Investors tend to think of the US as a single economy. They forget that in many ways it is much closer to the European Union, a federation of states, but without all the EU’s different languages. Interesting opportunities arise once investors recognise this, especially at the moment.
Americans pay three sets of taxes: local, state and federal. Historically, if you lived in a high tax area, you could offset the local and state charges against your federal tax bill.
In 2017, Donald Trump limited that deduction to $10,000. The fact that the limit has most hurt those living in the wealthier Democrat-governed states was purely coincidence of course.
Democrats are fighting to repeal the cap, but in the meantime, it is having an interesting effect, particularly in the American small- and mid-cap arena. The US is the world’s most entrepreneurial country, and it is in this space that you will find some of its most exciting companies.
Trump’s fiscal legacy
Trump’s law creates a competitive advantage for Southern states, including Texas, Florida, Georgia and the Carolinas, which tend to be jurisdictions with low taxes.
Many technology companies are now moving significant operations to these states, bringing with them jobs – lots of them – for young and highly qualified professionals.
Take Florida, for example. Residents are not subject to state income tax, whereas in New York the highest earners can pay nearly 11%. Taxes on death are significantly lower, too, as are property prices and living expenses.
Since 2017, Florida’s population has grown by over 850,000 to nearly 22 million and New York State’s population has declined by nearly 600,000 to just over 20 million.
This shift is creating opportunities for a number of companies we hold. One example is Pinnacle Financial Partners, a commercial bank with a strong footprint in the Southern states of Tennessee, Georgia, the Carolinas and Virginia.
Pinnacle has been opening new offices and offering its services to the businesses that are moving south or setting up there. The banking sector tends to grow in line with the economy – pretty slowly. However, because of its business model and location, in the past quarter Pinnacle has seen growth year on year of over 15%.
It was set up in 2000 by a group of bankers in Nashville who quit their jobs at a much larger bank that was going through a merger. Since then, they have hired similar groups of disaffected staff from the big banks, most recently in Atlanta.
Pinnacle offers a high service model, favoured by commercial borrowers. Unusually for a financial institution, it achieves high satisfaction scores from customers at levels you usually only see among companies selling popular consumer products. The combination of this business model and being located in a part of the economy that is expanding quickly has produced growth well ahead of its industry’s averages. Its most recent figures show that Pinnacle’s loan book has seen a 15% growth in loans year-on-year.
A very different example is Pool Corporation (Poolcorp). This is the world’s largest wholesale distributor of swimming-pool products. That means chemicals, filters pumps, ladders and everything. It distributes more than 200,000 national brand and private label products from over 2,200 vendors.
The business is prospering from the population’s growth in warmer Southern states. It has also benefited from the wider shift to working from home, which encourages more people to sit at their kitchen desks, look across the garden and dream wistfully of installing a pool.
Poolcorp is one of the biggest providers in the business. This is important. Even in the South most people will close up their pools for winter, but as soon as the sun returns, they will eagerly pull back the cover and discover the water is green. They will call the pool maintenance company and learn that the pump is broken and several parts are needed. And they will want them quickly.
These contractors are busy and know they can get everything they need from Poolcorp, so they don’t need to ring around lots of suppliers. This is where they inevitably take their business, which gives Poolcorp pricing power, which is useful at a time of inflation.
Since its initial public offering (IPO) in 1995, Poolcorp has generated a compound average annual return of over 26% for shareholders.
Poolcorp’s size relative to its competitors was particularly beneficial in 2018, when the tariffs imposed by Trump’s government produced significant inflation in raw materials, such as steel and chemicals. The company was able to use its financial strength to increase its inventory significantly in advance of these price increases, giving it a competitive advantage.
Finally, like lots of companies with a leading position, Poolcorp is the distributor that suppliers prioritise when there are shortages and logistical challenges.
A third company that has enjoyed the population shift in the US is Advanced Drainage Systems (ADS), which is a manufacturer of durable wastewater pipes. It estimates that over 10 billion feet of its corrugated plastic drainage pipe is in service around the world.
ADS has benefited from the southern boom in housebuilding, as well as the need for piping to replace crumbling concrete and poisonous lead pipes across the country.
As the biggest manufacturer of these pipes in the US, ADS has volume advantage when purchasing the plastics and, increasingly, recycled materials that go into producing their pipes.
None of these companies are exciting. They don’t offer the glamour of tech companies, but they are exploiting the geographic shift in the US population, growing strongly and delivering good returns for shareholders.
Cormac Weldon (pictured above) is manager of the Artemis US Smaller Companies fund, which has returned 58.8% over three years compared to a sector average of 41.8%. Over five years it is up 154.2% versus 93.1%.