Emma Wall: Hello and welcome to Morningstar. I am Emma Wall, and joining me today to give his three stock picks is James Harries, Manager of the Trojan Global Income Fund. Hello, James.
James Harries: Hello.
Wall: So, what's the first stock you'd like to highlight today?
Harries: First stock we like to highlight today, even though we're very long-term investors, we think is looking pretty attractive is Novartis (NOVN). It's as you – I'm sure you know a Swiss but global pharmaceutical company. It has three branches to the business. Basically, it's got a branded pharmaceutical business, a generic pharmaceutical business and a quite fast-growing eye care franchise.
And we think for all those reasons that this is a business where the long-term prospects are good, the returns on capital are pretty exciting, where there has been quite a lot of restructuring focusing in on spending money more wisely within this quite large and disparate business. And yet it is offering a dividend yield of about 3.7% in Swiss francs and trading at slightly north of a 6% free cash flow yield. So, I think all of that together makes it a pretty compelling opportunity today.
Wall: What's the second stock today?
Harries: The second one I'd highlight is a little bit different, is Vonovia (VNA). It's a German residential property company. They are in something like 330 units in Germany. I mean there's several points to this investment case. The first is it's genuinely inexpensive. It's pretty remarkable actually that the portfolio within Vonovia is trading at a discount to replacement cost.
Sitting here in London that sounds remarkable that you're able to buy property at a discount to replacement cost, but you are. They are also upgrading the asset base, which means the NAV is gently increasing over time and because of their scale, they are able to do this very attractive economics.
So, overall, you've got a pretty interesting asset, which is yielding about 3.7%. But there is also a macro element to the story, because, of course, Germany being within the European Union has effectively zero interest rates. Now if there were to be a problem in the future, such that the euro was to break up, and it's certainly not something I'm predicting, but if there were then you effectively hold a Deutsche mark asset, which is incredibly inexpensive. And therefore, I suspect we do well in that scenario.
If the euro doesn't break up, then it's likely that Germany is going to continue to have the wrong interest rates essentially, and therefore you could argue you should discount the value of this property at a far low discount rate than the market is currently doing. And, therefore, it looks again incredibly good value. So, there's lots of reasons why we think this is an interesting inexpensive asset in a world, where there are quite difficult things to find today.
Wall: You mentioned the macro element. Germany has not been doing too well on a GDP level despite it being seen as a sort of euro powerhouse. It's actually being sort of flirting with recession. How linked is the residential property market to the economic health of Germany?
Harries: Well, obviously, it is linked at the margin, but I would say, on a longer-term view, the shorter-terms concerns relating to Germany economy – German economy are not particularly concerning. I would say a more important fundamental driver is both positive immigration, both into the country and within the country. There's quite a lot of immigration notably amongst the younger population into cities at the moment in Germany, and that's providing an underpinning, if you like, to property values, which I think should be relatively sustainable even in the context of relatively sluggish economic performance.
Wall: And what about the third and final pick?
Harries: The final pick is good, old Domino's Pizza (DOM). We really like this business. It's very, obviously, simple and predictable business. It's very large costs of the U.K. particularly, but also elsewhere pizza delivery business. They've being very proactive in terms of their offering with regards to technology, the Domino's Pizza app. There has been two things that have recently at least knocked the valuation down to more attractive level.
The first is some level of competition from Just Eat or similar source of apps. Now, we think they are more about other forms of takeaway, such as Indian and Chinese, which tends to be far more fragmented, and don’t have such a good technology offering. Therefore, we think Domino's is going to hold his own in that context.
Secondly, also, there will be concerns relating to the U.K. consumer, and how there is somewhat of a cyclical downtown or potentially a cyclical downtown related or unrelated to Brexit. All of those reasons meant that we were able to buy it relatively inexpensively with an attractive dividend yield, which is growing through time. Now, it has already done rather well, I'm afraid. So, it's less good value than it was, but we still think that we get an opportunity to invest at a cyclical low in what we think is a really attractive long-term franchise.
Wall: James, thank you very much.
Harries: Thanks very much.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
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