UK equity markets are home to a remarkable number of world-leading companies that most people would completely fail to recognise. According to William Tamworth, co-manager of the Artemis UK Smaller Companies Fund and the Artemis UK Future Leaders investment trust, that’s because these businesses operate in specialist niche areas.
As William sets out below, he believes that by buying them at the right price, some of them have the potential to generate handsome long-term returns.
By way of illustration, he sets out three examples for us below:
AB Dynamics
Let’s start with AB Dynamics. This is the market leader in automotive testing. It offers car manufacturers advanced track and laboratory facilities to help them put prototypes through rigorous specialist tests. It also offers high-performance driving robots and wireless telemetry to enable accurate and repeatable testing.
This is a company we’ve admired for a long time, but it has always been on too high a valuation for our tastes. It has recently derated to a P/E of 12x, with a free cashflow yield of 8%. That’s half the price it was a couple of years ago.
Trade tariffs disrupted short-term demand from the US. AB has also had to write down the value of its China operation, as European car makers have pulled back from testing and trading there in the face of strong Chinese competition.
So is testing cars really a growth business? The proliferation of sensors, more automation (or autonomy), higher safety standards and tighter environmental requirements all lead to more testing. This isn’t optional – it’s mandated by regulators. Car manufacturers are now building models on several power trains – petrol, diesel, hybrid, electric – and all need to be separately tested. AB is targeting double-digit organic growth at greater than 20% margins. It won’t achieve that every year, but few companies have such attractive tailwinds.
Tristel
Tristel manufactures hospital-grade disinfectant for medical equipment. It’s the market leader outside of the US and has only recently entered the US market, which has the potential to drive a step up in revenue and profits.
Without its products, hospitals need dedicated machinery – a piece of kit like a high-powered dishwasher to clean surgical equipment with hydrogen peroxide. But much of this gear – think ultrasound probes – is sensitive and easily damaged. Tristel’s chlorine dioxide products are often quicker and easier to use and don’t risk damaging expensive medical equipment.
It’s a unique business and one that’s growing strongly. Revenue was up 14% last year, driven by volume growth; profits before tax were up 36%; and it’s debt-free.
Ashtead Technology
Our third example takes us in a completely different direction – under water. Ashtead Technology is a subsea equipment rental business for the offshore oil, gas and wind turbine industries. Its kit is relied upon by energy companies to survey sites, in construction and in operations, maintenance and decommissioning.
Ashtead’s facilities and expertise are mission-critical. The cost of down days because of equipment failure – or even equipment incompatibility – can be disproportionate to the cost of equipment rental. The cost of a floating production storage and offloading unit used by the offshore oil and gas industry for the processing and storage of oil until it can be loaded on to a tanker might be $250k a day. The cost of Ashtead’s equipment is just a small fraction of this. So Ashtead has pricing power. Its EBITA profit margin is 29.1%.
The company is investing in growth, with management targeting 6% per year, and has generated a return on invested capital of over 20% a year for the past four years[1]. On a P/E multiple of 9x, it’s attractively priced.
Advantages of world leaders
We like niche world leaders for a number of reasons. To build these companies from scratch, acquiring the necessary specialist knowledge, equipment and licences, would be very difficult indeed. Those barriers to entry give a better chance of having pricing power and sustaining higher returns. Companies that carve out a strong market position in a niche market can be almost impregnable to newcomers.
Of course, it’s no guarantee of success. But increasing your chance of success is the best available option in an uncertain world. We feel that seeking out market-leading businesses and being very mindful of the valuation we pay for them maximises our chance of success. Smaller companies are typically less well known and researched, so they’re more likely to be wrongly valued.
There will be challenges and (many) disappointments. The AB Dynamics bump in the road this year is an example. But having a well-diversified portfolio and taking a long-term approach can help to mitigate this.
Diversification requires a strong research team. The doldrums in the UK market mean many fund groups have been tightening their belts and cutting research resource. We’ve recently taken on an experienced analyst to strengthen our team. We believe this gives us an extra edge.
These niche businesses aren’t glamorous. But, chosen well and bought at the right price, they have the potential to deliver powerful long-term returns.
