Underappreciated improving fundamentals – conviction beyond the cycle


Opportunities arise when the market is slow to recognise changes in strategic, cyclical or competitive dynamics that improve the fundamentals of a business, particularly where it has a history of value destruction. Our structured investment approach and long-term horizon allow Northstar to identify such opportunities and support superior returns over time. Goldman Sachs and Accor are two underappreciated companies in our Funds that stand to benefit from both improved financial performance and a rerating as the market factors in recent changes to their business models.

Northstar Asset Management’s bottom-up research process focuses on identifying companies whose investment fundamentals are underappreciated and therefore undervalued by the market. Such investments create an opportunity to benefit from changing perceptions and the subsequent rerating of these companies in addition to growth arising from improved financial performance.

Sometimes, these opportunities are discovered through a revised assessment of the potential competitive advantage period for a company that is considered to be a perpetual value destroyer, but which, through strategic, cyclical or changing competitive dynamics, is able to improve returns and establish a competitive advantage not previously appreciated by the market.

Goldman Sachs and Accor are two notable examples held in our funds that have improving characteristics, but that remain meaningfully undervalued by investors. Both are strengthening their competitive advantages through strategic initiatives focused on business models that are capital light and deliver durable returns, with a shift toward sustainable and less cyclical earnings profiles.

Goldman Sachs – achieving and exceeding ambitious goals

At its first ever investor day in January 2020, Goldman Sachs outlined clear and ambitious goals to reach mid-teen returns on equity (ROE) over the long term from a starting point of 10%. Banks have rarely been able to beat their cost of capital on a sustainable basis and as a result the market refused to credit these targets when valuing the group.

Companies like Goldman Sachs with emerging moats are often overlooked by investors as the cyclical narrative tends to dominate investment fundamentals. We discussed our investment thesis and the group’s targets in some detail in our Q2 2020 Quarterly Report. Fast forward almost 2 years and Goldman Sachs is well on its way to achieving and/or exceeding its targets and pivoting the business model towards higher, more sustainable ROEs. In a short period of time, it has demonstrated its ability to execute on its strategic initiatives and achieve its overarching goal of delivering higher, more durable returns. It did so by leveraging its strong brand franchise to strengthen its core, operating more efficiently and expanding into more consistent fee-earning areas. These include third-party alternative asset management, transactional banking, wealth management and consumer banking.

Chart 10: Return on equity improvements drive subsequent price-to-book re-rating

Source: Capital IQ (Date: December 2019 to November 2021 )

The faster than expected rate at which Goldman Sachs has been able to improve its competitive advantage is testament to its strategy, execution and ability to leverage its strong brand franchise. As a result, the market has rewarded its improving competitive position with the share price reaching a high of US $424 – almost double its pre-pandemic levels. Despite this strong rise, it still trades at a 25% price-to-book discount to close peers JP Morgan and Morgan Stanley, a testament to its strong financial performance. As the change in strategy continues to drive improved financial performance and more stable revenues, there remains further upside to Goldman Sach’s valuation.

Accor’s shift to an asset-light business model has yet to be rewarded

As the leading hotel group outside the US, Accor is attractively positioned to benefit from the ongoing recovery in travel, but its positive strategic initiatives and cyclical dynamics have yet to be rewarded by the market. In addition, the group’s recent shift to an asset-light business model and improving industry structure point to an underappreciated strengthening of its competitive advantage.

Hotel groups have increasingly been moving to asset-light business models to increase exposure to the more favourable components of the inherently cyclical travel industry through lucrative fee-based management and franchise agreements, while moving away from the capital heavy, illiquid property market. Additionally, brand scalability allows for expansion with near zero capital.

This favourable growth story is augmented by a structural realignment towards branded hotels. While the pandemic has disrupted travel, it has arguably strengthened the value proposition of branded hotel groups to both guests and hotel owners. Guests are increasingly booking directly, benefitting from best rate guarantees, free perks and flexible cancellation, while hotel owners are attracted to the broader customer base and the expertise available from hotel brands to keep the doors open.

Accor lagged US peers in the move to an asset-light business model, only announcing a successful transition at the end of 2019, just before Covid-19 hit. The strength of the group’s new operating model is yet to be proven in normal operating conditions, but lessons from peers suggest fundamental improvements to operations. Accor is also best positioned to benefit from the structural shift to brands, with leading scale and a growing loyalty programme in markets currently dominated by independents.

Chart 11: Hotel peers share price performance (based to 0)

Source: Capital IQ (Date: January 2019 to November 2021)

The market disagrees. Of its largest asset-light peers – Marriott, Hilton and IHG – Accor is alone in lagging pre-pandemic price levels. Consensus EBITDA forecasts suggest Marriott, Hilton and IHG will exceed 2019 earnings by 2023 (2022 in Hilton’s case), while Accor is expected to lag until 2024. Predicting the exact timing of the recovery of travel outside the US is impossible, and Europe has so far lagged the US, but the ongoing recovery in revenue per available room, unit growth and permanent cost savings at Accor suggest that the market’s valuation of the group is far too conservative and implies a vast mispricing of the strategic improvements and newfound resilience.

Market volatility following Covid-19 created opportunities

The pandemic created a dislocation between price and underlying value that offered Northstar an attractive entry point to these opportunities, with an adequate margin of safety to mitigate potential execution risk. The market cycle has done most of the heavy lifting to date, with further strong performance expected from strategic shifts and improving fundamentals that continue to be unappreciated by the market.

Airbus, Blackstone, Marriot, JLL and Schwab are other examples of underappreciated companies exposed to cycles that have been positive contributors to returns in Northstar Funds. It can take time for investors’ perceptions to catch up and fully appreciate the value in such companies. Northstar’s rigid investment framework and long-term horizon allow us to identify and take advantage of these opportunities to deliver superior returns over time.