After significant multiple expansion in 2013, some of the best remaining opportunities for equity investors may lie with stocks that are due for a change in market sentiment as the company enacts dramatic changes to its business. Dan Kozlowski, Portfolio Manager of the Janus Contrarian Fund, explains how a slow-growth economic environment has forced more companies to make the types of changes that can reshape their long-term destinies, and outlines where he is seeing some of the most promising change opportunities emerge.
Companies making big changes offer attractive opportunities in today’s market
When the going gets tough, the tough get going. We believe the old adage is true for a number of companies in today’s slow-growth economic environment, and will be important for investors seeking to maximize equity return potential going forward.
Slow economic growth over the last five years has put pressure on many corporate boards to get creative and affect real, often dramatic, changes to grow their per share profitability. We believe the companies making those sweeping changes will provide some of the best investment opportunities in the current market environment.
Easy monetary policies and a stabilizing (albeit slow-growing) economy have provided a supportive backdrop for stocks, and equities enjoyed one of their best years on record in 2013. Now that multiples have broadly expanded, it is hard to envision a catalyst that will dramatically lift all stocks.
Instead, we believe the push driving further stock-price appreciation must come from within. The remaining opportunity set in equities is limited to those companies that grow earnings to justify their current multiples, or companies that experience a complete shift in market sentiment caused by the company rewriting its long-term destiny.
The good news, at least for contrarian investors who seek stocks that are due for a change in market sentiment, is that a greater number of companies have been encouraged to make the sweeping changes required to reshape a business, and the sentiment around it.
Without the tailwind of a roaring economy, boards have taken a harder look at their businesses. We’ve seen an increase in the number of companies divesting noncore assets, changing management teams or making acquisitions that consolidate the industry in which the company operates. We expect these companies to provide outsized returns in an environment where stocks are more fairly valued and there is little impetus for a broader market push.
A slow-growth economy has forced more companies to enact big changes
One of the most prominent examples of how bad economics can force positive, material change is in the airline industry. Airline companies are a major theme in our portfolio because we think consolidation in the industry will be a long-term game changer for these companies.
Rising fuel costs, destructive price wars and a weak economy that dampened flight demand grounded major airlines for years. But these headwinds were an impetus for economic rationality among the major airlines. Since 2008, we’ve seen several large airline mergers consolidate the industry. The four largest airlines now operate 85% of all domestic flights, compared to 58% in 2003.
Consolidation has reduced industry-wide capacity. With less capacity, major airlines have pricing power for the first time in decades. As dynamics for the industry have changed, stock prices for major airlines have risen considerably. Over the past two years, the NYSE Arca Airline Index is up 124%, compared to a 54% return for the S&P 500 Index.
We see positive change in the specialty pharmaceutical industry, and through European restructuring
The weak economy has played a hand in forcing positive change within many other companies and industries. The European Crisis forced restructuring and union concessions at many large companies, making them more profitable and competitive. In the U.S., shareholder activism in the industrials sector is high, and new management teams are improving the fundamentals for many companies.
Though less tied to the general economy, we’re seeing big changes among specialty pharmaceutical companies as well, where merger and acquisition activity is consolidating the industry and new, financially-minded CEOs are taking out costs and making research and development spending less risky for their companies.
In a world where a slow economy forces companies to create their own avenues for growth, we expect to see more shareholder-friendly boards make major changes to their businesses to remain competitive. And in a market environment where valuations for most stocks have already risen considerably, we would expect these companies to be top performers.
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Investing involves risk, including the possible loss of principal and fluctuation of value.
Past performance is no guarantee of future results.
The views expressed are those of the portfolio manager(s) and do not necessarily reflect the views of others in Janus’ organization. They are subject to change, and no forecasts can be guaranteed. The comments may not be relied upon as recommendations, investment advice or an indication of trading intent.
There is no assurance that the investment process will consistently lead to successful investing.
The transportation industry can be significantly affected by changes in the economy, fuel prices, labor relations, insurance costs and government regulation.
The health care industries are subject to government regulation and reimbursement rates, as well as government approval of products and services, which could have a significant effect on price and availability, and can be significantly affected by rapid obsolescence and patent expirations.
In preparing this document, Janus has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources.
Statements in this piece that reflect projections or expectations of future financial or economic performance of the markets in general are forward-looking statements. Actual results or events may differ materially from those projected, estimated, assumed or anticipated in any such forward-looking statements. Important factors that could result in such differences, in addition to the other factors noted with such forward-looking statements, include general economic conditions such as inflation, recession and interest rates.
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NYSE Arca Airline Index measures the performance of highly capitalized companies in the global airline industry.
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