Understanding how a small company meets the challenge of growth is a fine art. John Wilson, an equity analyst and member of the team that oversees the 5-star, gold-rated $2.5 billion Mawer Global Small Cap A, argues that it’s particularly useful to focus on those companies that have decentralized operating structures in order to manage their growth.
“One of the things that we talk a lot about here is being in ‘the right part of the forest.’ That basically means lining up several attributes that put the odds in your favor,” says Wilson, who is based in Toronto, although Mawer Investment Management Ltd. is based in Calgary. “The base line is around management and having a good business model. Included in that [framework] is that a decentralized structure can be helpful. It is not a silver bullet. But it can be a component that helps with [completing] the formula.”
Referring to “Drive: The surprising truth about what motivates us,” a 2010 management bestseller by Daniel Pink, Wilson notes that employees are motivated by three job characteristics: autonomy, mastery and higher purpose. “A decentralized structure can allow employees to experience these things. They can impact your culture, which is one of the things we look at when we evaluate companies.”
Wilson hastens to reiterate that having a decentralized culture is not a guarantee of higher profits and better share price appreciation. “It’s simply one of the components within management that can help you find investments that will do well over the long term,” says Wilson, noting that picking stocks that trade at a discount to intrinsic value is equally important.
Looking closely at decentralized companies, Wilson points out that aligned incentives is one of the hallmarks of successful firms. “Employees are encouraged to be aligned with a company’s goals. In addition, these firms have oversight systems that track performance at the individual unit level and ensure that units are performing well,” says Wilson, a native of Chatham, ON who joined Mawer in 2012 after he graduated with a bachelor of business administration from Wilfrid Laurier University. Wilson works alongside co-managers Paul Moroz, chief investment officer (CIO), deputy CIO Christian Deckart and equity analyst Karan Phadke.
Sharing best practices is also common to decentralized companies that reduce duplication and waste. “They share knowledge across their business units. That’s another component we look for.” One of the key advantages of decentralized companies, Wilson adds, is that they can make quicker decisions and are not hampered by cumbersome bureaucracy that affects larger companies. This will result in a more motivated work-force.
The portfolio has about 70 holdings, spread across over 20 countries. One favorite name is Freightways Ltd.(FTWYF), a New Zealand-based courier services firm that operates at home and Australia and allows its units a high degree of autonomy. “Each branch is compensated based on its own profit and loss. They really encourage their employees to think like entrepreneurs,” says Wilson, noting that the firm was launched in 1964 and has 3,000 employees.
“Over the last 10 years Freightways has been able to grow 6% per annum. While they pay out 70% of their net income, and require little capital, they’ve paid a 4% dividend yield over that period. In that time, the stock has compounded at about 15% per annum.”
Acquired in 2017, the stock trades at 17.5 times forward earnings and pays a 4.2% dividend.
Another top holding is Rotterdam-based Amsterdam Commodities N.V. (ACNFF), a firm that acts as a middle-man between producers of spices and nuts and large food processors. “They ensure the high quality of these ingredients and can actually trace back who produced the nut or spice and whether any pesticides were used, for example. ACOMO helps the end-customer with traceability and high quality,” says Wilson, noting that the firm operates throughout Europe and North America and has a market-cap of about EU450 million ($680 million).
From an operational stand-point, ACOMO is divided into 10 units, each with its own chief executive officer who makes decisions for the unit and reports back to head office in Rotterdam. “The units are incentivized based on profitability. But the company goes one step beyond that. When the units need to invest in new equipment or a factory, the head office tells them, ‘We’re going to charge you for that investment.’ This creates a mentality that this capital must generate a certain amount of return. The units must overcome a hurdle to get the support.”
Acquired in 2011, the stock has generated a 14.6% annual return. It trades at 13.6 times forward earnings and pays a 6.2% dividend.
Another example is Bravida Holding AB, a Stockholm-based supplier of electrical and plumbing services to contractors and construction firms. “This business model revolves around the idea that you want your plumber or electrician to be close to your job site. If there are issues, they can respond quickly. Each branch only serves about 1-2-hour radius. This is attractive because it limits the number of competitors in their area,” says Wilson, adding that branch managers are compensated based on profitability.
Employing 11,000 people, the firm also benefits from the advantage of scale when it makes bulk purchases. The CEO can look down at the employee level, notes Wilson, and see who is using the system to purchase materials, and who isn’t. “He’s found that there are some instances when certain types of project require a part immediately and they can’t wait. This provides a natural feedback mechanism and exerts some social pressure to help improve profitability,” says Wilson. “The CEO might call you and ask, ‘Why aren’t you using the system?’ This is a great way to align employees with the company.”
Acquired in 2017, the shares have generated a 16% annual return. The stock is trading at 12.8 times forward earnings and pays a 2.5% dividend.
Looking ahead, Wilson is reluctant to make a market call and prefers instead to focus on businesses that have strong management teams and competitive advantages and are trading at reasonable multiples. “We pay attention to the market but prefer to focus on what really matters over the long term,” says Wilson. “We partner with good management teams and companies that have competitive advantages. Decentralization is one of the things that we consider---along with purchasing stocks that are trading at a discount to their intrinsic value.”
