Exchange : Investing In A Low Or No Growth Environment

2004
(Manliffe Goodbody)

When growth in the economy is low or static - as has been the case in the Uk in recent times - there will still be companies which manage to buck the low growth trend.

They're harder to spot since most companies tend to grow as the economy grows.  They also tend to be more risky investment prospects because, instead of paying dividends to shareholders, they tend to retain profit to finance the growth.  AstraZeneca and Vodafone are good examples of growth companies that have made it.  The "dot.coms" of the 1997-1999 are good examples of growth companies that did not make it.

The conventional wisdom in a low or no growth environment tends to be to prefer well-established businesses which may be mature (i.e. without the prospect of much growth going forwards) where less profits are retained and more are paid out to shareholders.  Good examples of such companies are food producers, general and food retailers, drinks companies and utilities.  All tend to pay quite good dividends and attractive dividends are always welcome in a low growth environment when interest rates tend to be lower.

However, a degree of caution is called for.  Some businesses which have grown well in the past find it difficult to settle down with pedestrian performance in what may have become a mature market.  There is a temptation to expand into areas where growth looks more promising or even to go overseas where margins may be more attractive and prospects look better.  Such ventures may prove successful - the quality of the management team in assessing the project and implementing it is all important.   However, history is littered with management teams which have become bogged down in new ventures and ended up having to sell them off after they have proved a failure.  It is often not appreciated how much management time and effort is required to set up a new business, or to export a winning business formula and managers can end up taking their eye off the main business.  Similarly, cultural differences often prove greater than originally expected.  Finally, businesses with critical mass in their traditional market do not always realise that the same formula does not work for businesses or areas where they do not have critical mass.

Businesses most at risk from this syndrome in the coming years are food retailers and utilities.

It is becoming increasingly difficult for food retailers to get any bigger.  The market is mature and the regulators do not want any more consolidation.  Only Morrisons, and none of the other majors have been cleared for a clean takeover of Safeway.  In the past, consolidation (i.e. mergers or acquisitions) has been a very effective way of increasing profit (viz. consolidation in the banking sector - Lloyds merging with TSB and Royal Bank's takeover of NatWest) but this route is probably largely barred.

Utilities also tend to operate in largely mature markets.  They, too, are subject to interference by regulators and see both the growth and profitability of their businesses in the UK restricted by regular price reviews.  Scottish Power moved into the USA and got their fingers burnt.  National Grid Transco have also moved into overseas markets and got entangled with the US  Coast blackout in the summer.

The safest answer in a low or no growth environment may be to concentrate on conservative, albeit slightly dowdy, businesses in largely mature markets which have good market share. 

The banks, the oil companies, the food producers and retailers, the general retailers, the drinks companies, the insurers all have members within their ranks who would meet these criteria.