Boring Companies, Exciting Stocks

 

October 30, 2017 [capital allocation, financial crisis, growth opportunities]
Josh Rubin


Economic dislocations, regulatory shifts or intense competition can change the market dynamics confronting big, and at times unwieldy, conglomerates. They often force corporate restructurings that can result in more effective capital allocation and returns for investors who recognize promising new strategies amid the prevailing market pressures.

 

Tough times can force smart people to make hard decisions, the merits of which may all too easily be overlooked by investors focused on the forces driving the changes, rather than the company-specific changes themselves.

Take two unsexy examples that have cruised under a market radar dominated, it seems, by soaring tech and economically sensitive financial and materials stocks: an insurer and a manufacturer of automotive seats.

Following increased regulatory pressure after the financial crisis, ING Groep had to reassess its business mix. The Dutch financial conglomerate was the product of numerous multi-national mergers and acquisitions over decades. After receiving government bailouts, all financial firms were forced to reassess their capital ratios and business risk exposures from new angles.

Ultimately, ING shrunk its balance sheet by nearly half as it spun off business units around the world, including NN Group. NN Group is the leading Dutch insurer and has a strong insurance business across Europe and Japan, along with operating a solid asset management business. It is a straightforward business, but given regulatory and capital pressures on the bank, management made the difficult decision to separate NN Group.

When NN Group launched an initial public offering in 2014 to raise capital for the bank, it had a simple investment proposition: first, strong business positions and a solid balance sheet; second, the opportunity for cost restructuring as a stand-alone business; third, differentiated growth opportunities in more profitable and higher-return segments; and fourth, a strong management focus on cash flow and paying an attractive dividend.

Over the last three years, NN Group hasn’t generated big headlines or made splashy announcements. It has just focused on executing its business plan by blocking and tackling every day. For the first year after the IPO, share price performance was slightly better than the index, but nothing to write home about. This proved an opportune time for investors to establish a position or add exposure—before more market participants began to take notice of the "boring" insurance company's financial strength. Since mid-2015, NN Group’s shares have outperformed major global indices, as well as U.S. blue-chip and financial sector benchmarks by 1,000-1,700 basis points on an annualized basis. And it pays a dividend of more than 4%. Not bad for a boring insurance company.

 

When Boring is Beautiful 7/1/2014 - 10/26/2017

Source: Bloomberg

 

Or how about Adient plc, an automotive supplier whose primary business is seats for the fiercely competitive auto sector companies? Adient was spun out of U.S. industrial conglomerate Johnson Controls in October of 2016, giving it the opportunity to allocate capital in the most effective way—to the seating division, not the whole conglomerate. Moreover, it became better able to position itself within the automotive supply sector, unconstrained by the complex corporate strategy of a diversified corporate parent. An Irish domicile and therefore a lower tax rate was an additional, attractive feature.

In August of this year, Adient announced an accretive acquisition of a company that gave it exposure to “exciting” customers like Tesla and growing Asian auto manufacturers, demonstrating a judicious deployment of its strong free cash flow into high-return opportunities, both organic and inorganic. Meanwhile, Adient has paid a reasonable dividend with the chance to substantially increase cash returns to shareholders over time. Its total return since going public just more than a year ago? Nearly 80%.

Staid companies with bright prospects are usually easier to spot when investors think like company owners looking to capitalize on unique opportunities that aren’t immediately or generally apparent to others. But the prospects are visible to those with a sharp focus on execution following a key strategy shift that should benefit both the company and its shareholders in the foreseeable future.

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