Gary Channon Long Easyjet: London Value Investor Conference

We're posting up notes from the 2017 London Value Investor Conference.  Next up is Gary Channon of Phoenix Asset Management who pitched a long of Easyjet (LON: EZJ).


Gary Channon's Presentation at London Value Investor Conference

Phoenix is a UK focused fund that since inception in 1998 has returned 12% annualised vs the 4.9% for the UK benchmark.

Long: Easyjet (LON: EZJ) 

There is an intrinsic human desire to travel. GDP per capita and the cost of travel drive the overall market. Air travel has been doubling about every 12 years. Yet airlines have been terrible businesses except for Southwest Airlines in the US. The Southwest model has been copied by both Ryanair’s and Easyjet’s founders.

It is often assumed that Ryanair and Easyjet are competing. Ryanair is thought of as the low-cost producer and to be more effective than Easyjet. Channon argued that the two airlines have different strategies and are not competing. They do not fly the same routes – there is only 4% overlap. This is not an accident but a deliberate strategy. Easyjet takes customers from convenient airport to convenient airport. Ryanair is low cost - inconvenient airport to inconvenient airport. Both companies produce a similar return on capital.

Easyjet has a moat which is underappreciated by the market. The moat is derived from the slots it owns. The slot is the right to take off and land at a certain time on a certain day. The slots are regulated by quasi-legal international conventions referred to as Grandfather Rights. The slots belong to the airlines not the airports. A slot can provide pricing power if it is at a sought-after airport where demand outstrips supply. The lack of runways in the UK and Europe and the failure to build new ones guarantees a shortage of supply. Because of the value of slots airlines tend to be against the expansion of runways while the owners of airports tend to be supporters.

The slots provide a barrier to entry as people’s propensity to switch airports is limited. Only 20% of passengers are prepared to add an extra hour to their travel if they are on a short-haul European flight. Easyjet’s real competitors are those who fly the same routes from busy airports - mainly British Airways and Air France but certainly not Ryanair. British Airways and Air France are not strong competitors to Easyjet because they have structurally higher costs due to pension schemes, staffing costs and culture. This creates an environment in which Easyjet will keep expanding, gradually taking the flag-carriers business.

Channon estimates that three-quarters of Easyjet’s business is protected by a slot-constrained moat. This provides pricing power and high returns.

The opportunity for Phoenix to invest in Easyjet came about because of Brexit. Channon said he thought Brexit was a non-event for Easyjet. It does not change the competitive landscape and Easyjet will get a European license. Phoenix bought their Easyjet stock 9 months ago. Channon said he would not buy today but would wait for the price to fall below £10 per share (the stock is trading at around £13.80).


Be sure to check out the rest of the presentations from the London Value Investor Conference.

Gary Channon's Presentation at London Value Conference: Long Glaxosmithkline

Continuing our notes from the London Value Investor Conference 2013, the next speaker is Gary Channon of Phoenix Asset Management.  He talked about portfolio construction and presented a long idea: Glaxosmithkline (LON:GSK).


Channon's Investment Approach

Gary Channon is strongly influence by Warren Buffett and Phil Fisher. Phoenix is long-term, focused,  looking for great businesses run by shareholder aligned managers, companies with strong pricing  power, generating a high returns on capital. In short, they look for long-term greats.

The Phoenix  portfolio usually has around 15 stocks with the top 5 making up >60%. All the stocks are UK listed.  They carry out detailed research with extensive fieldwork and monitoring. Since inception in 1998  Phoenix has returned 9.6% net annualised or 290% in total. On a total return basis the UK market  has returned 4.6% per annum during the same time period. Phoenix have a high win/ lose ratio with  78% winners against 22% losers.

Channon talked about “Finding Opportunities in Flawed Heuristics”. A heuristic is a mental shortcut  that allows people to solve problems and make judgements quickly and efficiently. Channon argued  that investment heuristics like P/Es, price to book and EBIT lead investors to oversimplify and  misunderstand companies. At times these commonly used heuristics fail to identify stocks that are  really cheap creating opportunities for informed value investors.

Channon used the homebuilder, Barratt, as an example of how heuristics can fail. Historic cost  accounting creates a distorted picture of homebuilders in a rapidly rising or falling housing market.  The financial crisis wiped out IFRS earnings and made book value different from cost or market  value. No earnings and an unfathomable book value left the market without its usual heuristics of P/  E and P/BV which in turn led to the stock becoming cheap.


Long Idea: Glaxosmithkline (LON: GSK)  

Channon noted that the orthodox view of big pharma is that pricing power is being lost due to  patents expiring and therefore companies deserve to trade on a lower multiple than they did in  years gone by. Channon argued that this was a faulty heuristic.

Phoenix’s research on the pharmaceutical industry indicates that the pharma industry is not  prone to creative destruction with open competition leading to lower prices, rationalisations and  bankruptcy. Instead Channon painted a picture of pharma as being a cosseted sector, with high  profitability, little cut throat competition and little change. The time horizons in pharmaceuticals  are very long. All the big companies are at least 90 years old. It is hard for new companies to break  into the large pharma sector. New products take 10-12 years to develop. Companies tend to keep a  stable market share over time.

Glaxo has kept a steady market share at 5% for 30 years. You get stability and high returns due to  industrial scale, not new drug development. Channon argued that patents are irrelevant to the long-  term investor. National health care spending is much more predictive of profitability than the drug  pipeline. Health care spending tends to go up over time as a proportion of GDP.

Channon likes the Glaxo management particularly the CEO Andrew Witty. He believes that Witty  has successfully changed the culture with the company becoming genuinely socially responsible. For  example, Glaxo is working with the Bill and Melinda Gates foundation, they are open with their drug  test data and they are making some drugs available for free in poorer countries.


Book Recommendation

Alfred Chandler’s Shaping the Industrial Century – Channon said the book  is a great introduction to the chemical and pharmaceutical industries.


Be sure to check out other investor presentations: notes from the 2013 London Value Investor Conference.