On May 29 1953 Edmund Hillary clambered to the top of Mount Everest. It was 11.30am. Hillary knew this because on his wrist was an English-made Smiths watch. It now has pride of place in London’s Science Museum. But what of the company that made it?
Today, Smiths is a multinational industrial technology conglomerate. The company that began life in 1851 by making watches for the Admiralty ended that side of its business in 1980. You are now most likely to come across its name on the side of airport security equipment scanning your luggage.
It is an important reminder of the extent to which companies can change. And a great many do. Recognising successful change can yield outstanding returns for investors.
Watching companies evolve over decades, I realise change is essential. Take the RELX group. It is an amalgamation of Reed, a newsprint manufacturing company originating in 1895, and Elsevier, a Dutch publisher that started out in 1880, printing encyclopedias. Today RELX is an information and analytics company with a large specialism in scientific and medical data.
Change is not always dramatic, but to remain relevant and profitable companies must evolve. In the digital age, the life cycle of companies appears to be shortening — they can grow faster, but they can reach maturity and decline more quickly, too.
Think of Vodafone’s history since its inception 40 years ago, when the company won the licence to build Britain’s first mobile phone network. By 2000, Vodafone had 10mn customers and its share price was more than £5. Today it has over 18mn mobile and fixed-line customers — but its share price is just over 70p. It has failed to uncover profitable new avenues in a mature, competitive market.
Change is normally a response to challenge. Companies rise and fall, but sometimes — if they make the right changes — they can rise again.
Marks and Spencer was once the doyen of British retail. Its brand was synonymous with affordable quality. But it lost its way at the turn of the century in the face of ultra-cheap, high fashion competition and the rise of online shopping. Management made a litany of mistakes — not accepting credit cards other than M&S’s own, for instance.
Then something happened. New management arrived. This year, its shares are up 73 per cent.
Change was not radical. It does not always have to be. But it was significant. M&S offers a useful case study of what to look for in a recovering stock.
New management
Management change is probably the most common catalyst for recovery, as old management can find it hard to admit that things need to alter substantially. Archie Norman, who was appointed M&S chair in September 2017, has a philosophy that new leadership teams need to arrive “like a thunderclap” to succeed.
It became immediately clear on investor telephone calls that he was acting as more than a non-executive chair. He brought in a strong board determined to take tough and sensible decisions. Other smart hires included former Top Shop fashion director Maddy Evans, who has transformed the women’s range.
But it is not just the senior people who matter. The rest of the workforce has to be ready for change as well. After nearly two decades of decline, M&S was. Covid probably helped management to accelerate its transformation plans.
Less fortunate was Dame Sharon White at John Lewis. You may disagree with her strategic decisions, but John Lewis was arguably less in desperate need of change than M&S and its staff were probably less ready to accept it. Unlucky timing can limit how decisive and bold you can be.
How can you tell if you have the right new management and the right plan? Norman’s proven record included transforming supermarket chain Asda. As fund managers, we felt that if anyone could lead this change it was him. As for the plan, cost cuts help. M&S closed unprofitable stores.
Cuts
Another of our recovery favourites at the moment is chainmaker Renold. It has struggled with debt and pension obligations, but during the past couple of years the company has worked hard to cut costs and change what the chair has described as “longstanding inefficient business processes”. With orders and returns on sales rising, the share price has bounced 35 per cent this year.
Difficult decisions become easier to execute when everyone is having a tough time. Building products supplier Marshalls has closed a factory near Glasgow and trimmed around 400 jobs.
Costs are only part of the story. Investors should also look out for a razor-sharp focus on core priorities.
Focus
M&S needed to win back its reputation for quality and value. I remember standing in M&S a few years ago, gasping at a small box of cherries costing £7. By cutting prices on basics in the food department, the company has encouraged shoppers to visit more often — and then tempted them with higher-price luxury ready-made meals.
It has shrunk product ranges. No longer are men faced with a bewildering array of trousers that look virtually identical. This has allowed M&S to increase order sizes, negotiate better deals and bring down prices.
For another fallen star in recovery mode, Rolls-Royce, focus has meant disposal of non-core businesses, including the €1.8bn sale of Spanish joint venture ITP Aero.
Buying well
You might have the right management and the right plan, but you also need luck. Readers like me to relive painful failures, too. Take Studio Retail, which started as a catalogue gift retailer and then expanded to sell clothing, home and electrical products while also supplying schools with stationery and other equipment.
After hitting turbulence, management abandoned periphery business streams to focus on the company’s online catalogue. Things seemed to be going the right way, but then Covid hit. Supply-chain issues ahead of Christmas 2021 meant customer demand could not be met at the busiest time of the year. Studio Retail folded with £30mn of debt and was bought by Mike Ashley for £1. It is a reminder of why you should not put all your money behind a recovery story. Diversification is vital.
Timing
The opportunities in recovery stocks come from recognising positive change is afoot before the rest of the market does but timing the bottom is difficult. Sometimes recovery happens faster than you expect. It has with Rolls-Royce and M&S. If you have a great idea as an investor, act on it — they are too rare to ignore. If worried about timing, build your position slowly in dips in the price over time. Be prepared to be patient, too.
Restoring a company’s reputation can take time. Archie Norman and his team had a mountain to climb at M&S — the commercial equivalent of Everest. The company is still to surmount all its challenges six years on, but it is way beyond base camp. Its customers are returning. So are shareholders. About time.
James Henderson is co-manager of the Henderson Opportunities Trust, Law Debenture and Lowland Investment Company.
