Fund Manager

Why Nikko likes 'picks and shovels' and the ASX name that fits the bill

Wed 15 Mar 23, 9:04am (AEST)
Expert Insights PrimaryYoutube (18)

Key Points

  • Inflation remains a concern, but supply chains are normalising
  • Fulton takes a long-term view and prefers companies providing infrastructure
  • Worley is a favorite in the energy space due to the coming energy transition

This article was first published for Livewire Markets on Wednesday, 15 March.

I recently sat down with Iain Fulton from Nikko AM to discuss his background, the team's investment style, how he and his team are seeing markets right now, and some of the burgeoning opportunities he is pursuing.

In this wide-ranging interview (this wire being part three of my conversation with Fulton), we talk about inflation, taking a long-term view, why Fulton focuses on the picks and shovels, and why he likes Worley (ASX: WOR) so much.

Previous wires in the series can be viewed via the links below:

Expert Insights EDM (5)
Iain Fulton, Nikko Asset Management

Inflation - where are we now?

When talking to the journey of inflation, Fulton notes that it has taken longer for it to moderate than he expected, but the direction now seems fairly clear.

It has run on for a few more months, or a couple of quarters longer, than we perhaps expected. But the direction of travel now I think is fairly clear. Supply chains are normalizing," says Fulton.

While inflation is now moving in the right direction, Fulton remains concerned about the destination. Increasingly there is this idea of "no landing", a scenario that sees inflation settle at a level higher than previously thought, and perhaps higher than central banks would like.

“We are concerned about where [inflation] settles longer term. And we know that inflation's coming down and will probably continue to come down for the balance of this year, but it's how that translates into labour markets in particular," he explains. 

Fulton goes on to point out that normally, if an economy goes into recession, you also see a significant increase in unemployment, and that “typically takes care of your inflation problem over time”. We are yet to see a significant uptick in unemployment, however, and the market is grappling with what the ultimate outcome could be.

I think we're moving in the right direction from an inflation point of view but the Fed, rightly, are signalling that they're going to do what it takes to try and get things back into a normal range.

The question is whether that normal range is what it was before, 1-2%, or whether we need to live with something that's very slightly above that. And that means a cost of capital that's slightly higher for the equity market over time. 

A longer-term perspective

While the market, as Fulton puts it, is feeling its way in the dark at the moment, he remains comfortable zooming out and taking a longer-term view.

It could be due to his formative years as a historian, but Fulton is always mindful of the bigger picture. That being the case, he and his team have gone back and analysed the market cycles all the way back to 1929. The data pre-the 1950s is a little patchy, according to Fulton, so they focus heavily on the period from the 1950s onwards.

“So, it's 70-odd years of data and between 1957 and today, you've basically got 11 market cycles. And, if you take from the bottom of the 20% or more drawdown, to the top of the next peak, that would be one market cycle… and so we've had 11 of these since 1957," he says. 

And what you see is that if you were leadership, if you were the best-performing industry in that up-cycle, then it is almost certain that you won’t be the leader in the next cycle.

It has only happened once out of the 11 cycles, i.e. the leadership has been repeated. 

"So I think it's a big assumption to make that technology would be the leading industry and that shapes the next kind of long-term bull market," Fulton says. 

He adds that the evidence of how much capital was thrown at new business formation in 2021 - a trillion dollars; more than three times the normal level - suggests that there was an excessive level of investment.

So we're interested in areas that have been starved of capital, that have not been over-invested, have got a shortage of skilled labour, or there's a capacity constraint.

Picks and shovels

Throughout the conversation with Fulton, it is made clear that he and his team favour companies that provide the ‘picks and shovels’ to the industry in which they operate.

In a previous wire, he spoke about Danaher (NYSE: DHR), a medical company that provides the infrastructure for new drug development. In the travel space, he spoke to Amadeus (AMS.MC), which provides the engine for bookings on airlines and hotel systems. And in the energy space, Fulton highlights local player Worley (ASX: WOR) as a favourite – which we will discuss more in a moment.

When asked why he likes ‘picks and shovel’ type business, Fulton is clear.

Those kind of picks and shovel business take some of that risk away from who is ultimately going to be the winner. And at the end of the day the activity level's going to rise, and these companies should see a good size benefit from that. 

While still trying to pick the best opportunity, Fulton and his team are mindful that what they are also trying to capture is a bigger trend. In the cases listed above, those trends are an ageing population, a recovery in travel, and underinvestment in energy and the coming energy transition.

Energy transition and the local hero

As discussed in the previous wires with Fulton, energy transition is one of the major themes he and his team are focused on, as it leverages the idea that today’s underinvested areas will spawn tomorrow’s winners, while today’s overinvested areas won’t.

Putting it more succinctly, Fulton doesn’t pull any punches: 

Simply put, it's more important how we power our economy, than which video streaming service we use, or how we chat and communicate with our friends, or even how we communicate at work.

That’s hard to argue with, and Fulton believes that how we power the global economy will be the “debate and the driver which will potentially dominate the next decade”.

With that as his base case, and with 17% of the portfolio invested in this theme, Fulton highlights a local company, Worley, as a potential winner in this space.

In spelling out the case for WOR, Fulton makes two salient points.

First and foremost, he reiterates the capital cycle theory and the underinvestment in oil and gas over the past decade and comments that;

There's a real clarity to get from where we are today, in terms of our energy mix, to where we want to be tomorrow. We need to have sustainable, secure supplies of oil and gas to enable our economies to function efficiently.

Fulton and his team believe that the boost seen in commodity prices recently will prompt a significant response in terms of capital expenditures – something that was already starting to happen in 2022. While that is a rising tide that could lift all boats, Fulton sees the interesting area being “around sustainability spending and the opportunity for companies like Worley to move into an expanding addressable market”.

Expanding on the total addressable market, Fulton notes that as well as the traditional engineering expertise that would be deployed to oil and gas projects, there is now the construction of renewable projects to reduce emissions across a whole range of industries as well.

We think there's opportunity in that sustainability spending, for Worley to really capitalise on the large scale of projects that are going to come into reality over the next few years. And that represents a step change in their growth profile and should give them good pricing power. 

Ultimately, engineering expertise globally is going to be in much higher demand, which is something that Fulton notes is already being observed in the consulting area at the moment. That consulting will eventually convert to large-scale infrastructure projects and include engineering and production phases.

Fulton sums it up by saying that the opportunity looks pretty attractive over the longer term, given that there is now a much clearer idea of how much work there will be available for Worley as the world transitions. Throw into the mix that the stock is still priced as cyclical, yet boasts “fairly robust earnings and a cash flow outlook over the next couple of years, if not longer”.

I think Worley should stand to gain a good amount of their share of that over time.


Written By

Chris Conway

Managing Editor

Chris is the Managing Editor at Livewire Markets and Market Index. His passion is equity research, portfolio construction, and investment education. He is also very keen on the powerful processes that can help all investors identify great opportunities and outperform the market, and wants to bring them to life and share them with you.

Get the latest news and insights direct to your inbox

Subscribe free