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9 undervalued companies with 'exponential' growth potential: pt 3

Lex Hall  |  11 Apr 2019Text size  Decrease  Increase  |  
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When Hewlett Packard launched the first low-cost LaserJet printer in 1984 it set off a revolution in desktop publishing. For just under $4,000, you could print off your own memos, letters and spreadsheets on a machine that was quiet enough to allow you to speak on the phone while it worked its magic.

Since then we’ve made a few more advances: printers now produce not only your birthday invitations but also 3D objects, including orthopaedic implants—and even houses. Meanwhile, the field of bioinformatics—the collection and analysis of biological data—has made similar advances.

Breakthroughs in the examination of the human genome have paved the way for advances in treatments of cancer and neurological disorders. At the same, the way we pay for things has completely transformed.

The humble cheque has vanished, replaced by instantaneous payment platforms preventing fraud and produce data helping boost business.

Together, these three themes—3D Printing; Bioinformatics; and Financial Services Innovation—are set for exponential growth in coming years. In the final part of our series, we examine these themes and identify the most undervalued leader in the field.

The Morningstar Exponential Technologies Index tracks companies across sectors in the early stages of creating or advancing these technologies. The index features 200 names—some of which are trading at discounts of up to 35%—identified by Morningstar’s equity research team, companies that are positioned to experience meaningful economic benefits as a user or producer of promising technologies.

Morningstar has identified nine technology themes:

  • Big Data & Analytics
  • Network & Computer Systems
  • Nanotechnology
  • Energy & Environmental Systems
  • Medicine & Neuroscience
  • Robotics
  • 3D Printing
  • Bioinformatics
  • Financial Services Innovation

Leaders in the respective themes are often beneficiaries of the network effect, boast cost advantages, and maintain powerful brands that block competition. They’re gatekeepers with extraordinary influence because of the way they can define processes and/or control resources. Leaders are expected to have significantly more exposure to a given theme, and, as a result, should capture disproportionate economic benefits compared to other firms. Companies can be leaders in more than one theme.

3D Printing

As we have previously said in Your Money Weekly, 3D printing—or additive manufacturing as it’s also known—is undergoing rapid advances and transforming the way we create everyday things. Much like a builder bringing an architect’s drawings to life, a 3D printer reads a design file—of say, a ball bearing—and painstakingly but flawlessly creates a three-dimensional usable reproduction of it by building up thin layers of plastic, metal, ceramic or other materials. From tiny aviation components to medical implants, cars, even houses, 3D printing is revolutionising the way companies create products and get them to customers. It is tipped to disrupt several industries, from industrial manufacturing and medicine to consumer products and retail.

Its applications are widespread. Aerospace companies such Spirit Aerosystems, Boeing and Airbus are using it; in healthcare, medical devices company Zimmer Biomet, the undisputed king of hip and knee implants, according to Morningstar analyst Debbie S. Wang, last year received approval for a spinal implant; and in the semiconductor space, chipmakers such as Nvidia, Advanced Micro Devices and Infineon are using 3D printing to make chips.

The 3D printer market is dynamic and competitive as the product cycles are rapid and the prices of printers and they materials they use are constantly falling, says Morningstar research director for industrials Keith Schoonmaker. But he expects many companies will look to 3D printing to view and test prototypes as well as to make finished goods, particularly as the properties of available printable materials expand.

Most undervalued leader:

Zimmer Biomet Holdings ZBH

Industry: Medical Devices

We expect favourable demographics, which include ageing baby boomers and rising obesity, to fuel solid demand for large-joint replacement that should offset price declines. However, Zimmer has been plagued with pitfalls over the last two years, including integration issues, supply challenges, and quality concerns that have caught the attention of the US Food and Drug Administration.

A Zimmer Biomet facility in Westminster, Colorado

A Zimmer Biomet facility in Westminster, Colorado

But new management has tackled these issues, and we expect meaningful improvement in the next year or so. Key to Zimmer’s wide moat is substantial switching costs.

Research has found surgeons stick with their preferred vendor and sales rep for 5–15 years and use that vendor for approximately 95% of their orthopaedic procedures over the period. Switching to another instrumentation system would require taking time out for training, developing a relationship with new sales rep, and working less efficiently during the early period of mastering another vendor’s tools, possibly raising risks for the patient and reducing the number of procedures (and income for the surgeon).

This dynamic explains why market share among the six top orthopaedic implant makers has remained remarkably steady. (Debbie S. Wang)

Bioinformatics

The fitness tracker—be it a wearable device or as an application in your smartphone—is perhaps the most ubiquitous example of bioinformatics—the science of collecting and analysing complex biological data. But bioinformatics spreads far beyond ensuring you’re clocking up your 10,000 steps for the day.

In the medical world, it has exponential potential to improve longevity and wellbeing. Medtronic, the world’s largest medical device company, and rival Insulet, are racing towards the development of a self-contained pancreatic system, allowing a feedback loop between the device and patient to determine daily treatment and self-correct based on glucose levels and other constantly monitored metrics.

The understanding of biological data is rapidly accelerating, particularly in the field of genome sequencing—a process that maps out your genes and helps identify the presence of disease. A leader genome sequencing is Illumina.

Technological advancements in the sequencing industry have brought down the cost of assembling one genome from nearly $3bn and 13 years by completion of the Human Genome Project in 2003 to almost $1,000 in a matter of days following the announcement of Illumina’s HighSeq X in early 2014, notes Morningstar sector strategist Michael Waterhouse.

Genomic information has allowed the development of better targeted therapies for different types of cancer, rare genetic disorders and neurological conditions, say Conover and Strole. “Drugs targeting certain cancer biomarkers—a measurable indicator of some biological state or condition—can lead to almost curative outcomes in certain settings.” Leading companies Bristol-Myers Squibb, Merck and Roche are transforming cancer treatment with the help of biomarkers.

Most undervalued leader:

Bristol-Myers Squibb (BMY)

Industry: Drug Manufacturers—Major

Bristol’s competitive advantage stems from its range of patent-protected drugs, an entrenched salesforce, and economies of scale. The patent protection allows the company to price its drugs at levels that translate into superior returns on invested capital compared with its cost (particularly in cancer drugs, an area of focus for Bristol).

The patents also provide Bristol with ample time to bring forward the next generation of new drugs. Additionally, several of Bristol’s currently marketed drugs are biologics, which create additional hurdles for generic companies as the cost of developing and marketing biosimilars is much higher than for typical generic small molecules.

Further, because many small drug companies lack a distribution channel, Bristol’s entrenched salesforce enables the company to partner with these smaller drug companies to gain access to externally created drugs, augmenting its internal drug-development efforts.

Additionally, Bristol’s sheer size generates the strong and stable cash flows required to fund the approximately $800m needed, on average, to bring each new drug to the market. We expect 20% average annual earnings per share growth over the next five years. (Damien Conover)

Financial Services Innovation

The era of exponential computer power has ushered in new ways of paying for things. The 1970s cheque was usurped by the automatic teller in the 1980s, which is in turn being phased out by contactless payments.

As Deloitte put it in a recent overview of the “paytech” revolution, the physical instruments for initiating payments have been subsumed into apps and other digital processes such as ride-sharing services.

Beyond the revolution in transaction speed, payments are being integrated with customer engagement and business management software, says Morningstar equity analyst Colin Plunkett. Merchants aren’t just happier that there’s time gained at the counter. They’re also using the fresh deluge of transactional data to boost sales and created tailored marketing drives. This has ramifications for competition.

Apple Pay is a case in point. The smartphone maker may never gain a big slice of the transactions market, says Plunkett, but its payment platform is another service allowing it to prevent its estimated 252 million Apple Pay users from switching to rival smartphones.

Other innovations are occurring in bond trading and in blockchain technology. Bond trading is currently a resource-intensive, manual process. As price data for less frequently traded bonds improves, it could enable an exchange to automate much of the process and potentially lead to greater liquidity and lower transaction costs. And blockchain, while nascent, has the potential to disrupt industries by cutting out the middle man of a securities exchange, says Plunkett. “Any business process where the main function is to exchange and transfer information could potentially be threatened,” he says.

The payment pie is still expanding at a rapid rate. PayPal has become a digital wallet of choice for online shoppers and earns revenue through transaction fees and by providing a variety of other financial services, including lending.

PayPal has become the digital wallet of choice

PayPal has become the digital wallet of choice

In 2017, 46% of its revenue came from outside the US. But such is the pace of change, the company’s long-standing lead in the digital wallet space is now threatened as the line between online and physical commerce blurs due to the widespread use of mobile devices, says Morningstar equity analyst Brett Horn.

Rivals abound, including Chinese wide-moat internet giant Tencent. It has the largest social-networking platforms in China. Its two social-networking platforms Weixin/WeChat and QQ have monthly active user bases of more than one billion and 803 million users. When you consider many of these users are being linked to the platform WeChat Pay, the potential is meaningful.

Most undervalued leader:

Tencent (TCEHY)

Industry: Internet Content and Information—Major

Tencent’s monetisation potential in financial technology, or fintech, is substantial. It had the second-largest mobile payment market share of 38% in 4Q17, versus Alipay’s 54%. We believe it will gradually convert users to its financial services products, such as wealth management products.

Its wealth management platform Licaitong’s assets under management reached CNY 300bn as of January 2018, compared with “over CNY 100bn” as reported by Xinhuanet in 2015. Monetisation of the user base consists primarily of fees, sale of virtual items, and advertising revenue.

 Tencent chairman and CEO, Pony Ma

Tencent chairman and CEO, Pony Ma

Fee income is derived via games as well as through subscriptions and revenue share with third-party vendors, such as third-party game or application developers. One of the ways to monetise the user base is through gaming. We model strong top-line growth of 19% a year for the next 10 years. (Chelsey Tam)

is content editor for Morningstar Australia

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