Lazard is a leading global financial services company with significant brand and franchise value. Its world-class capabilities focus on three practice areas: merger & acquisition advisory services, restructuring advisory services, and asset management. The firm began in 1848 and now operates in 27 countries with over 3,000 employees and ~$235 billion in assets under management. Lazard offers a unique diversified business model with countercyclical aspects that minimize revenue volatility over time versus pure-play peers, creating lower exposure to economic cycles. Advisory share gains in downturns due to restructuring activity are augmented by non-M&A revenue from asset management.
Innovation and Scale
Since its 2005 IPO, Lazard’s independent boutique advisory model has gained meaningful market share at the expense of the bulge bracket leaders as large global banks have retrenched after the 2008-2009 financial crisis. The asset management business has also experienced material share gains over the same period—more than $50 billion of cumulative net flows since 2005—during a time when passive and alternative asset classes have taken share. Furthermore, half of all assets under management are now in new strategies launched since the IPO, demonstrating Lazard’s ability to innovate and scale new product categories.
Cost Structure Improvements
Perhaps most impressive is management’s admirable success in fixing the cost structure and addressing poor compensation practices of past management which favored insiders over external shareholders. The company has more than doubled operating margins since pre-crisis peaks—low double-digits to over 25% in the last few years. This has allowed for a substantial return of capital to shareholders through share repurchases and dividends, paid for with its prodigious free cash flow.
While shareholders have somewhat been rewarded by the major improvements from its multiyear lows, Lazard continues to trade at an unwarranted discount relative to its intrinsic worth. Specifically, market valuations appear to penalize the company’s leading asset management franchise. Despite outperforming peers, solid growth and industry leading profitability, the broad rerating of traditional asset managers has depressed valuations for Lazard.
Valuation Levels Undervalued by the Market
On the financial advisory side, geopolitical concerns have weighed heavily on merger and acquisition activity outlooks. The negative sentiment has been particularly acute for Lazard given the company’s preeminent position in European cross-border transactions. Uncertainty surrounding Brexit and the fate of the European Union have cast a dark cloud over its primary franchise. More recently, the fears concerning trade wars and broad protectionism have rattled CEO confidence. Despite excellent capital market conditions, weakened confidence in combination with elevated valuation levels for potential acquisitions has slowed transaction activity. Finally, although transaction volumes and revenue productivity remain healthy, the investment community has wondered how long the good times can last for investment bankers with the global M&A market entering its 10th year of this cycle.
As a result, Lazard shares trade at valuation levels not seen since the depths of the great recession in 2009. We think this is a severe penalty for a well-managed company with proven execution, tremendous competitive advantages, and a pristine balance sheet suffering through a cyclical rough patch. As of June 28, shares of Lazard traded at $34.39, a 46% discount to our estimate of the company’s intrinsic value of $62 per share.
Molson Coors is a Colorado-based beer company that brews, markets, and sells beer and other alcoholic beverages under Coors Light, Miller Lite, Blue Moon, Carling, Henry’s Hard, and Leinenkugel’s among others. The company primarily operates in the mainstream beer segment and mature geographic markets, with the majority of its business in the U.S. and Canada. In October 2016, Molson Coors acquired the remaining 58% stake of its MillerCoors JV with SABMiller for $12 billion. The company was formed in 2005 when Molson (founded in 1786) merged with Adolph Coors Co. (founded in 1873). As of 2017, it was the #5 beer brewer in the world by volume.
Mainstream beer drinkers are typically brand loyal and Molson Coors’ consistent #1 or #2 position in its core markets is a testament to its brand power and scale. It is the second largest brewer by volume in the U.S., its largest and most profitable market. Historically, Molson Coors has been able to support its brand through effective advertising (“Silver Bullet” and “Taste the Rockies” campaigns) as well as product and packaging innovation (cold activated bottles/cans). Management has been adept in identifying and executing on productivity enhancements and the U.S. JV consolidation only enhances its scale. Given these attributes, Molson Coors generates healthy free cashflow, with roughly $1.4 billion expected this year.
Changing Consumer Tastes
The stock is down ~50% since the JV consolidation as Molson Coors has struggled to generate volume growth—especially in the important U.S. market, where declines have been more pronounced. This is not only a function of secular pressures facing the overall beer industry, but also a result of its disproportionate exposure to the mainstream and value categories, which have been experiencing headwinds. U.S. per capita beer consumption has been declining for over a decade—driven by changing consumer tastes in wine and spirits, health and wellness, and greater appetite for craft beer and other emerging categories.
Marketing Refresh and Brand Expansion
Management’s strategy to combat these secular trends involves a marketing refresh for the Miller and Coors brands and a greater focus on portfolio premiumization through faster-growing brands and categories, which currently account for 20% of its overall portfolio. In early 2019, Molson Coors hired Michelle St. Jacques, its first-ever female CMO, to lead the refocused marketing efforts. Ms. St. Jacques boasts a resume that includes some of the largest brand portfolios in the world—Kraft Heinz, Unilever, and SC Johnson. We met with her while touring the Molson Coors Milwaukee brewery and were impressed. On the product side, premium brands such as Peroni, Sol, and Arnold Palmer have shown progress this year. Molson Coors is also exploring the nascent nonalcoholic cannabis beverage space through its Hexo JV in Canada. Additionally, it is executing on its $700 million savings plan in an effort to support brand investment and profit flow while focusing on debt-paydown.
While stabilization will likely take time, the market is overly pessimistic and the current stock price reflects this sentiment. We are cognizant of the challenges facing the beer industry and Molson Coors; however, we believe the company can improve volume performance over the next several years, which should result in meaningful valuation upside from here.
Founded in 1966 and headquartered in Eden Prairie, Minnesota, MTS Systems is a leading global supplier of high-performance testing systems and sensors. Its test and simulation solutions simulate real-life forces and motions, helping customers optimize characteristics like durability and performance. Similarly, its specialized sensor products measure properties such as acceleration, position, vibration, motion, pressure and force. Recently, investors have been overly focused on near term headwinds in the automotive testing market, which we believe is too myopic a view. Over the past 50 plus years, MTS Systems has established itself as the trusted supplier of first-of-a-kind solutions, perfectly positioning itself for growing demand across several industries and trends, including industrial innovation, automation and safety.
More Than Just Automotive Testing
As a supplier to some of the largest automotive manufacturers in the world, MTS Systems has historically benefitted from the requisite durability testing in the development new car platforms. Amidst the global race to develop fully autonomous vehicles, however, some manufacturers have temporarily put durability testing on hold, prioritizing safety-related testing instead. Not only should that concern prove to be short-sighted – the automotive test business exhibited growth just last quarter - but it also ignores the strong growth in the other 60% of the test business tied to materials, structures and services. In materials for example, the proliferation of carbon fiber composites is driving strong demand from aerospace customers. In structures, natural disasters in heavily populated areas are fueling demand for more robust infrastructure testing. Last quarter, total test segment orders grew 26% and total backlog is near all-time highs.
Sensing an Opportunity
With the acquisition of PCB Group in 2016, MTS Systems rounded out its sensors portfolio, adding breadth to its historical specialization in position sensors. Now accounting for nearly 40% of total revenues today, this segment is benefitting from the growing global demand for increased automation, precision and safety. In industrial automation, the company’s products are used to precisely measure the position of anything that’s moving in a factory, from robot arms to saw blades. In automotive, its sensors are used to analyze acceleration, vibration and torque. In defense, military customers are increasingly requiring more sensors, particularly in modern surveillance systems. Overall, management expects double-digit revenue growth in this business for the foreseeable future.
Adept Capital Allocation
Over the past few years, management has allocated capital towards acquiring highly complementary businesses, strengthening the balance sheet and paying a dividend. The company acquired sensor business PCB Group a few years ago and flight simulation business E2M Technologies last fall. Both businesses have shifted the overall business mix towards faster growth and higher profitability. In between strategic acquisitions, management has been laser-focused on paying down debt, with more to come this year. Additionally, the company has a long history of paying a consistent dividend and opportunistic stock buy backs.
Passing the Long-Term Test
We believe investors are finally starting to acknowledge MTS Systems’ broad growth prospects. Yet even at current stock price levels, investors are still underappreciating several secular opportunities. The company is a rare example of a market share leader in a growing industry trading at an attractive price. As of June 28, shares traded at $58.53, an 11% discount to our private market value of $65.66.
Investing in small cap and mid cap stocks is more risky and more volatile than investing in large cap stocks. The intrinsic value of the stocks in which the Funds invest may never be recognized by the broader market.
On this page, we candidly discuss three individual companies to illustrate our investment process. These companies are current holdings of certain Funds, one of which was a top performer for the quarter, one was a new addition to a Fund, and the other was, in our view, undervalued by the market. The information and our opinions were current as of December 31, 2018, but are subject to change. The information shown does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. These securities do not represent all securities purchased, sold, or recommended to investors during the period. Investors that were not invested in a Fund that held each stock for the entire holding period shown will not have experienced the performance shown. Past performance does not guarantee future results. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of any Fund or of any particular Fund itself. Portfolio holdings are subject to change. Click here for the top holdings of the Funds.