2019 – The Year Ahead
Tantrum : outburst of bad temper or petulance (the Oxford Dictionary)
Given the current tone of financial news, investors might be forgiven for thinking the sky is falling in, and one can sympathise with some of the resulting investors’ tantrum. Equity markets have been weak through much of the second half of 2018, concerns about global growth have been mounting, US interest rates are on an upward path and the ongoing trade saga between Presidents Trump and Xi has also weighed continuously on investor confidence. Many are questioning the outlook for global growth and market performance next year.
But, we would ask in response to these concerns, what has that got to do with a Chinese millennial buying their favorite yogurt drink, a family in an emerging market taking their first holiday abroad, the research into cures for previously incurable illnesses, the development of the autonomous cars of the future, the take up of electric vehicles to save the planet, or the spread of internet connected devices? The answer is: nothing very much at all. Short-term fluctuations in stock markets (including the recent wild swings) and concerns about global growth may impact share prices in the short-term, but the long-term structural demand patterns Dominion Global Trends invests in will continue to power ahead, whatever way the winds of market sentiment may be blowing.
As long-term growth investors we continuously attempt to identify persuasive growth trends, which can appear “from nowhere” and dominate sectors in relatively short time periods. Changes in spending preferences also reflect dramatic changes in social patterns: according to one survey, 77% of US millennials would rather give up alcohol for a year than lose access to Amazon (Source: Max Borges Agency). While this statistic may surprise some of the more dipsomaniacally inclined baby-boomers, it neatly serves to illustrate both the changes in generational behaviour and priorities (in England, 30% of millennials forgo alcohol already) – but also the massive importance of ecommerce to the new consumer, and no company better exemplifies this than Amazon. The conclusion for global investors is both powerful and crystal clear: products often become subject to forceful dynamics leading to accelerated obsolescence and unexpected financial headwinds: today’s winner can be an obscure memory tomorrow (remember Nokia?)
Each of the Dominion Global Trends Funds has been positioned for an optimal exposure to the global growth trends projected for 2019 and thereafter. Some key trends for each of the three Global Trends Funds are:
- In the Ecommerce area we expect the effects of the dichotomy between structural growth - driving strong fundamental performance - versus threats to the ability to sustain growth as the key differentiator within the universe.
- The spread of connected devices (a key product area in the Managed Fund), already numbering in the billions, will continue apace with an additional 1 billion people and 45 billion devices connected to the Internet by 2030.
- We focus on business models catering to affluent elites worldwide in the Luxury Consumer portfolio. We also continue to see Asian demographics and cultural/aspirational change as a major demand driver and will maintain a material exposure to this factor.
Global Trends Ecommerce - The Year Ahead
Throughout 2018 Amazon, like many large technology companies, has found itself on the receiving end of negative headlines; mainly media organisations who find themselves suffering, not coincidently, from the shift towards digital media. Yet, despite this, Amazon was rated America’s most loved brand according to Morning Consult.
The inconsistency between negative headlines (and the sentiment they often drive) and performance also extends to ecommerce companies’ performance both on a fundamental and share price level. Despite a fourth quarter which has seen investors rotate out of technology, ecommerce and growth, we still see the likes of Amazon and Netflix returning +28.4 and +39.4% respectively since the turn of the year (as of 31/12/2018 USD), while the MSCI World index has returned -10.4% and the NASDAQ -3.9%. This is because even as headlines and sentiment have driven volatility strong underlying fundamental performance and consistent growth have driven returns.
Looking forward in 2019 we expect the effects of the dichotomy between structural growth - driving strong fundamental performance - versus threats to the ability to sustain growth as the key differentiator within the ecommerce universe. We expect intolerance for companies that over promise and underperform or chase top-line growth with little to no meaningful profitability appearing in the foreseeable future to persist. We also see disproportional upside for companies with high-quality consistent growth, strong ecosystems and demonstrable profitability.
The payments sector, which form the transaction backbone of the ecommerce sector, exemplifies these qualities. The GT Ecommerce payment holdings of Visa, Mastercard, PayPal and Global Payments average a 2019 sales growth forecast of 14% with operating profit growth of 15%, have high margins, competitive advantages and, post equity market pullback, their most attractive valuations for a number of years.
Elsewhere we see strong valuation opportunity in the digital entertainment segment, most notably computer games. This segment has been amongst the hardest hit by the market reaction, which suggests that half of players have abandoned down their controllers and found other, equally addictive, hobbies. Not only is this is not the case, but in fact the opposite is true. However, discretion is key within this sector, again favouring demonstrable growth. Hence, we prefer the likes of Take Two Interactive which, with the release of Red Dead Redemption 2, is forecast to have its best year ever (with revenue forecast to grow +65% and operating profit to more than double), rather than the likes of Electronic Arts which may go ex-growth in 2019 due to franchise fatigue.
The end of 2018 was a trying period for the ecommerce sector and the market as a whole. However, this has provided a valuation opportunity to invest in high quality structural growth companies at very compelling valuations. The GT Ecommerce portfolio has taken full advantage of this and has an average 2019 sales growth forecast of 14%, with earning growth forecast to be 16% and a P/E ratio and free cash flow yield at historically cheap levels (25x and 4.6%, respectively).
Source: Bloomberg – Dominion Global Trends SICAV – Luxury Consumer fund (EUR I share class)
Global Trends Managed - The Year Ahead
For those of us who follow the markets, it is easy to let short-term market performance change our perception of reality. But the truth is, the world will keep turning, the sun will keep rising in the morning and the structural demand trends we invest in with the Managed Fund will keep playing out. In the long-term, this will drive growth in revenue and profits well above global GDP growth, and will in time reward the patient investor who has remained exposed to these groundbreaking changes underway in the global economy. Just one example illustrates this point: next year in 2019, just like in every year for the foreseeable future, Chinese millennials will still be buying their favorite yogurt drinks, an $18bn market growing at +20% a year for our investment name Chr Hansen.
Demand for air travel will continue to grow at more than twice the rate of global GDP growth, driven by massive new demand from emerging markets and the need to double the total number of commercial aircraft in the air by 2030, driving demand for new aircraft supplied by our investment name AerCap.
In the industrialized world an ageing population, growing wealth and new frontier R&D technologies will continue to drive demand for new medicines to treat illnesses that effect the elderly, driving demand for the research services offered by our investment names IQVIA and Charles River Laboratories.
Other key product areas in Managed show the following trends:
The pace of innovation and development of driverless cars and electric vehicles will continue, driving demand for the leading technology in this space offered by our investment name Aptiv. The spread of connected devices, already numbering in the billions, will continue apace with an additional 1 billion people and 45 billion devices connected to the internet by 2030, all of which will rely on the technology supplied by our investment name Skyworks Solutions.
Across these and many more structural demand trends we invest in through the Managed Fund, growth in profits will continue to be driven by the trends changing the world and driving demand for the products and services offered
by the investment names. These trends are structural. This means they are driven by fundamental changes in the global economy; changes which will continue to happen and are not impacted by short-term swings in equity markets or investor sentiment. We remain as excited as ever about the prospect for our investments to continue to facilitate global change and grow their profits well ahead of growth in the global economy. The future continues to energise demand for the products and services our investment names produce and we see 2019 as another year for strong growth across the portfolio.
Source: Bloomberg – Dominion Global Trends SICAV – Managed fund (EUR I share class)
Global Trends Luxury Consumer – The Year Ahead
For GT Luxury Consumer 2018 was a year of sweeping changes in expectations. The year opened with considerable optimism for the global business cycle. This, like a tide, carried up every consumer stock able to show a modicum of growth, or at least the “promise” of growth, irrespective of the quality of the growth. The “luxury” moniker meantime became ever more ubiquitous appearing upon ever more mundane objects and experiences from quilted cashmere toilet paper to five-star Pet hotels. Truly scaleable “luxury” businesses able to set prices and turn the evolving aspirations of a structurally growing global wealthy elite into real revenue gains, rising margins and improving returns on invested capital had become ever scarcer, especially in the traditional luxury space. A process which has accelerated into the second half of 2018, when consumer confidence began to flag in a growing number of countries in the face of macro concerns. Dominion thus focused on looking for unique business models in new “luxury” demand segments, primarily private education, companion animals, and live entertainment.
Our focus on demonstrable growth and pricing power meant we avoided the many “tier two” luxury retail brands with contradictory “shrink to grow” restructuring strategies. While many have achieved the “shrink”, the “growth” remains elusive if not illusory for some. Ever more diffuse ecommerce penetration has meant more and better educated and even more discerning “luxury” consumers with near perfect price information and access to near infinite shelf space 24/7. This has relegated many aspiring brands to the status of low margin cyclical fashion companies. For these companies, 2019 could be especially problematic if the business cycle shifts down a gear.
Mid-2018 we reduced our exposure to Etailers to zero as the spectacular >20% revenue growth that was being achieved appeared increasing profitless and that the rich mantle that these companies were expected to inherit from the demise of traditional department stores, and a more general contraction of physical retail space in developed countries, proved to be threadbare. Contrary to the consensus we see Etailers’ wafer thin margins persisting as consumer loyalty remains fickle, is subject to ever-shorter fashion cycles, and is driven by bargains now euphemistically referred to as “demand creation”! Enduring business models in this space will be those able to leverage ecosystems to make money in “other ways”.
For 2019 we anticipate that the gap between rich and poor in developed countries will widen further as the business cycle turns down, notwithstanding efforts by increasingly populist government to redistribute or regulate. We will thus continue to focus on business models catering to affluent elites worldwide. We also continue to see Asian demographics and cultural/aspirational changes as major demand drivers and consequentially will maintain a material exposure to these factors. We also note that unique “provenance” is often one of the factors underpinning a luxury brand’s appeal and as such acts as a safeguard against local substitution in a world of escalating trade barriers. We can thus confidently predict that in 2019 the world will not be awash with Icelandic Ferraris, Tibetan “Kelly” bags nor Mongolian Cognac!
Source: Bloomberg – Dominion Global Trends SICAV – Luxury Consumer fund (EUR I share class)
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