Innovation is not necessarily dependent on the latest tech. Rather, an innovative business is one that creates genuine value for customers by delivering a product at a lower price or a higher quality-to-price ratio than what was available before. In terms of lower price, think of Costco, which beats Walmart and even the mighty Amazon by welcoming its members directly into its warehouse premises. In terms of quality-to-price think of the ever-growing value proposition of the Apple iPhone, now a 15-year-old invention.
But not every great innovation is a good investment. A successful innovative business must capture an adequate share of the value it creates. If an innovative product is easy to replicate, then everybody does it and nobody makes any money. Think of Peloton and its copycats. As such, we only invest in innovative businesses that possess or are in the process of building lasting barriers to competition to protect their profits, and whose market valuations present significant long-term upside to shareholders.
Planet Fitness: gyms for less
Planet Fitness (NYSE: PLNT) is a franchiser and operator of over 2,000 gyms in the US. Its no-frills gym and low-priced offering are disrupting the market and bigger competitors. The average gym membership fee in the US is $50 per month and Planet Fitness’ basic membership comes in at $10. Incumbent gyms are committed to their plush facilities and associated high costs, and are simply unwilling and unable to cannibalise their higher membership fees. This gives Planet Fitness its runway to grow. The company has weathered the pandemic well in a badly affected industry, and is well positioned to capitalise on the recovery.
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Otis: on the way to the top
Otis (NYSE: OTIS), the lift maker, has recently spun out of its parent United Technologies. We love when excellent businesses spin out of poor performing conglomerates. With a portfolio of approximately 2.1 million elevator units, Otis is around 40%-50% bigger than the other three global original equipment manufacturers in elevator maintenance, which gives it opportunities to drive incremental scale advantages.
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The elevator maintenance industry has retention rates of 95%, strong pricing power and the ability to add additional customer value through innovations. This means strong cash generation, which management, relishing the opportunity as a standalone company, is busy reinvesting in growth while returning the rest to shareholders via dividends and share buybacks. Meanwhile, the stock trades at a 40% discount to lower-quality peers Kone and Schindler, and we believe it is at a significant discount to intrinsic value.
American Express: handsome rewards are paying off
American Express (NYSE: AXP) is gaining market share against the big two card networks, Visa and Mastercard, as card transactions become electronic. Digital wallets and online checkouts create a more level playing field than leather wallets. The burgeoning ranks of Amex members are increasingly focused on rewards, where the company beats the big two hands down.
As commerce shifts online, merchants are pressured to reduce payments frictions, so accepting Amex is essential. The firm is thriving even though travel remains subdued. Revenues and profitability are above pre-pandemic levels. As travel recovers it will enjoy excellent operating leverage.
