Navigating structural change during the pandemic
Guy Anderson, lead portfolio manager of The Mercantile Investment Trust discusses some strong performers from the trust’s portfolio which are successfully navigating the structural change that has been a key theme for many sectors in a year of unprecedented challenges.
One of the key themes in the market this year has been structural change. This is a trend that has been catalysed or, in some cases, accelerated by the ongoing Covid-19 pandemic. During the initial UK lockdown from March to July, we witnessed forced changes in the behaviour of consumers and in the operations of businesses. The most obvious examples are the accelerated adoption of online shopping and increased demand for home-working solutions, balanced by a collapse in demand for travel and some forms of leisure. These shifts have inevitably created winners and losers. While many of Mercantile’s holdings have been direct beneficiaries, the challenge remains to maintain balance in the portfolio by identifying those companies in sectors which have been challenged, but could emerge in a relatively strong competitive position.
Technology companies have generally benefitted from the structural changes caused by the pandemic. The en-masse move from office to home-working has elevated demand for products such as cybersecurity software and technology sourcing. This has helped our holdings in Avast, the antivirus provider, and IT sourcing and services business, Computacenter. Moreover, changes in corporate behaviour have lowered cost bases – a case in point is Computacenter, which is also profiting from material cost savings.
As well as corporates, consumers have been forced to adapt to the new restrictions. We have changed the way we spend our leisure time and money – from going out or going on holiday, to stay-at-home pursuits such as gaming. Video game developer and publisher Team17, in which Mercantile holds a stake, has been one of the beneficiaries of this behavioural change. The company has experienced very strong demand since the onset of the pandemic, particularly for its back catalogue of games.
The sector that is arguably experiencing the largest bifurcation in outcomes as a result of Covid-19 is retail. While the Mercantile portfolio only holds a handful of retailers in the mid and small-cap space, in aggregate retail constitutes one of the Trust’s largest sectoral overweights, reflecting the pockets of opportunity where companies are not merely surviving, but thriving.
One of our largest positions is in homewares retailer Dunelm. Heightened demand for home improvement products and an excellent omnichannel proposition has contributed to the company’s robust position. Furthermore, it has demonstrated very strong trading momentum since the re-opening of its stores in May. Another implication of consumers spending greater amounts of time at home has been an increased desire for pets and pet products. Pets at Home, another retailer with strong multichannel capabilities, has been a clear beneficiary of this trend.
Both of these businesses have been placing increasing focus on harnessing customer data in order to drive improved retention and loyalty, and they are both now reaping the reward of investment in these measures. This highlights another important theme – that companies which can more effectively utilise the data they generate will enjoy a significant advantage in a world of accelerated channel shift.
While retail has produced both winners and losers, one sector that has undoubtedly been negatively impacted is travel. While travel and leisure as a whole is one of the largest sectoral underweights in the portfolio, our largest holding in the space, National Express, reflects our view that the bus company is likely to be the winner in its category over the longer term. The business is highly diversified but has no exposure to UK rail, where many of its peers have previously shed value. It has a track record of strong operational performance, with industry-leading margins and cash generation. In fact, even this year the business has been cashflow-positive, with a large proportion of revenue underpinned by contractual agreements. This is in stark contrast to other names in the sector that are burning through their cash reserves while pandemic restrictions remain in place.
A balanced approach
While the portfolio’s relative performance has been elevated by its holdings in companies that have successfully navigated – and benefitted from – accelerated structural change, there remain a number of positions in stocks that we believe are likely to outperform their peers in a recovery scenario. This balanced approach is an important component of our strategy in navigating these volatile markets.