Finding the next generation of “global brands”

I’m Darius McDermott from FundCalibre, and today I’m delighted to be joined by Laura Bottega from Morgan Stanley Global Brands. Good afternoon, Laura.

[00:10] Hi.

So look, maybe one of the most telegraphed recessions in history – normally they creep up on you, but this one looks fairly well telegraphed [and] even if it we don’t end in a technical recession, you know, economies are slowing, cost-of-living crisis – why do we think a brands-type portfolio can do well in this environment?

[00:34] That’s a great question. It’s worth remembering of course, that companies with brands are just a part of our portfolio. Global brands is short-hand for companies with strong intangible assets, high returns on capital, fat gross margins, strong, free cash flows, all these good characteristics. And we believe they can be found in consumer brands, but we also find them in healthcare and software. We’re looking for the complete package; high quality companies with high quality management, at the right price. 

In the consumer space, to your point about the deteriorating macro environment, we are really particular about the categories we are exposed to. So, we choose companies which demonstrate pricing, power and recurring revenues. And these superpowers means that both margins and revenues are robust in a downturn, supporting profits. So, we try to look for companies where the consumer is comfortable to keep paying because the product is mission critical. Think software that keeps your business going, or needles and syringes in a hospital environment. Spaces that are becoming more personalised like beauty or diagnostics, sectors where price is no object, like pet care. 

So, what’s really interesting is that the combination of the pandemic and then the supply chain issues pushed us into a world of excess demand where many companies look as if they have pricing power, given their shortages of product. But as supply chains improve, as things normalise and we return to a world of excess supply, we believe more commoditised industries’ lack of pricing power, is likely to be revealed. And then you [will] see an earnings and performance gap between quality and the rest of the market.

So, sticking with the brand’s theme, if we like, a lot of brands that are household names are well-established, old companies, that have built these moats and barriers to entry over multiple decades. And they’re global – [they] obviously tend to be rather than local companies. As the world’s dynamics are changing, are you finding that there are challenger brands that either come to threaten established brands or are on the journey, I suppose, to becoming more established brands? And if that’s the case, how would you expect the fund to adapt?

[03:15] Of course, that’s an ongoing dynamic. I think the notion of disruption by smaller challenger brands felt more of a threat a few years ago, when challenger brands first began using social media to gain market share. But as the larger established brands have put real resource into digital, the scale and breadth has really come to the fore, allowing them to continue to dominate. They can also fairly easily acquire challenger brands and offer them better distributional resources within a larger ecosystem. Beauty is a good example, where your Instagram feed – maybe not yours! – may suggest a host of smaller, new companies trying to gain traction. But the reality of global distribution and steady supply, continuous marketing, is much harder than it looks and more easily handled by established brands. 

Of course, younger generation – the next generation – do seek out different brands to their parents. Some revert back to the brands favoured by their grandparents. We look for diversified, decentralised companies that are agile in incremental innovation, and that will appeal to the consumer and allow the company to keep charging a premium for that novelty. And generally, we’re not trying to hop onto the next fad, but we like the established brands that have the global resource and diversified product set to navigate changing tastes.

So, a number of well-known brands have taken a step recently to ditch their wholesale distributors, preferring to deal with the consumer directly. Why is that happening? Because often platforms, those intermediaries have been good businesses with good brands. Are you seeing this within some of the holdings in your fund?

[05:10] Yes, and of course the answer is, really great brands want to stay in control of their brands. And the best brands are really tightly controlled. We’ve seen this direct-to-consumer trend, most particularly in sporting goods. Going D2C [direct-to-consumer] bypasses the wholesaler, the retailer; it bypasses distribution costs; it bypasses the risk that the distributor doesn’t display or price or market the product the way the brand would prefer. 

A further factor we think is technology and the advance of digital analytics and social, which allows companies now to [have] better metrics about the consumer which is then used in future product design. And I think these companies are also looking for a more direct and personalised relationship with the consumer.

So, [it was] a tougher year, 2022, for quality companies, which I think you are describing and attributing to your global brands fund. What’s your outlook today, as we are sitting here in the early part of 2023? Do you see much more value? Or are you seeing that these are strong companies – having been quite resilient, even not dependent on their share prices, which obviously are function of stock markets?

[06:39] Yeah. I would have to reiterate that we see a continuing fairly tough environment for companies going forward. Generally, higher input costs put pressure on margins. Supply chains need investing – they want to be as modern and flexible and local today, as they need to be in a more polarised world. 

The interest rate environment, whether it’s 25 bps [basis points – also expressed as 0.25%] up or down, the point is more that this higher level of rates creates more pressure for indebted companies. And that’s exactly why we focus on the companies we do; high quality companies, more resilient earnings that are more likely to survive and thrive through the cycle. Some of these are brands you would recognise as a consumer, but some are brands that dominate business-to-business such as software or cloud companies or credit card companies. Where we find potential earnings resilience today is in the subset of quality and software, medtech [medical technology] and staples, particularly. 

We believe that adding earnings resilience to your portfolio gives investors more predictability in the top and the bottom-line, and a peace of mind that only comes from owning quality.

Laura, thank you very much. For more information on the Morgan Stanley Global Brands fund, please do visit FundCalibre.com.