find companies. But we think it's a retailer that is positioned well from the standpoints of the way it's going to go about growth from here. They've had a very successful track record. They've had a lot of growth in their number of stores here in the U.S., in Canada, and in Europe, but at the same time they've had good same-store sales growth, which is always a barometer in the retail industry. I think it's the fact that they have the combination of both as drivers for their business that gives us additional comfort fundamentally that the company can continue to grow at a decent clip rather than simply being dependent upon same-store sales growth, where sometimes retailers can get trapped once they reach a saturation point in terms of square footage that they can offer.
Then I think the other thing that's a good component for them from a growth perspective is the fact that off-price retailing has really been a growing part of the economy, unfortunately so perhaps, because of some of the damage that the downturn has done to consumers in terms of moving to a lower price point or needing to move because of stagnant wages and the like, but there have been at least some companies that can benefit from that, and TJX certainly represents one of those opportunities.
Carlson: Can you expand on that a little more, Eric, because I think a lot of folks, including myself, think of TJX as kind of a trade-down play for consumers. How long can that last? What does that mean in terms of valuation, given how well the stock has already done?
Schoenstein: Trade-down, I think that's a good way to think about it, though I would say it's more off-price in terms of what it really is accomplishing. It's the same goods that will be available to consumers in sort of, I guess, what you might call a first-run or full-price retailing opportunity. But it's the fact that with nearly a 1,000 buyers and working with nearly 15,000 or so vendors, they are very good and have a long, successful track record of being able to bring in merchandise, and make the mix of that merchandise applicable to their customer base, whether it's by geography or otherwise.
As they continue to do that and as the stagnation, if you will, in the economy continues to be present, from our perspective I don't think that's going to change their growth prospects anytime soon because I think unfortunately with this sort of limping recovery, the good news is it's becoming a bit more sustainable, but it's not becoming sustainable with any sort of additional growth into it. That still bodes well for an off-price retailer, particularly because consumers still want to be able to go out and get new clothes or get new home goods. To be able to do that at 20%-60% or more of the price they would pay in a full-price situation, that's an attractive concept, no matter what part of the economy you are in.
Carlson: One other thing we talked about is how the fund has often had a significant weighting in health care, sometimes well above that of the S&P 500. Now it's a bit closer to the index's weighting, and that's been an area that's been a tough one for the fund in terms of performance versus that index for the past few years. Can you talk a little bit more about the challenges and what you see as the opportunities there?
Schoenstein: I think the challenge has been sort of the market's reflection in a short-term perspective of what's been going on in the industry. I think when you talk about the Affordable Care Act and how that ultimately is going to play out, there still is some settling that needs to occur as we get closer to the full implementation of it in 2014. I think there's still more devils in the details that are starting to come out. That I think is having a bit of a compression on health-care stocks.
I also think that just generally speaking, there's been a lot of concern and rightfully so about the fact that procedures are not keeping up. That folks aren't necessarily going out and engaging in health-care services or elective procedures as much as they had been sort of predownturn, and that's strictly because of economics and people not on insurance. With the high levels of underemployment that we have, insurance isn't something they can afford, and so that means that they don't engage in those procedures. That's created a bit of a new baseline, if you will, for what we should expect from health-care companies going forward from here. But that very much because of that new baseline gives us the opportunity to think about the growth again, the growth opportunities, and we still see them as pretty darned attractive.
Once you see your way past maybe some of the slowdown on procedures or some of the challenges with full implementation of the Affordable Care Act, particularly as you start looking at emerging markets, which are still very strong growth prospects for health-care businesses, and the demographics that still regardless of everything else that's going on people are getting older, that trend hasn't changed. And those two together, given the positioning of a number of our health-care names, we think does set them up well for good fundamental performance that we think ought to then allow them to come back in the marketplace a little bit from a stock perspective once we get past some of these hurdles that are in place right now.
Carlson: And one specific example, perhaps a company that's hurt the performance the past couple of years has been Becton Dickinson. Can you talk about what's going on there?
Schoenstein: Well, I think Becton Dickinson is one of those examples that has been hurt by the slowdown in the procedures and things like that. It's very much [a producer of] needles and syringes. So, it's not a high-cost portion of any part of the health-care spectrum. But if people aren't going to the doctor as much or slowing down in that perspective, simple diagnostic tests that they are having done and simple application of pharmaceuticals through needles that are preloaded and things like that have tended to come down, and that has hurt the business.
I think the things that are in their favor right now that we like continue to be the fact that they've moved to a set of safety-engineered products here in the U.S. a number of years ago. That has been mandated from a legislative perspective throughout the EU and has started to kick in here this year in 2013. Some countries have begun to delay that a little bit just for other reasons, but we think that will continue to be a growth driver as we move forward from 2013 into '14. And as those procedures begin to pick up again, there will be additional growth for Becton Dickinson.
I think the other thing, too, is that they continue to do a good job of diversifying their products. Prefilled syringes with particular drugs that might be applicable for different kinds of patient settings have become a bigger part of their business, and they continue to pursue sort of bolt-on acquisitions that help with those growth prospects. It's perhaps one that requires some patience. We've had to be a little patient with the health-care sector overall, but we think that patience will be rewarded because the prospects are still quite good.
Carlson: All right. Well, thanks very much your time here.
Schoenstein: Thank you.