Tapping into Exaggerated Demise and Underappreciated Growth

By
Henry Polkinghorne,
User

Henry joined Platinum in April 2019 as an Investment Specialist.  Prior to this, Henry worked at Goldman Sachs where he held the position of Executive Director, Australian.. More

09 Nov 2020

As a thematic investor, Platinum looks for opportunities where others are not - in the assets being left behind and not where we see ‘bubble-like’ valuations.

Key themes in our portfolios currently are a combination of exaggerated demise (semiconductors or travel) or underappreciated growth (Chinese consumers and healthcare, two areas where we believe we have a structural edge through experience and expertise respectively). We delve into each theme below.

1. Booming Chinese consumption

Andrew Clifford, CIO and CEO, has been looking at Asian stocks since 1989.  It has been the largest geographical exposure in the global equity portfolio since 2014. What does the growing middle class in China actually mean? Some numbers around the cohort’s growth show the exciting investment opportunities, driven by internal Chinese demand and hence somewhat shielded from geopolitical tension.

The McKinsey China Consumer Report 2020,[1] noted that in 2010, of the 800 million urban population in China, 92% only had enough money to cover basic needs like food, clothes and housing (disposable income below A$28,000). Today, more than 50% are living in relatively well-to-do households (with annual disposable incomes of A$28,000 - $60,000). This is a huge lift in disposable incomes, and what consumers desire most with their new-found wealth include eating better, looking more beautiful, a better home, mobility/connectivity, wellbeing, luxury and having more fun.

Having more fun is expected to be a significant growth area for the Chinese consumer over the next decade. This includes going out to eat, trips out of town, video gaming and sports - a thematic we are exposed to via Anta Sports Products and Li Ning.

In 2007, 100 million people actively participated in sports activities in China and the state council expects that number to grow to 500 million by 2025 (i.e. 10% annual growth). In 2011, only 400,000 people in China took part in marathons and running events and that number (until COVID-19 hit) was on track to reach 10 million this year (i.e. 40% annual growth). While running a marathon may not be everyone's idea of “having fun” it is extraordinary growth in sport.[2]

This sports boom underpins our investment in Anta Sports. Anta is the largest domestic sportswear company in China.[3] Chinese customers allocate just 9% of their apparel and footwear budget to sportswear, much lower than 19% in other Asian markets. Closing this gap drives a growth cycle beyond the 2022 Winter Olympic Games (to be held in China).  We expect Anta to benefit as the national champion of sportswear, and drive a doubling of earnings in the next three years, with further potential upside from the recent acquisition of Finnish company, Amer Sports.

Li Ning is another Chinese sports apparel business that competes with the likes of Nike and Adidas. Li Ning was established by its namesake, who won a gold medal in gymnastics at the 1984 Los Angeles Olympic Games. The brand was the “original” domestic sports brand, but struggled for a number of years in what has been a torrid competitive environment. Improvements in product design and a refreshed brand has seen the company turn its fortunes around, resulting in a strong improvement in sales and profits. Given the deterioration in US-China relations, we think that Chinese consumers will show a tendency to move toward brands with Chinese heritage in the years ahead.

Another way we are investing in growing Chinese consumption is via our holding in ZTO Express - China’s largest e-commerce parcel express network (i.e. the ‘FedEx of China’), delivering 12 billion packages in 2019.[4]

The aggregate number of packages delivered in China has risen 10-fold since 2005 with solid growth expected to continue. China’s express delivery market is being driven by a positive outlook for online retail sales (c.70% of China’s parcels are related to e-commerce).[5] We expect around 20% express and on-demand volume growth over the next few years, helping position ZTO as a market leader.

More recently, growth has accelerated even more, as ZTO benefited from a whole new cohort of consumers introduced to ordering online during the COVID-19 lockdown. It is widening its lead versus competitors in terms of service quality and cost structure.

We believe that Anta Sports, Li Ning and ZTO Express are excellent growth businesses largely overlooked due to their businesses being predominantly conducted in mainland China. With our experience in the region, we think they are compelling investments.

2. Resurgent semiconductor sector

The acceleration of the shift to online due to COVID-19 is well documented.

Among these accelerated e-commerce trends, semiconductors are the ‘oxygen’ powering the growth. This might seem at odds with technology stocks being white hot, but this is where a pricing disconnect creates opportunity.

The memory business has historically been cyclical, as seemingly endless growth always brought in new competition. But as Moore’s Law continues to get harder to achieve, the market has consolidated from around 10 players to only three in DRAM, and five in flash memory (NAND). There are now huge barriers to entry thanks to accumulated ‘know-how’, patents, intellectual property and huge capital requirements. This has boosted potential profitability for DRAM/NAND, helping Samsung Electronics’ earnings – a stock we have held for many years.

Samsung’s other businesses are already performing better – their foundry business has seen the number of competitors fall away from the leading-edge process as they struggled to keep up with investments needed. Samsung also makes high-end smart phones and is taking market share, especially in Europe.

At just above 1x book value,[6] we are obtaining exposure to the growth in technology without paying ‘bubble-like’ prices. Samsung has spent billions of dollars on research and development and is a clear global leader benefiting from structural tailwinds, and it has consistently been one of our largest positions in recent times, as the market exaggerates its demise.

3. Biotechnology

With COVID-19 front and centre of the pandemic, it’s important to remember biotech is not new to us. The Platinum International Health Care Fund (which is managed by trained virologist Dr Bianca Ogden) is 17 years old.

The healthcare sector has expanded significantly and we are excited by the technology advancements that are driving huge innovation in the biotech sector.

An industry article in the journal, Nature Reviews Drug Discovery highlighted how sponsorship of clinical trials has changed rapidly. In 2000, 50% of phase 1-3 trials were sponsored by one of the top 10 pharma companies. By 2017, this had fallen to 27% with biotechs playing a much greater role.

Biotechs push the innovation envelope and raise money independently as pharma companies cannot fund everything and this creates great investment opportunities. For investors it’s critical to understand the science but also how the business will develop and the internal drug development pipeline of each company.

An example was our investment in US biotech, Moderna in its December 2018 initial public offering (IPO). Bianca recognised the potential of their vaccine capability well before COVID-19 arrived.

Quanterix, another stock we hold, is a US biotech/tool company that is pushing the limits of disease detection. If they can detect a tiny bit of a disease in blood, they can treat it before it becomes acute. Their Simoa technology is an ultra-sensitive immunoassay technology allowing detection of proteins and nucleic acids at the lowest possible levels. The technology provides 1,000 times the sensitivity increase over conventional assays. Prevention really is better than the cure. Quanterix has a very commercial and technically capable management team who we have known for over a decade. They ensured the Simoa technology is well tested and placed in the right labs. Now they can detect biomarkers that are in high demand for diseases such as Alzheimer’s, Multiple Sclerosis and also in oncology.

Bluebird bio focuses on editing the genetic code. Many genetically defined diseases can be fixed by just editing this code. Bluebird now has a product approved in Europe and oncology cell therapy following in the US. Genetic engineering, manufacturing and supply chain management as a whole platform is key and Bluebird has the team to make this a reality.

We believe biotech companies should be considered in a similar vein to technology companies. In the near future, biotech will challenge and change the way healthcare is provided and profoundly impact on our longevity and quality of life. It’s a very exciting area undergoing constant change. We feel our expertise in this field allows us to bring an edge to uncovering underappreciated growth ideas in this sector.

4. Robust travel-related companies

At times of large market dislocations, we have used large sell-offs to add significant new positions to our portfolios, such as semiconductors during the memory price sell off in 2018, or banks post the GFC. We believe, this time is no different, and we have added considerable exposure to travel.

Travel has been critically impacted by COVID-related lockdowns, with a long recovery timeframe. Nevertheless, our view is that travel will recover, though it may take at least three years to return to prior levels with business travel potentially taking longer, given the widespread adoption of effective video-conferencing.

It should be remembered though, that prior to the pandemic, the travel industry had showed steady growth for many years. Global air travel has grown around 5.5% per year for 50 years.[7]  It’s important to note that this timeframe contained recessions, wars, oil shocks and the introduction of multiple technologies (e.g. the internet, live streaming), which would supposedly reduce the need to travel.

2020 is the ultimate exception but this presents an opportunity. Travellers have disappeared but the innate human desire to travel has not.

In early June, Ryanair reported their bookings for July/August were only 50% below the 2019 level. This was before any borders had re-opened and without any prospect of a vaccine. Cruise reservations for 2021 are up 40% from 2019, according to booking site CruiseCompete, as holidaymakers rush to reschedule cancelled trips and new customers plan ahead. 

On a base rate of 5.5% annual growth, we can add booming demand from emerging markets as income levels rise (only around 10% of Chinese have passports vs. 40% of Americans and 80% of British), Western consumers allocating more spending towards ‘experiences’, and the continued reduction in the cost of travel thanks to low-cost carriers and platforms such as Airbnb.

Our investments in the sector are dominated by capital-light internet booking platforms and software providers. We own online travel agents Booking Holdings (owners of Booking.com, KAYAK, Priceline, Agoda, OpenTable) and Trip (formerly called Ctrip). Both companies have significant cash buffers to weather the storm, primarily serve leisure customers and help hotels fill unsold rooms (where they will never have better access to inventory). Their competitive positions improved as smaller peers exited the industry.

Amadeus IT Group is one of only three GDSs (Global Distribution Systems). Type a couple of city names and dates into Booking.com or other ‘Online Travel Agencies’ and you’ll see a menu of airlines, routes, dates, times and prices. You can easily browse various options and book your trip right then and there. The backbone powering this technology is a GDS.

This is an online marketplace where airlines upload their ‘inventory’. Automating distribution was the only way to handle over four billion passengers and countless more enquiries and searches. It allowed airlines to automate their interactions with travel agents. Huge wage costs were replaced by a small fee per booking paid to the GDS. Not only is switching expensive, it entails a small possibility of massive operational disruption, which any CEO or Board would strive to avoid. This makes it hard for new players to gain a foothold. So, the GDS economics are excellent and barriers to entry are high.

Amadeus spends hundreds of millions of dollars developing and maintaining the GDS and other software offerings each year. They then sell them to many airlines, for a fraction of what it would cost each airline to do it for themselves.

Given the current concern over passenger volumes, this example of exaggerated demise was available for around 16x 2019 earnings.

 

[1] Source: McKinsey Global Institute, 18 December 2019,  https://www.mckinsey.com/~/media/mckinsey/featured%20insights/china/china%20consumer%20report%202020%20the%20many%20faces%20of%20the%20chinese%20consumer/china-consumer-report-2020-vf.pdf

[2] Source: Bloomberg consensus figures, correct as of 18 August 2020, http://www.wuxinews.com.cn/2019-11/11/c_423455.htm.

[3] Source: FactSet Research Systems, Fubon Securities.

[4] Source: FactSet Research Systems, TH Data Capital.

[5] Source: Bloomberg consensus figures, correct as of 18 August 2020.

[6] Source: FactSet Research Systems, 31 October 2020

[7] Source: International Civil Aviation Organisation.

DISCLAIMER: This article has been prepared by Platinum Investment Management Limited ABN 25 063 565 006, AFSL 221935, trading as Platinum Asset Management (“Platinum”). This information is general in nature and does not take into account your specific needs or circumstances. You should consider your own financial position, objectives and requirements and seek professional financial advice before making any financial decisions. You should also read the relevant product disclosure statement before making any decision to acquire units in any of our funds, copies are available at www.platinum.com.au. The commentary reflects Platinum’s views and beliefs at the time of preparation, which are subject to change without notice. No representations or warranties are made by Platinum as to their accuracy or reliability. To the extent permitted by law, no liability is accepted by Platinum for any loss or damage as a result of any reliance on this information.

 

 

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