International Alpha: investor letter Q4 2024

Your capital is at risk.

As we look forward to 2025, it is pleasing to report that operational performance for the portfolio has been strong across a diverse range of growth companies.

What gives us added confidence for the future is that earnings growth for the portfolio now comfortably exceeds the benchmark, whilst consensus estimates project earnings growth to be 40 per cent higher than the market over the next three years. The portfolio also exhibits a distinct quality bias across a range of different metrics, including balance sheet strength, returns on capital, and free cash flow margins.

The variety of business models, industries, countries and growth types represented in the largest positive contributors during the past twelve months is encouraging. Equally, both long-standing holdings and more recent additions to the portfolio are featured among the top performers. This highlights the benefits of sticking with great businesses, which at times can be uncomfortable, while still bringing in exciting new ideas as opportunities allow.

When we reflect on operational performance during the past year, the majority of the portfolio can be segmented into three categories: companies that exceeded expectations, those that keep delivering, and those that are beginning to see an improvement after a challenging period. As is typical in a portfolio of over seventy names there was also a small collection of holdings that disappointed us, some of which we decided to sell and reinvest in other ideas.

Featuring prominently among the holdings that exceeded our expectations were rapid growth stocks, which weighed heavily on performance in 2022. A shift in the direction of interest rates has been helpful, but it is the excellent progress made in pivoting towards profitability that has driven the sharp rebound in their shares.

Having been loss-making in previous years amidst a period of growth investment, Swedish music and audio streaming business Spotify made a profit in each quarter of 2024, making efficiency improvements without sacrificing subscriber growth. It continued to add customers at an impressive pace throughout the year, even as it raised prices in dozens of countries.

South-East Asian ecommerce, gaming, and fintech platform, Sea Ltd, also pleased the market by reporting a profit across all of its main divisions during the most recent quarter, having been loss-making a year earlier. Sea has successfully navigated a tricky balance, maintaining its leadership in ecommerce with necessary investments, expanding its fintech business whilst keeping non-performing loans low, and generating extra cash flow by extending the life span of its popular gaming franchises.

Perhaps more surprising to some has been the incredible share price run for the longstanding holding in SAP. Having now incurred most of the cost and effort associated with adopting a cloud-based model, SAP is reaping the benefits. The shift towards Software as a Service (SaaS) supports a more efficient and higher-returning delivery of services to customers and enhances SAP's ability to cross-sell additional products. SAP is also emerging as a key beneficiary and enabler of artificial intelligence (AI). A significant proportion of new business wins in 2024 included AI use cases, whilst at the same time integration of AI tools has led to improvements in productivity.

An important feature of the International Alpha strategy throughout its history has been its exposure to unglamorous businesses that don't typically command much attention but which keep delivering consistent, above-market returns. In 2024 several companies that fit this mould featured among the positive contributors. UK-domiciled data analytics business, Experian, generated profit growth in all business lines and regions against a challenging backdrop. Like SAP it has been successfully integrating AI features into its products, allowing it to add more value to its customers and enjoy continued margin expansion. Canadian serial acquirer, Constellation Software, enjoyed yet another year of double-digit growth in revenues and profits. Lumine, a business spun out of Constellation Software and also owned in the portfolio, grew at an even faster rate. Irish buildings materials business, CRH, followed up on an excellent 2023 by delivering another year of robust profit growth. Although volumes were much weaker this year, strong pricing power compensated for this.

Although they were not all rewarded by the market during the year we saw some signs of improvement for holdings that had been on our worry list. French manufacturer of single-use devices for biologic drugs, Sartorius Stedim, is finally seeing signs that customer destocking is nearing its completion, leading to an increase in order intake. MIPS, the Swedish maker of brain protection systems used in helmets, enjoyed a strong recovery this year with all product categories seeing a pickup in demand and operating margins doubling from the previous year. Japanese succession planning advisory firm, Nihon M&A, recently reported a sharp rebound in deal flow activity and an increase in the average fee per deal. All three of these businesses benefit from strong competitive positions within large and growing addressable markets.

In contrast, we didn’t see any signs of a recovery for the Japanese skincare business, Shiseido, or the Hungarian-based low-cost airline, Wizz Air, so we decided to sell out of these positions. For Shiseido, the demand backdrop in China - its most important market - has remained challenging. More worryingly, it has lost some share to Chinese local players and doesn’t seem to have a credible growth plan. Wizz Air has suffered from a series of operational challenges and we have become increasingly concerned that it doesn't have the ability to thrive in what is a very tough industry. At the same time, it is facing increasing competition from Ryanair - a formidable business also held in the portfolio.

Our long-term approach remains unchanged, with over half of the holdings having been held for over five years. In the vast majority of cases, these keep delivering on our expectations. At the same time, we continue to sow the seeds of future returns by adding new holdings, paying particular attention to how these complement the existing portfolio. In the final quarter of the year, we took one new position for the portfolio in TFI International, a Canadian provider of road freight services that boasts an exceptional record of acquiring small businesses at attractive valuations and improving their profitability. We hope that it follows in the very successful footsteps of the other serial acquirers such as Constellation Software.

To wrap up, it would feel remiss not to make a comment on the international equities asset class that our clients allocate capital to, given its persistent underperformance relative to US equities in recent years and an increasingly consensual view that this is likely to continue. We can point to the fact that the valuation premium between US and International equities is at its highest level in over 20 years. We can also point to the exceptional companies that we invest in, many of which trade at material discounts to their US peers or face much higher levels of structural growth. The diversity of opportunities contrasts with the increasing levels of concentration within the US market.

Perhaps the most important message is that consensus narratives should be approached with a high degree of caution. We have learnt this time and again, whether it be the widespread belief that mortgage-backed securities were safe investments in the lead-up to the financial crisis in 2008 or the widely held view in the 1980s that the Japanese real estate and stock markets would continue their rapid appreciation indefinitely. In our view, international equities offer the ingredients for strong returns and the future for the asset class is bright.

Source: Revolution, MSCI. US dollars. Returns have been calculated by reducing the gross return by the highest annual management fee for the composite. 1 year figures are not annualised. 

Past performance is not a guide to future returns.

Legal notice: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

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