Our funds delivered strong positive returns for October. Of course, the largest driver of underperformance across 2022 has been the speed and extent to which interest rates have been raised. This had a disproportionate share price impact on long-duration assets including Quality-Growth companies. Importantly this is not driven by any structural weakness within these firms. In fact, whilst they have historically been the first to fall during a significant market downturn, they also rise the quickest when markets recover. They then go on to outperform both high-growth and value cousins due to their powerful compounding earnings.
2022 has been disappointing, but not surprising. Russia’s war, soaring energy prices, Covid lockdowns, rising interest rates, and an exceptionally strong US Dollar initially hurt all stocks no matter their individual merits. The good news is these factors have only a short-term effect on Quality-Growth companies. Despite the gloom there is little enduring impact on their ability to generate wealth into perpetuity, which is to say the level, duration and risks to cash flows have not materially changed.
Patience & conviction rewards our investors as they dramatically increase the opportunity of our holdings’ stock prices to reflect their superior earnings growth. This works in both rising and volatile markets. Our efforts focus on identifying the best sustainable earnings and cash-flow growth companies matched with the benefits of our global megatrends.
Despite the macroeconomic backdrop, we expect our holdings to continue their earnings growth in 2022. The exceptionally strong US Dollar had knocked a few percentage points from these earnings yet are forecast to rise by an average of +9% in FY-23 and again in FY-24. Changes in the US dollar will wash out over the cycle and will again become a tailwind for many of our stocks.
Net Zero Megatrend
We view Energy Transition to be among the most important megatrends affecting the investment landscape. Hydrogen is viewed as a key component of the world’s quest to reach ‘net zero’ and avoid the worst of climate change. Hydrogen demand projections call for a 10-20x increase vs current volumes. This requires trillions of dollars of investment. Green hydrogen is produced with renewable power such as wind and solar, enabling the full life cycle of hydrogen production and consumption to be carbon free.
It is one thing to identify a great megatrend but it’s another thing altogether to then match this with one or more quality companies that also possess sustainable earnings growth and a superior ROIC. There are many unprofitable companies participating in the Energy Transition megatrend but we consider these to be of a more speculative nature.
Our research identified industrial gas companies to be strongly positioned as they are very profitable businesses and have unique domain expertise in hydrogen and CCUS technology (Carbon Capture, Usage and Storage). The Industrial Gas market has undergone significant consolidation in the last 20 years, comprising just 3 global majors: Linde, Air Liquide and Air Products. As a result of the oligopoly style industry structure, they have delivered steady sustainable volume growth over time with consistent pricing gains. Population, GDP and industrialization of middle income markets provide a solid basis for future growth.
Whilst being an attractive energy replacement for many key industrial needs, hydrogen can be difficult to handle safely and cost-effectively. Industrial gas companies possess significant domain and IP expertise in hydrogen and are heavily involved in both traditional and Energy Transition uses of hydrogen. We believe they hold prime position as key project integrators in the build out of green hydrogen infrastructure, providing decades of growth investment potential.