The Velox investment process in action
The Velox investment process uses a suite of signals to generate ideas on securities that match repeatable market behaviours with a goal to identify idiosyncratic returns. We then use a 5 lens approach to build conviction and appropriate sizing on the ideas proposed by these signals. The 5 lenses are Fundamental, Technical, ESG, Sentiment and Catalyst. The Velox ESG Lens We believe that for any company to deliver long-term, sustainable, value creation it needs to consider all stakeholders. Our ESG lens identifies companies that are leaders and laggards in their interaction with its stakeholders. The benchmark to be classified as high quality in today’s world is expanding, to include companies with strong sense of community and efficient operations to protect the limited resources in our world. Therefore, ESG issues have the potential to influence returns meaningfully over the short, medium and long term, and we recognise the importance of a formalised approach towards evaluating them. Using a proprietary industry specific materiality map, we have created a Traffic Light System that identifies those ESG leaders and laggards. A practical example | Air Liquide SA Let’s look at an example. Air Liquide SA, through its subsidiaries, produces, markets, and sells industrial and healthcare gases, including liquid nitrogen, argon, carbon dioxide, and oxygen worldwide. The Company also produces welding, diving, and technical-medical equipment. Air Liquide sells its products throughout Europe, the United States, Canada, Africa, and Asia. Air Liquide has been a key holding in the Velox Portfolio through 2021-22. In November 2021, Air Liquide caught our attention as it saw a gap down as it opened considerably lower than the previous closing price on no specific news. Sentiment for the security hadn’t changed as there were no new additional short positions entered on the security. The security was still relatively underweight and not very commonly held. Technically the stock had not reached relative overbought levels, but an impending announcement of a new CEO was being a drag on the security. We decided to do a deep dive into the security to see if it could fit our investment case through our fundamental and ESG lenses. Fundamental Our research analyst was quite bullish on the stock. The security had a good growth at reasonable price profile with compounder characteristics. She liked the defensiveness of the security due to its earnings resilience and pricing power due to industry structure, a characteristic very important as we were heading into an inflationary paradigm. A key peer had seen much stronger outperformance and was trading at a 20% premium which showed the valuation discount of Air Liquide. The stock started looking very attractive fundamentally and all that was left was to make sure there are no ESG risks. ESG A starting point for our ESG analysis on the company was its traffic light colour. Rated Green in our traffic light system, it indicated that the company is a leader compared to its peers on the material metrics for companies in the industrial gases subsector of chemicals. Environmental Toxic Emissions and Waste: Given the chemicals industry releases a lot of toxic waste as a result of its operations, it is quintessential for a leader in the industry to have best practices on managing the waste. Especially for a company like Air Liquide, which operates in the French jurisdiction where the compliance costs and liabilities associated with damaging health and property can be substantial. Air Liquide has exemplary practices to manage its toxic waste. It has an ISO 14001 Environmental management system, a leading percentage of sites with the Hazwoper certification, and recorded evidence of environmental audits across all locations of operations. It also has very low emissions per dollar of revenue compared to its peers, highlighting the leading nature of its policies and practices. Social Health and Safety: Another material metric for chemicals as it opens the company to production disruptions, litigation, and liabilities through accidents in the production facilities. Given that the industry relies on skilled workers it is imperative to manage the health and safety risk of them.
Air Liquide again came up top in the space. Its health safety systems are certified to OHSAS 18001 and has evidence of the same. It has a sustainability committee which manages the H&S strategy and performance together with a dedicated H&S task force. The policy even applies to its contractors.
Governance Pay: Using our framework, the company ranked in the top quartile (1) in its pay practices. It has strong pay and performance alignment policies and is an industry leader in its adherence to share ownership obligations. Board: The company also ranked in the top quartile in board practices as the board appears to be well organised to provide strategy oversight for management, has an independent majority and is diversified. The board membership is also timely reviewed and there are no overboarding risks. Accounting: The company ranked in the 2nd quartile in accounting as it has some concerns regarding asset-liability valuation ratios. Our analyst conducted a deep dive and whilst quantitively the numbers were worse than their peers, given the capital structure of the company, we were comfortable with the levels. Ownership Structure: The company ranked in the 2nd quartile, but the performance was at the 74th percentile i.e. very close to being top. Overall, our analysis showed that the ESG profile of the company was very strong and there were no-to-low risks from this space. Combining this with a defensive proposition, good discount to peers, good sentiment and a catalyst in the form of a CEO change, gave us good conviction in the stock.