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Consumer trends, global trade reshaped by coronavirus

Glenn Freeman  |  25 May 2020Text size  Decrease  Increase  |  
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The wind-back in globalisation that began before the pandemic has accelerated and is changing the nature of international trade, says Philip Saunders, co-head of multi-asset growth at Ninety One, an asset manager formerly known as Investec Asset Management.

Saunders says trade patterns are moving from globalisation to regionalisation, whereby businesses source raw materials, employees from their neighbourhood and relocate manufacturing from multiple international locations toward more regionally focused supply chains.

Saunders insists the nature of globalisation has been changing for some time, citing evidence contained in a study by Swiss University ETH Zurich. This study ssuggests international trade growth, despite being at historically high levels, has nevertheless stalled since 2008.

He cites the examples of apparel and footwear makers who are increasingly looking to manufacturing hubs on the subcontinent and Southeast Asia.

"A fair amount of that is already shifting to places like Bangladesh or Thailand … even as US companies might move this production out of China, the idea that all of this goes back to the US is a fantasy,” Saunders says

"A shift toward regionalisation means companies have to build more redundancies into their supply chain.

"And artificial intelligence is having an impact on all of this. Automated manufacturing and other new manufacturing techniques like digital 3D printing mean that you can locate production nearer to your home market."

Saunders argues that many companies – most notably iPhone maker Apple – have benefited from building large internationalised supply chains.

"Production and capital risk are shifted to China, you max out in terms of profitability because you don't have to deploy anything like the same amount of capital," he says.

"So, you become the front office that runs design, brand and distribution and this cuts out a lot of the redundancy in your supply chain."

However, he believes such offshoring of operations will be less common in future. This will be partly driven by the rise of regionalisation.

Apple stock comprises almost 3 per cent of the Ninety One Global Equity strategy, which is not currently part of Morningstar's research stable.

Apple

Price-to-Fair Value: 1.33 | Economic Moat: Narrow | Uncertainty Rating: High

A large global supply chain has been a revenue drive for the likes of Apple, especially when combined with the tax efficiency measures that are also often part of the business model.

Morningstar US equity analyst Abhinav Davuluri regards Apple as over-priced at current levels, the consumer technology company currently trading more than 30 per cent above his US$240 fair value estimate.

Following Apple's second-quarter results announcement, Davuluri maintained his fair value Estimate but "recommends prospective investors wait for a wider margin of safety given the tenuous state of the global economy."

'Multi-local' to replace 'multi-national'

Asset manager Capital Group's investment director Matt Reynolds says the coronavirus pandemic has inadvertently accelerated this trend to the point where companies that were previously referred to as “multinationals” are becoming “multi-local”.

"By that, we mean they're tailoring their local operations in different countries to the tastes, desires and demands of the local populations."

Reynolds suggests companies that have previously focused their production activities in China may seek to broaden their supply chains into other "high production footprint" countries in north and Southeast Asia such as South Korea Vietnam, and Thailand.

In terms of consumer trends that have accelerated during the pandemic, Reynolds identifies three areas:

  1. Entertainment platforms
  2. E-commerce
  3. Manufacturing technology and automation

Netflix

Price-to-Fair Value: 2.68 | Economic Moat: Narrow | Uncertainty Rating: Very High

In the first area, entertainment streaming giant Netflix is a prominent beneficiary of stay-at-home orders. Online gaming channels have also benefitted.

Netflix is a top 10 holding of Capital Group New Perspective, a fund that seeks to benefit from changing global trade patterns and which Morningstar analysts award a Gold Medal.

Morningstar US equity analyst Neil Macker recently noted the impressive Netflix subscriber growth that has resulted from more people staying home during the COVID-19 outbreak.

But he views the revenue growth, up just 1 per cent on his expectations for the first-quarter 2020, as a "a pull-forward of longer-term growth." Macker expects new competition from the likes of Disney+ and other US streaming services to reduce Netflix's ability to increase prices without losing customers.

Currently trading more than 2½ times’ higher than Macker's US$160 fair value estimate, Netflix currently holds only one star.

In the retail sector, more people have embraced online shopping for various types of goods ranging from consumer staples to office equipment and discretionary items.

Morningstar retail sector specialist and equity research director Johannes Faul suggests the pandemic has pulled forward online shopping's encroachment on bricks-and-mortar retail channels by around five years.

Mastercard

Price-to-Fair Value: 1.08 | Economic Moat: Wide | Uncertainty Rating: Medium

Companies close to electronic payment technology are among specific beneficiaries of this trend, particularly the likes of Mastercard and Visa.

"We've had electronic payments increase in popularity now with a lot more online shopping …and even when you do shop in-person, you are tapping the card a lot," Reynolds says.
"Some shops have had signs in the window saying they prefer not to take cash. The big payment platforms including Mastercard and Visa card are part of this accelerating growth.

Visa

Price-to-Fair Value: 1.15| Economic Moat: Wide | Uncertainty Rating: Medium

Both Mastercard and Visa are trading slightly above Morningstar's fair value estimates.
"We think a wide moat surrounds the business and view Mastercard’s position within the current global electronic payment infrastructure as essentially unassailable," says Morningstar US senior equity analyst Brett Horn.

He concedes there are some short-term issues, including the hit to cross-border transactions as a result of the coronavirus outbreak.

And over the longer term, this increases the likelihood that smaller and more regional networks will grow their businesses and compete directly with the large incumbents.

"But we haven't seen a material effect yet … and while this situation bears watching, Visa and Mastercard’s global networks remain unparalleled, and we think this will remain the case for many years to come," Horn says.

In the third area, Capital Group's Reynolds says artificial intelligence technology will also be increasingly used by companies to speed up decision-making and reduce the time it takes to market new products.

"In the process of using technology to do that, you will end up inevitably using a lot more micro-chips, and that will benefit semiconductor-makers over the longer term," he says.

Taiwan Semiconductor (TSMC)

Price-to-Fair Value: 1.08 | Economic Moat: Narrow | Uncertainty Rating: High

He highlights stocks such as Taiwan Semiconductor and ASML Holdings – both top 10 holdings in Capital Group New Perspective – as companies that will benefit from these longer-term trends.

Ninety One's global equity strategy also holds Taiwan Semiconductor.

Morningstar regards this company as holding a Narrow Moat because of the cost advantage that are enjoyed by only a handful of chip manufacturers.

TSMC also counts Apple, Qualcomm, Xilinx, AMD, and Nvidia among its customers, all of which require advanced chips for premium smartphones, computers and other devices.

Morningstar's Davuluri views the company as fairly valued at its most recent share price of US$49.80 – a little above the US$46 his fair value estimate.

But this fair value is regarded as highly uncertain, partly because of the company's high reliance on the smartphone market, which exposes it to more volatile consumer cyclical trends.

"It also makes chips used for cryptocurrency mining, which has been inherently volatile," Davuluri says.

Consumer trends affect the company during both upturns and downturns, as it needs to satisfy high production demands when times are good. Conversely, TSMC has to deal with excess capacity and the high fixed costs of its fabrication plants during market downturns.

"Additionally, the uncertainty regarding major customers, such as Apple and its multi-sourcing of components from suppliers, is an important risk that must be taken into account when evaluating TSMC’s future prospects."

ASML Holding

Price-to-Fair Value: 1.30 | Economic Moat: Wide | Uncertainty Rating: High

Dutch company ASML Holding, which manufactures lithographic machines used in the production of microchips, is another top 10 position in the Capital Group strategy.

Davuluri recently increased his moat rating for ASML to Wide from Narrow because of the increased demand for the company's extreme ultraviolet chip-making manufacturing capability.

"While we are lowering our near-term estimates for ASML due to COVID-19, our moat upgrade and increased optimism for the firm’s longer-term prospects collectively lead to raising the firm’s fair value estimate to US$245 per share from US$200," he says.

But the company remains over-priced at current levels, its latest closing price of US$319.36 around 30 per cent above Morningstar's latest fair value estimate.

is senior editor for Morningstar Australia

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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