Luck, Lego & The Power of Brands: Mayar Capital Quarterly Letter

Welcome to this quarter’s letter from Managing Director Abdulaziz Alnaim. In this edition we cover Fund performance, the power of brands and the role lego plays in the portfolio.


For the twelve months ending December 31st 2018, Mayar Fund is down 0.35%, net of expenses and management fees, but before performance fees (down 0.56% net for the Initial Series). Over the same period its benchmark, the MSCI World Index, declined by 8.71%.

Since its inception in May 2011, Mayar Fund is up 97.57% net of expenses and management fees, but before performance fees (up 92.02% net) versus a 64.28% increase for the MSCI. That corresponds to an 9.3% annualized rate of return excluding performance fees (8.9% net) for Mayar Fund, compared to 6.7% for the MSCI.

The Power of Brands

The value of brands is a subject that has arisen in many discussions over the past few years. Whether they are weakening as a moat, and what the future holds for them, is frequently debated. Let us start by venturing back in time to look at why brands exist, why they have prospered, and the effect they have had on the companies that own them. Each industry had different drivers for the emergence, persistence, and success of brands. Some, like jewelry and other luxury goods, had to do with quality, heritage, aspiration, and signaling. Those, we believe, will continue to be relevant and have arguably increased in importance in a globalized world. Others had drivers that are now more under threat. An example of that is the packed goods (CPG) industry.

Brands became popular in the industry because they signaled safety and consistency. When buying a box of Kellogg’s cornflakes a hundred years ago, purchasers could rest assured it would be safe to consume and uncontaminated by bugs, unlike some of the un-packaged stuff that sat in open bins. Consumers of this era also knew that a bottle of Coca-Cola would taste the same wherever they bought it.

That gave brands an advantage over traditional competitors, which translated into higher volumes, then to economies of scale in manufacturing, distribution, and advertising, and to further volume increase on and on in a virtuous cycle of growth. National and international expansion and widening these companies’ brand portfolios further deepened that advantage.

As retailers consolidated in the latter part of the 20th century and controlled an increasing portion of the end market they were able to start selling their private labels and because they didn’t need to advertise as much, they were able to sell somewhat similar products for a lower price.

Two factors, I believe, contributed more than others to the disruption we’ve been observing in the CPG industry over the past 10-15 years. The first is the internet. The second is a prolonged period of low interest rates

The branded companies reacted by investing in more innovation, wider variety, better packaging and marketing, and seemed to have weathered that storm reasonably well. Then in the mid- to late-2000s, several smaller brands started to pop up and capture significant shares from the incumbents.

Two factors, I believe, contributed more than others to the disruption we’ve been observing in the CPG industry over the past 10-15 years. The first is the internet. The second is a prolonged period of low interest rates.

The internet did two powerful things for smaller brands. First, it substantially reduced the scale needed to acquire new customers. You no longer had to spend millions on TV and magazine advertising. Instead, you could buy advertisements by the click on Google and Facebook.

Second, it enabled small and sometimes single-brand companies to sell directly to consumers online, removing the advantage that big CPG companies had in controlling shelf space at major retailers.

The second factor is the low interest-rate environment of the past decade. That encouraged entrepreneurs to start companies and, with access to cheap funding, build volume and the infrastructure that supports it without the conventional ”old-fashioned burden” of having to provide a decent return on capital to their investors. Start-ups started to engage in what were arguably uneconomical activities such as shipping small batches of low-priced personal care products to consumers’ homes.

Consumers loved that. Established companies with the need to make a profit simply couldn’t compete.

Some of these new start-ups eventually figured out how to make money, often by moving into traditional retailers after they had gained enough scale. While that brought them into an arena where the major CPG companies still had home field advantage, the two factors mentioned above have already decimated the historical barriers to entry in this industry, allowing a lot more competition than would have emerged otherwise. Time will tell if future higher interest rates will change things or not. As you are aware, we’ve invested a lot in the past and continue to invest in CPG companies, so the above situation has direct implications on our investments.

We have seen companies react to the current status of the marketplace in different ways. Initially, they all started trimming their portfolios and refocusing on a handful of “super brands.” This, I would argue, was a way for them to focus on their strengths and play more to their edge. It is not, however, a good long-term strategy because the forces mentioned above, possibly with the exception of interest rates, are not going away. In a world with many smaller, specialized brands emerging you want to have many niche brands, not a few super brands, at least not exclusively.

Luckily, a few of the incumbents have also started a three-prong approach to the problem by developing some in-house niche brands, investing in some emerging brands, and acquiring successful brands and helping them scale. We believe that some of the major CPG companies will be able to navigate this environment successfully. They will need to combine their scale advantage in existing areas of strength with the more nimble approach of smaller brands. A change of culture will be required. It will be hard, but not impossible.

We also believe that higher interest rates and higher inflation—should they come— could help the big guys through their better access to capital, in-house manufacturing, distribution capabilities, and experience in dealing with procurement on a global scale. Brand alone was never the sole advantage or source of moat for major CPG companies, and it was never enough for us to make an investment case. Its importance and how it interacts with other factors will undoubtedly change in the future.

Our job over the next few years will be to continue to observe and learn. We will find evidence in comparable sales figures, the stability, or lack thereof, in market share data, and in whether the current efforts of the major CPG companies will bear fruit. In a sense, brands are not actually dying in the CPG industry. Older brands are being replaced by younger ones that are doing a better job satisfying their customers’ needs and desires.

The brand is dead, long live the brand!

Oh, Mr. Market, What Have You Done?

We wrote in late December regarding our excitement about current market conditions. We’ve been complaining about the lack of attractive opportunities for more than two years and are now finding many avenues to deploy the capital we’ve patiently protected.

Luck & Lego - Our Portfolio

We believe in the importance of serendipity in investing. Luck, however, is not enough.

It must be combined with curiosity and experience to yield to good results. That means reading outside the Financial Times, asking the right questions, and making the necessary connections about the world.

Examples we’ve mentioned in the past include me first hearing about WGSN (now part of Ascential PLC) from a podcast about design and architecture. A recent example further illustrates this principle, and it comes via the route of Lego sets.

A couple of months ago Aubrey was looking for a new Lego set to buy for his five-year-old daughter. (she’s too young to start building financial models, so he’s starting her on Lego models for the time being!)

Vestas Lego Model

Vestas Lego Model

While flipping through the upcoming Lego sets catalog, he came across the Vestas Wind Turbine (pictured below). Aubrey, with many analyst years under his belt, quickly recognized the name and knew that it is publicly-listed in Denmark. The analyst’s naturally curious mind took care of the rest. Aubrey then came across a piece of information that got us excited. For the first time, there are now many places in the world where the cheapest source of incremental power generation is wind, even without government subsidies. If this persists, we believe it will be a gamer changer not only for the economics of power generation and wind turbine companies but for the environment and world energy markets overall.

Recent changes in how wind turbines are purchased (namely, the increased use of auctions) have had a negative impact on turbine manufacturers’ margins. However, we believe that a combination of growing demand and Vestas’s position as the lowest-cost producer, position it well to not only survive but also thrive in the next few years.

Vestas’ scale also gives it a competitive advantage in the growing services side of the business, and that deepens the moat around the company. While short-term uncertainties remain, we believe that the price we’re paying for the shares will reward patient investors.

Vestas scale gives it a competitive advantage in services

Vestas scale gives it a competitive advantage in services

Recently volatility and declines presented us with several opportunities this quarter. We were lucky (and disciplined) to have so much cash on hand and ready to deploy. As we’ve said before, our investment style produces long periods of no activity punctuated by short bursts of hyperactivity. This period was one, as you should expect from us in such a market environment.

And Finally…

In response to growing interest in Mayar Capital, especially on the institutional side, we added a new member to our team during the quarter. Marc Cox joined us in mid-November as Head of Investor Relations. Marc has over ten years’ experience as an investment sales professional, previously serving as a Product Specialist for the Global Equity platform at Insight Investment. He also spent six years as a Product Specialist in the Emerging Market equities team at BlackRock. Marc began his career in Financial Services at BNY Mellon in 2001 and has a BSc in International Relations from the London School of Economics.

Also during the quarter, we promoted Aubrey Brocklebank to the position of director, and he joined the Mayar Capital Advisors board. Aubrey has been doing amazing work over the past three years, improving our investment process and developing our Mayar Research Process System (RPS). Having him by my side to bounce ideas off and to play devil’s advocate has improved our decision-making capability significantly. He also has a great sense of humor, which always helps!

I would also like to remind you all that we have switched our reporting year to the more conventional calendar year basis versus our previous practice of reporting on a fiscal year basis. Starting this month when you see us referring to “year-to-date” or “YTD” we mean the period beginning January 1st.

We ended the year with $38.3 million of assets in Mayar Fund and $52.0 million of Assets Under Management (AUM) by Mayar Capital. The Fund remains open to patient investors who share our values. If you know any, please send them our way. Please do not hesitate to reach out to me if you have any questions. Thank you for entrusting us with your capital. We take this responsibility very seriously.

Best regards,

Abdulaziz A. Alnaim, CFA

Managing Director

January, 2019

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