Latitude Horizon Fund
THE OBJECTIVE OF THE LATITUDE HORIZON FUND IS TO DELIVER CAPITAL APPRECIATION OVER THE LONG TERM BY HOLDING A CONCENTRATED PORTFOLIO OF STOCKS, WHILST LOWERING THE EQUITY RISK THROUGH A SELECTION OF NON-EQUITY INVESTMENTS.
Imperial Brands has been a detractor from performance since we launched, despite reasonable underlying operating trends. With mature businesses like Imperial, the most important consideration is the ability of the business to generate cash. This can be used either to invest or, more likely, to return to shareholders justifying the decision to own shares in a mature franchise. We also look for under-appreciated optionality which if realised, will lead to better than expected growth and a stock re-rating. We believe that Imperial possesses both these attributes.
Critically, the business can continue to generate healthy cash flow. The tobacco industry has enviable characteristics: it is a consolidated six player market with barriers to entry, principally regulation and scale. Size matters for purchasing, manufacturing, and distribution as well as a company's capacity to respond to regulatory demands. This size advantage reasons the marked absence of smaller players and private label alternatives. Consequently, incumbents operate in a formidably strong and rational pricing environment with a 'tax shield' of more than 70%. This shield enables big price increases with only a small change to cost for the consumer. For Imperial, this innate pricing power combined with a limited fixed cost base means that even with declining volumes, the business is still able to generate healthy operating profit and cash conversion in excess of 95%. This annuity-like cash flow underpins the dividend.
The optionality in Imperial is two-fold - a portfolio rationalisation programme and its NGP (Next Generation Product) business. For the past two years management have been reducing the number of brands in the portfolio and focusing capital investment on higher return and growth markets. We are seeing the fruits of this programme with reported volumes outperforming its underlying markets. The CEO has also outlined a £2bn disposal opportunity. Once these proceeds are realised, the company's net debt position will improve considerably.
By the end of this year, Imperial will have more than £400m of sales in NGP products - namely myBlu, the company's vaping product, currently growing more than 200% annually. Despite the headlines around the popularity of the market leader Juul, the industry is still in its infancy and represents an exciting growth opportunity with room for many players. Imperial has assembled a strong team around its NGP initiative and the company is very well positioned to grow this part of its business. NGP's could generate profit of £400-450m by 2021 equating to 10% of company profits v 0% today.
Management’s long term incentive plan is telling of internal optimism with a target of 4-10% top line growth over the next three years. Achieving just the lower end of this range would still result in a material uptick to market expectations. Meanwhile the stock is attractively valued, trading on a 11% dividend yield and less than 7x next year's earnings. At this valuation, the market is suggesting the business will shrink whereas we see prospects for future growth. We are happy to be patient, collect the dividend and use the stock as a welcomed diversifier within the portfolio.
|Fund Launch Date||1st November 2016|
|Legal Structure||Irish Domiciled UCITS V Fund - ICAV|
|Regulator||Central Bank of Ireland|
|Regional Exposure||Global, primarily developed markets|
|Benchmark||The fund is not benchmarked|
|Share Classes||£ - A/I IE00BDC7CZ89 / IE00BD37NY30|
|$ - A/I IE00BD37NZ47 / IE00BDC7JY67|
|€ - A/I IE00BDC7CX65 / IE00BDC7CW58|
|Management Fee||1% per annum|
|Administrator||SEI Investments – Global Fund Services|
|Custodian||SEI Investments Trustee and Custodial Services (Ireland)|
|Firm Compliance||Optima Partners|
|Contact Details||Patrick Valentine|
|+44 (0)207 087 9278|