Long-Serving Management: Experienced or Entrenched?

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by Kames Capital

 

Author: Craig Bonthron, Kames Capital

In 2010, when new home construction in the US was bottoming at 500 thousand (a 75% fall from the two million peak prior to the global financial crisis), the management team of the residential flooring company Mohawk took the decision to invest $500 million (14% of Mohawk’s $3.5 billion market value at the time) in a plastic bottle recycling plant. This recycling plant would convert those plastic bottles (now in excess of 5.5 billion per year) into carpet. This was a bold and unnecessary decision that put the team under pressure to deliver in unfavourable markets.

Why did the company do it? Management believed that this investment had a high return on invested capital and offered a future competitive advantage. The goal was to reduce and stabilise input costs by no longer relying on volatile and carbon intensive oil-based raw materials. This, in turn, would lead to improving gross margins versus the competition.

We like experienced management teams. Some traditional measures of corporate governance disagree with this view, calling them ‘entrenched’. Indeed, governance-screening tools mark down many company boards on this basis. We understand this point but, as ever, it needs to be considered in context. For us, length of tenure is actually more likely to indicate that the management understand their business and the industry. Tenure combined with an assessment of corporate governance checks and balances, past behaviour and shareholder alignment can be a powerful qualitative indicator of high-quality decisions in the future. Deep domain expertise combined with a long-term view often leads to high quality, high-conviction decision making. Experienced management teams also develop a relationship of trust with long-term shareholders who, in turn, provide them with a mandate to make bold decisions. It should be clear that this is inextricably linked to higher returns on capital over time, and the market will ascribe a higher valuation to such a business.

The Kames Global Sustainable Equity Fund currently invests in 41 companies. As a result of our bottom-up sustainable investment process, 19 of these companies are run by CEOs with a tenure of greater than 10 years.

So what about Mohawk? We think it’s notable that the Mohawk CEO, Jeffrey Loberbaum, joined the company in 1994 (and the CFO Frank Boykin before that). Have their bold decisions added value for shareholders? Well, US housing starts have doubled from their 2010 low to a long-run average of about one million. Meanwhile at $18.5 billion, Mohawk’s market valuation is 5.2 times what it was in 2010.

About the author:

Craig Bonthron is an investment manager in the Equities team at Kames Capital, responsible for co-managing global equities portfolios. He joined Kames Capital in 2014 from SWIP, where he was investment director in global equities. In addition Craig also had analysis responsibilities for the tech, energy and utility sectors. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors, a member of the global environmental equity team. Craig has a 1st Class honours degree in Building Surveying, an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 16 years’ industry experience (as at 31 October 2017).

Important information

For Professional Investors only and not to be distributed to or relied upon by retail clients.
The opinions presented are those of Kames Capital fund managers as at the time of publishing and may change as subsequent conditions vary. They are not intended to be relied upon as a forecast, research or investment advice, and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Companies mentioned may not necessarily be held in any of Kames Capital funds. The information and opinions contained in these pieces are derived from proprietary and non-proprietary sources deemed by Kames Capital to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. Reliance upon information in this material is at the sole discretion of the listener/viewer.

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