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Finding value in the intricacies of industrial distributors
Unlocking the investment power of distributors in the industrials sector can be lucrative if you know what to look for, says Fidelity's Vince Montemaggiore.
- Although distributors are often thought of as unsophisticated intermediaries that lack pricing power and can be disintermediated over time—which can be true in some instances—Fidelity's Vince Montemaggiore believes others possess attributes that allow them to rise above the competition and create value for shareholders over time.
- "First and foremost, when assessing stocks in this category, I prefer to invest in distributors that sit in the middle of complex transactions, with fragmentation on both the supplier and customer sides," explains Montemaggiore, portfolio manager of Fidelity Advisor® Overseas Fund.
- In managing the diversified international equity strategy since 2012, he favors companies with a unique business model that can generate a sustainably high return on capital through a full business cycle and trade at a discount to their intrinsic, or fair, value.
- This approach partly explains his preference for distributors that boast complexity in the form of order size, customization, new geographies, speed to market, product knowledge, and consultation.
- A distributor possessing one or more of these attributes, Montemaggiore believes, is more likely to grow in excess of the broader market, given the tendency to gain a greater share of its customer's wallet.
- "In fact, I would underscore that the distributors I favor sell a product where the price is opaque and cannot be easily shopped around," he contends.
- This helps distributors pass on more price than their cost of goods sold during times of inflation, while also enabling them to give back less during times of deflation, observes Montemaggiore.
- "Although it's perfectly fine to invest in a distributor selling underlying products that are cyclical, ideally as an investor you want an end market that grows from business cycle to business cycle," he says. "Furthermore, distributors can be a safer way to invest in a secular trend because you don't necessarily have to be right on which specific product or supplier wins, since in many cases the distributor works with all of them."
- What's also important to keep in mind, he remarks, is that many distribution-based industries remain highly fragmented, allowing the big to get bigger through the competitive advantages of scale, reach, and technology, which, in turn, can prompt suppliers to consolidate their accounts.
- Additionally, he mentions that when you combine a strong distribution business model with an ability to acquire smaller players at attractive prices, the results can be very powerful.
- As of October 31, the fund held several distribution businesses with the characteristics Montemaggiore covets, including IMCD Group, Azelis Group, Diploma, Ferguson, Indutrade, and Addtech.