Hyperion’s Tim Samway considers how COVID-19 is changing global industry. Loftus Peak’s Alex Pollak looks at how ‘disrupted’ companies are becoming the ‘disruptors’. Platinum’s Julian McCormack outlines the case for Chinese property.

Trapped in our houses in lockdown, we did a record amount of our shopping online.

How quickly did we respond to restricted in-store shopping? According to Mastercard Spending Pulse, the ecommerce share of total retail sales in the US doubled in April and May 2020 from that of the prior year to reach 22 per cent of total retail sales.

In the UK, the ecommerce share of total retail sales in those two months reached 33 per cent. The story is similar in Australia even though the virus only brushed our shores and has been mostly contained.

Even with a return to in-store shopping, ecommerce has enjoyed a permanent uptick and it has substantial ramifications for the ecommerce sector and the digital payments sector beyond the incredible lifts these businesses enjoyed in 2020. 

Digital payments businesses, such as Square and Paypal, which handle a growing percentage of contactless and online payments, have enjoyed giddy share price increases on the back of substantial increases in earnings.

This time last year, Square Inc. (Class A) was trading at US$60 per share. At the date of this note it trades at US$245 per share. That’s an increase of around 300 per cent.  Paypal, currently trading at US$262 is up approximately 127 per cent over the same period.

But that’s history. Hyperion believes there is another megatrend hidden within the trend of using digital payments instead of cash, which creates a substantial long-term opportunity for investors.

There is growing evidence to suggest Millennials and Generation Z don’t have any loyalty to traditional banks and that they shun credit cards.

Hyperion estimates that 70 per cent of those under 30 years of age in the US don’t possess a credit card and there are at least 60 million consumers in the US that are under-banked.

There are inherent security issues with using debit cards for both online and in-store transactions.  Our research shows that consumers have embraced cash apps that run on their phones to increase the security of their money and increase the flexibility of how they use their savings. In doing so, they are replacing traditional banking relationships.

Square, for example, has created an ecosystem for merchants and younger consumers. Merchants can accept contactless payments with widely available cheap in-store terminals that have no lock-in contracts and free point-of-sale software.

Consumers use the Square cash app that provides convenient ways to send money to friends and family (peer-to-peer), pay for goods and services (cash card), receive their weekly pay by direct deposit, invest in shares and cryptocurrency, plus earn rewards for spending using the cash card.

Square and Paypal are taking market share from both traditional banking services and credit card suppliers and are transitioning consumers to a super app that allows them to enjoy superior control over their finances.

Globally, there are over 3.8 billion people under 30 years of age, and Square and Paypal have only just started to monetise the opportunity. Now that’s a megatrend worth following!

This business, although approaching 100 million subscribers, is still far less profitable than the company’s existing model, but the company’s stock price has nevertheless doubled as investors take the view that Disney will get there – that is, emerge as a credible competitor to Netflix.

Then there are internal combustion engine (ICE) vehicle makers looking to electrify their offerings. Tesla has been the most visible electrical vehicle (EV) champion to date, and it has grown strongly in part because it had no legacy ICE assets.

Volkswagen (VW) in March held a “Power Day” (its answer to Tesla’s annual “Battery Day”) announcing plans to build six battery "giga-factories" with an eventual production capacity of 240GWh per year.

VW also announced plans to spend US$50 billion to build 15 electrical vehicle plants on three continents. It believes it will sell more EVs than Tesla in 2022.

VW has also unveiled a new “unified cell” technology to be launched in 2023 that would by 2030 reduce the battery cost in entry-level cars by up to 50 per cent and by 30 per cent in the volume market segment. Given that batteries are currently about a third of the price of an EV, the VW technology promises to reduce production costs drastically.

So, are Disney and VW examples of value (companies) meeting growth?  Our answer is, yes.

But it's not just any growth meeting any value. The value companies fell into disfavour because of their slow progress in this technological world – a world where the pace of change continues to increase. Kodak was a value company that didn't adapt to digital imaging, and paid the price.

Value companies around the world have started to recognise the existential threat of rapid change, and we have seen the first of them adapting (including Disney and VW). No real surprises here. This is a significant opportunity for Loftus Peak investors, so expect to see more on the topic.

This value-meets-growth investment development is, in turn, playing into three big issues shaping returns. All three call into question the accepted wisdom of globalisation – a trend that has lifted living standards around the world (though at different rates, and often with harmful effects on the environment). These three issues are:

1. Trade tensions

The build-up of trade tensions between the US and China spilled over into a semiconductor arms race, following former President Trump's decision to significantly limit the supply of crucial chips to China's Huawei. That decision effectively sidelined the most important company in China.

2. Renewables technology

Expect strong growth in battery demand as car (such as VW) and oil companies are forced to move away from fossil fuels because of environmental concerns.

This, too, is driven by governments (especially those in the EU) as they impose deadlines after which new internal combustion engine vehicles will be effectively banned.

Of course, oil companies are harmed as a result, driving them to dramatically widen their renewables business to compensate. This investment thematic is one that Loftus Peak has incorporated since inception, under the heading “energy as a technology, not a fuel”.

3. Supply chains

Concerns around the global nature of the supply chain for pharmaceuticals and equipment shortages in the wake of COVID-19 have caused countries to question whether there should be more on-shore capacity.

The Loftus Peak investment team has closely followed all the developments raised in this note over recent years, with favourable results for investors.

That means there are almost half a billion people living in properties of greater than 20 years of age – and China only started building modern housing when it liberalised the housing market in the 1990s[iii].

The older housing stock is of extremely poor quality indeed, often with shared bathrooms and kitchens between multiple apartments.

But perhaps there has been an extraordinary bubble in Chinese property prices? Well, no, it does not appear so, to us.

In the 20 years to 2017, Chinese property prices performed roughly in line with Belgium, and nowhere near as excitedly as in New Zealand or Australia.[iv]

In a more recent data series, real property prices in China are shown to have performed roughly “in the middle of the pack” of large economies from 2010 to 2020.[v] Remember – this is in the midst of the largest urbanisation in human history, and with no modern housing stock 25 years ago. This is not a bubble, folks, in Platinum’s view.

The primary reason for this moderate house-price appreciation in China is regulation – Chinese officials have exercised a heavy hand in regulating excess out of the property market, guided in recent years by Xi Jinping’s maxim “a house is for living in, not for speculation”.

In recent months, China’s listed property developers have been beset by further news of regulatory changes around property purchasing, in addition to the years of regulatory constraints on property demand in China.

China’s listed developers are large, but the industry is vast and the very largest account for only low single-digit percentage points of the industry.

We think we have seen this movie before: an industry under regulatory scrutiny, with lots of smaller, irrational players. This reminds us of Chinese insurers some 10 years ago. Then, regulation drove industry consolidation and helped the largest and highest-quality companies.

And that is exactly what Platinum Asset Management owns in Chinese property – names like China Vanke, China Resources Land and China Overseas Land & Investment (COLI).

These stocks are trading on single-digit price-to-earnings (P/Es), paying 4-6% dividend yields at the time of writing, have good balance sheets and long histories of high returns and share-price performance.

Sources 

[i]CSLA 

[ii]http://english.www.gov.cn/archive/statistics/202001/19/content_WS5e24542bc6d0db64b784ccef.html

[iii] http://press-files.anu.edu.au/downloads/press/n4267/pdf/book.pdf?referer=4267

[iv]  For the data underlying the discussion of relative real property price appreciation see The Economist, https://infographics.economist.com/2017/HPI/ ; and also see https://www.economist.com/graphic-detail/2018/08/09/global-cities-house-price-index for Shanghai versus other global cities.

[v] For the more recent series see here: https://www.economist.com/graphic-detail/global-house-prices