F* you viruses

I’m sick of viruses. I’ve had more than my fair share over the past few weeks. The beginning of my honeymoon was blighted by Rhinovirus – just a humble cold, though a nasty sore throat coupled with incessant air conditioning resulted in sensation of a shard of glass lodged in the back of my throat for several days. For the end of the honeymoon, I was graced by the altogether more unpleasant presence of Norovirus in some dodgy seafood and am still recovering from the after effects. Unsatisfied with ravaging my physical health, the viruses have decided to go for my portfolio as well, with the outbreak of the Coronavirus epidemic in China halfway through my trip. (Other than that we had a magical time, thanks!)

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The Coronavirus outbreak is pretty alarming. It certainly seems contagious and has claimed more than 1300 lives at the last count, well in excess of SARS. The virus is also likely to have a significant economic impact with large parts of China on lockdown. Several luxury retail businesses, including Burberry and a host of others, have reported significant disruption to trading in China. There are also concerns that the many supply chains that rely on Chinese manufacturing will be disrupted.

The stock market doesn’t seem to be too bothered, though it is possible this is overly complacent. It will probably start to react if the outbreak gets much worse or if evidence of more serious and lasting disruption starts to emerge. However, I’m not sure these effects are serious enough to pose much worry from an investing perspective. I think it makes sense to ride out any resulting volatility, regardless of how widespread the outbreak turns out to be. Any effects are likely to be temporary with a rapid recovery. I’m not aware of any historic examples where a health scare like this has caused a big problem for investors.

I’ve allowed a bit of a lag to develop between my trades and when I report them on my blog, as other commitments are making it difficult to keep up to date. To follow my portfolio in real-time you can use the link to the fantasy fund on my portfolio page.

Almost a month ago I sold for Judges Scientific for an average 65% return, swapping it for Monster Beverage. Momentum was weakening at Judges and, while its last results came in marginally ahead of expectations, talk of uneven demand and ‘less buoyant’ order intake gave me the jitters so I decided to sell up.  The price has since recovered somewhat, leaving me wondering whether my sale was an error. Certainly it was made at a temporary low point and a little more patience after the results announcement would have saved me a bit of money (lesson here!) Nevertheless, this was a successful trade overall, my second most profitable ever in absolute terms as I had built up a very large position over the past year.

Two weeks ago I sold Dart Group for a 20% profit and swapped it for Lululemon. I was having second thoughts about Dart’s quality and felt that the Coronavirus might pose some risk to short term sentiment, so I decided to take my profits quickly and move on.

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Monster Beverage

I’m a fan of investing in the drinks sector because of its defensive nature and its many strong growing brands. Monster Beverage, a £29bn US-listed business, is the world’s largest supplier of energy drinks with a whole host of brands, most notably the eponymous Monster Energy. Monster has a franchise model, in that it doesn’t manufacture its own products, instead outsourcing to third-party bottlers.

Quality

  • Business economics: the economics are excellent. The franchise business model is capital-light and highly profitable, with operating margins and returns on capital both consistently well above 30%.
  • Track record: Monster Beverage is one of the most successful listed businesses on the US stock exchange in recent years. The share price is up almost 700 times in the last 20 years. Revenues and profits continue to grow consistently at a decent pace, albeit not as explosively as they once did.
  • Competitive advantage: Monster seems to have strong competitive advantages from its brands and distribution network. It is dominant in the US energy drink category with the next closest competitor Red Bull being considerably smaller. Monster is some way behind Red Bull in many international markets. However, it has been closing the gap in recent years thanks to its close relationship with Coca-Cola, which gives it access to Coca-Cola’s international distribution network. In return Coca-Cola has a large minority shareholding in Monster. Coca-Cola is restricted from distributing rival energy drink products, with the exception of its own recently launch brand ‘Coca-Cola Energy’. I don’t think this is likely to pose a major risk to Monster.
  • Growth prospects: given the success and large size Monster has already achieved, it makes sense to be wary about its scope for further growth. Certainly it’s best years are likely to be behind it now but I believe there is still plenty of gas left in the tank. The energy drink category as a whole is still growing rapidly and Monster continues to introduce new flavours and brands every year. There is also plenty of scope for Monster to add to its market share in many geographies.

Price

Momentum is excellent. Recent results have been strong and the price is near breaking out to new highs originally set in 2018. The valuation seems decent given the quality, defensiveness and growth rate.

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Lululemon

Lululemon is a large £27bn US listed business. It describes itself as intensely dedicated to one clear goal, which is creating high-quality athletic apparel “for yoga, running, training and most other sweaty pursuits.” It designs, distributes and retails upmarket sportswear under its brand, now synonymous with figure-flattering yoga pants. Lululemon is basically a luxury fashion brand, focused on a sportswear niche.

Quality

  • Business economics: Lululemon has needed to invest extensively in expanding its retail and distribution network globally. It is nevertheless been highly profitable in doing so, with operating margins above 20% and returns on capital consistently above 30%.
  • Track record: As is evident from its market capitalisation, Lululemon has enjoyed fairly spectacular success since it was founded in 1998. It has consistently grown revenues and profits at a rapid rate for a number of years and the share price has made corresponding progress.
  • Competitive advantage: I’m no aficionado of athleisure fashion, but it seems to me that Lululemon has created a high quality, premium brand in a clearly differentiated niche. A limited amount of internet research suggests that its brand commands a hefty price premium and a large cultish following who laud the brand for its quality. It seems likely to me that these characteristics should translate to an enduring competitive advantage.
  • Growth prospects: as for Monster Beverage, I think the main question-mark concerning Lululemon’s quality is just how long its growth runway is, given the scale it has already achieved. Its consistently high growth rate suggests that its immediate prospects are good. It’s hard to judge its more long term scope for growth but I’m encouraged by the fact that its penetration in geographies outside of North America is still relatively low.

Price

Momentum is excellent, with the price in a steady long term uptrend and all of its recent results consistently coming in above expectation. The valuation is fairly demanding but I think justified by its quality and long term growth prospects.

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