Learnings & Predictions
Welcome to 2025
At the start of 2024, we thought inflation might bite harder than it did. Instead, the world simply learned to live with elevated price changes. Still, we’re holding to our outlook.
In the US, a CPI of 3-3.5% isn’t a crisis, but it does tie the Fed’s hands. Rate cuts become harder. Yields could spike, especially if “bond vigilantes” make a comeback. A debt scare in the U.S. (or emerging markets) is not out of the question.
On the other hand, we also imagine Trump likely favors striking a deal with China / Europe before bringing the full force of his threatened 60% / 20% tariffs to bear. We imagine China and Europe want that too. A relief rally could follow a reconciliation, probably into risk assets. Valuations would get even more stretched, and rates would drop.
We believe investor sentiment will see-saw between these two themes throughout the year. The first seems more urgent and longer-lasting.
At the moment, we see very few opportunities for fairly priced companies in the US market. Europe offers a bit more value, and government debt levels there also hover at more sustainable levels (excluding France and Italy—which nevertheless enjoy the protection of the union). So, that’s where we’re focusing our attention.
Below is a quick round-up of our thoughts about the companies we recommended last year.
Valero has a top-notch management team with a strong commitment to returning cash to shareholders, mostly through dividends & buybacks. Current FCF yield stands at around 8-10% (with likely no growth), which is fine but nothing to write home about.
Fears around the future use of diesel in the transportation (trucking) industry seem overblown. Electric vehicle trucks, and their enormous batteries, are still prohibitively expensive. And the uncertainty around that might even perhaps work in our favor by depressing industry-wide capex on refineries, constraining supply, and putting upward pressure on future diesel prices.
What Valero mainly offers in our portfolio is a hedge against rampant inflation and/or geopolitical events. We should have recognized this and sold it when it soared to ~$180 following Ukraine’s attacks on Russian refineries.
Conversely, a short-term risk for the stock is a peace deal in Ukraine. We’d be happy for that outcome for the world, but would probably refrain from adding to our position on weakness; we will more likely sell on strength. It currently makes up 2.5% of our portfolio, bought at an avg. price of $120.
Hershey was our biggest mistake last year. The stock looked deceptively cheap on a P/E basis, since earnings quality had been slipping. The company spent too much on acquisitions that delivered little in return.
We also failed to acknowledge the threat to its core business. We’ve come around to the view that private label brands do in fact pose a legitimate challenge to Reese’s, since customers don’t seem to mind paying a dollar more for higher-quality chocolate (and often are not given a choice at supermarkets).
What makes the demand for candy resilient against inflation-driven price increases (it constitutes a small part of a shopper’s overall basket and is therefore regarded as an affordable indulgence), also opens the door to competition and fragmentation.
We got out of the position and booked a small profit.
Vinci is an interesting beast. The fundamental story remains generally intact: in the next decade governments will need to spend on infrastructure and will increasingly opt for public-private partnerships due to concerns over public debt.
At first glance it looks like the company delivers a predictable 8% FCF yield with >10% growth p.a. However, it’s important to observe that FCF-based metrics favor acquisitive companies like Vinci, since the capex line tends to exclude other types of investments for growth which is rather expressed through cash acquisitions or purchase of intangibles. When we adjust for this it’s more like a 6% FCF and 9% growth, and a fair bit lumpier.
In our analysis last year, we focused too much on what the stronger dollar might mean for Vinci’s revenues (more Americans flying and using Vinci’s airports) and not enough on its implications for the Central Bank, which remains cautious about lowering rates for fear of importing inflation, should the Euro weaken further.
What do France’s debt and political problems mean for Vinci? In the event of severe panic, the ECB would likely step in to stabilize the situation. However, even without a full-blown crisis, these challenges could trigger a credit slowdown in France.
Fortunately, the majority of Vinci’s EBITDA comes from outside France (~60%), which helps cushion the impact. So, the French situation might have more of an impact on the price rather than on business fundamentals. We do not expect the price to recover any time soon. It currently makes up 3.5% of our portfolio, bought at an avg. of €100. We’ll probably just hold at this level and collect the 4.5% dividend.
Verallia was our favorite pick of last year. It’s great company with a strong moat, operating in a rational and oligopolistic industry. The predictability of its business (outside of unusual times like these) allows it to safely sustain a higher debt-to-equity ratio, juicing profits on the upside.
Over the past year, it’s faced continued headwinds as customers worked through excess inventory and ordered fewer glass bottles. The media, with usual intensity, has fixated on declining alcohol demand and prints daily headlines proclaiming the end of drinking as we know it. We don’t buy it.
People will still be drinking many years from now, in our view.
Depressed earnings from temporary weak demand combined with a low valuation (and negative sentiment) serves as a decent entry point, and we are prepared to withstand possible further downside from here in order to gain long-term exposure to the name.
Looking to 2025, Verallia can:
pay down a portion of debt
keep its dividend
keep the same level of capex
It can do one of those things, possibly two, but not all three. So something will have to give. We expect cash flow to trend closer to $200mm in 2025, which gives us a 4% yield, but eventually revert back to $350mm, which would be closer to 7%. We estimate FCF growth at around 7% p.a.
Verallia currently makes up 12% of our portfolio, bought at an avg. price of € 25.87. It’s a hefty amount so we don’t expect to add any more. One concern is the management team which has a very European, income-first mindset [NB: By this we mean that their approach of issuing dividends while simultaneously taking on debt seems value-destructive and too focused on short-term shareholder rewards].
Lantheus is our bet on a “growthier” stock, currently trading at a 6% FCF yield. We believe we’re buying exposure to a reasonably-priced leader in the radiopharmaceutical industry (an industry that has strong growth prospects), and a rich pipeline of radiopharmaceutical diagnostics and therapies.
Our main concern for Lantheus is emerging competition in its flagship product, PYLARIFY, which is a radio-diagnostic agent for prostate cancer, and contributes almost 70% of the company’s total revenue. Several competing agents have entered the market since PYLARIFY was first launched in 2021, and increased competition is already hurting pricing for PYLARIFY.
Even so, a growing market can support multiple players. Today, Lantheus announced the acquisition of Life Molecular Imaging for $350 million. Life Molecular has a diagnostic on the market for detecting the accumulation of proteins in the brain that may cause Alzheimer’s Disease. Lantheus makes up 4% of our portfolio.
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