Looking for value in long-term growth prospects

Funds Management

by Clive Tompkins

Intermede Investment Partners CEO and Portfolio Manager Barry Dargan talks with NAB Asset Management Research Manager Stephen Barbarich about Intermede's approach and how it screens global equities for the best long-term growth prospects without overpaying.

Stephen Barbarich: My name is Stephen Barbarich, and I'm a Research Manager at NAB Asset Management. Today I'm joined by Barry Dargan, CEO and Portfolio Manager at Intermede Investment Partners. Thanks for your time today, Barry.

Barry Dargan: Thanks Stephen.

Stephen Barbarich: Can you tell us a little bit about Intermede Investment Partners?

Barry Dargan: Intermede Investment Partners was set up in 2014. It is a boutique, global investment management company. We manage a relatively concentrated portfolio of around 40 stocks, and we are looking for high quality, long term growth and return companies that we want to buy at a price that we think undervalues their long term growth prospects.

The firm is backed by National Australia Bank (ASX:NAB), who has a minority stake in the business, but it's majority owned by the partners that founded the business back in 2014. We're now three and a half years into our track record, and we're pleased to say that that's all going well.

Stephen Barbarich: In your time before Intermede Investment Partners, can you talk us through a bit about your background, the journeys so far?

Barry Dargan: Yeah. I came out of university with an economics degree, and then became a chartered accountant, and then went into the investment world as a sales side analyst, covering mostly technology stocks in London. And then moved to Japan, and had a spell there with doing sales side technology research, as well.

I went to the buyer side in 1996, with MFS Investment Management. I did a couple of years in Boston with them, and then I opened their Tokyo office, more time in Tokyo, covering Asian sectors, and then began managing portfolios around 2001. And in 2010, I joined Artisan Partners, did three years there, opened their London office and set up their global equities strategy, and then myself and some people that I worked with at Artisan came and we set up Intermede in 2014.

Stephen Barbarich: With Intermede, how would you define the investment philosophy that yourself and the team adopt?

Barry Dargan: Yeah, so we take the view that if you find high quality, long term growth, compounding businesses, with great management, in attractive industries that are innovating and growing their businesses, and you make sure that you don't overpay for these, if you buy them at a discount to their intrinsic value, then you're going to be in a good place.

That's really what we're looking for. We really want to try and find a relatively concentrated portfolio of the highest quality, long term compounding businesses.

Stephen Barbarich: And looking through your investment process, valuation is kind of one of the key planks of the process. Can you talk about how you think about that and how that plays into the research?

Barry Dargan: Absolutely, yeah. We do think valuation is the key discipline, so we're not paying any price for high quality businesses. It's got to make sense for us. We recognise that a great business doesn't always make a great investment, if you don't buy it at the right price. When we're thinking about valuation, we really want to look at all aspects of the business to figure out what we think is intrinsic value for a business.

That will include looking at the static multiples for the business, going back through time, we will look across the global peer group for a comparative of what we're paying for it. We will do a discounted cash flow calculation, we will do a spreadsheet and really build out where we think the forecast for the business is going to go.

And one of the things we pay a lot of attention to is the free cash flow yield, and we have a minimum hurdle of 4 per cent on a prospective, unlevered basis. We think that really provides quite a bit of cushion in terms of safety, that if you're getting a 4 per cent yield on a business, it's not a bad yield in a low yield environment.

And of course, we're looking for that compounding growth that's going to drive up that yield, year in and year out. We'll always want a discount from intrinsic value when we buy and own a stock.

Stephen Barbarich: So there's a lot of work that goes into those parts of the process. At the other end, how do you think about the sell discipline that, yourself and the team?

Barry Dargan: Yeah, that's right. The intrinsic value forms the price target of the business, and so if the stock price gets up towards the price target, we're going to be thinking about redeploying the basis points into other names that have not yet performed. That's one way that we'll end up selling a stock.

We will also sell a stock if the thesis changes, if the thesis gets broken, if you like. So, we bought it for a reason, and then that's not playing out, and we lose conviction in a name, because we only want to own the highest conviction names that we have, then we'll sell a stock in that situation.

The only other time we might sell a stock is if we find something that's better, a comparator to it. That would be a substitution.

Stephen Barbarich: When you think about the portfolio, and your role as portfolio manager, what sort of guidelines do you think about as to minimum and maximum positions of stocks there? Given the higher conviction.

Barry Dargan: That's right, yeah. We want to make sure that we're rewarded for owning great stocks and have enough allocation of basis points to any stock that we're going to own. We have a minimum cutoff of 100 basis points. We won't go lower than that in any stock that we own. We have a cutoff of 5 per cent at cost, on the higher end. We're playing in that space one to five, so typical position sizing for us is around two to three, and that naturally gets us to around 40 stocks in the portfolio.

Stephen Barbarich: Okay, and being quite a concentrated portfolio, thinking about the sectors of the market, are there sectors that you tend to avoid because of certain characteristics?

Barry Dargan: Yeah, we are looking for these high quality compounding names that can grow, and don't require a lot of cash to grow. They're very cash generative businesses. That's one often attractions of the business model of these types of companies.

You don't tend to find those in capital intense sectors, so if you think about energy, metals, mining, utilities, these are all businesses or markets that require businesses to have a lot of capital in their business models. If you're putting more capital in, it's harder to get an incremental return on that capital.

We're pretty shy of being in those sectors. We just don't really find much that suits what we're looking for.

Stephen Barbarich: How has that helped structure the team in relation to their responsibilities, given some of those sectors that you don't necessarily look in?

Barry Dargan: Yeah, sure. Look, I mean there's six of us. And we're all experienced, and I think we've got two Harvard MBAs, three chartered accountants. I think they're all CFAs, apart from me. They're very experienced at what they do, and knowledgeable in financial sectors. We are organised into sector teams, so there's global expertise that each have in their own sector of longstanding.

I'm the generalist, as the portfolio manager, and so that's how we work together as a team. But I would also say that the companies that we're going to own are quite rare in the stock market. Although global equities sounds like an enormous universe and is, if you look for the higher rates of growth and return that we look for, and we have minimum criteria, we call it 5, 10, 15, so we want 5 per cent revenue growth, 10per cent EPS growth, and ROE of 15per cent to be delivered on an average annual basis.

If you screen for that, you find it eliminates over 90 per cent of the companies that are out there. So, only a very elite top decile group of companies have actually delivered on those metrics, on average, if you look back 10 years. We're playing in a very small pool of high quality businesses, and we have the resources, adequate resources to cover all of that from the six of us.

Stephen Barbarich: When you're talking about the portfolio, what's the average turnover within the portfolio? How long are you holding positions for?

Barry Dargan: Yeah, we're running around the high 20s in terms of turnover. Which means we have an average holding period of over three years for each of our stocks, so yeah, we are long term, patient investors. That fits the model.

Stephen Barbarich: All right. Well, thank you very much Barry. That's been a really good insight into both Intermede Investment Partners, as well as the portfolio. I appreciate your time today.

Barry Dargan: Thank you, Stephen.