In recent weeks the wheels have been turning on a market rotation as positive news continues to be releases regarding COVID-19 vaccine developments. We now enter 2021 with confidence that it will be a year in which we see a continuing rebound in global economic activity with vaccine adoption acting as the accelerant.
For Pfizer and Moderna we know efficacy of the first two vaccines is around 95% which is fantastic and is also positive for the durability of the vaccine. And it also means we are within reach of achieving the nirvana of so called “herd immunity” assuming strong uptake of the vaccine.
Another data point we found really interesting or critical was that 40% of candidates in Pfizer’s trial were in the 56 – 85 year old age bracket, which is the population most at risk from Covid. Pfizer reported efficacy in people aged over 65 was 94%. This is really positive. And a good uptake from the most at-risk populations will materially reduce the number of severe, including fatal, COVID cases going forward.
But investors shouldn’t disregarding the risk associated with COVID-19. While we are confident that a vaccine will be successful, we think the pathway to get there may still have some twists and turns.
The timing of ultimate vaccine success and broad availability of the vaccine is still uncertain, with the next catalyst most likely to be Emergency Use Authorisation for the vaccines. In the meantime, detected infection rates in Europe and the US are at very high levels, and we are watching these. Antipodes is also cognisant of the fact that certain behaviours won’t revert to what we once knew as ‘normal’.
So, how are we positioning for reopening?
In our most recent podcast titled, Investing in the reopening, I discussed reopening exposures at-length with Antipodes’ Consumer and Domestic Services, Developed Markets, Portfolio Manager, Andrew Baud.
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Since the end of September, our portfolio exposure to developed world reopening beneficiaries has increased roughly 5% to around 30% of the portfolio. This is highlighted below within our reopening clusters of Consumer Franchises (Developed Markets) and Travel, Autos, Energy.
And within some of the most neglected sectors in global markets we have identified compelling opportunities. In retail banking our exposure has grown to 6.8%, consumer 10.8% and travel 4.4% (as of November 2020).
This has come at the expense of our global defensives which have fallen 5% to around 26%.
Here’s a deeper-dive into the opportunities we see within those ‘neglected’ sectors, buoyed by vaccine development and reopening.
Ecommerce has increased from 15% of total US retail sales at the end of last year to 25%, as lockdown and social distancing pushed consumption online. Even in a reopened environment, online retail penetration is not falling back to 15%. Certain changes in consumer behaviour triggered by COVID are here to stay.
There’s been a permanent shakeout across the retail landscape, particularly retailers dependent on mall foot traffic . ￼We’ve seen a ￼handful of high-profile bankruptcies in the US, such as Nieman Marcus (a premium end department store chain not dissimilar to David Jones in Australia) and JC Penny (a mass market department store chain). In our portfolio we’ve focused on retailers that can seamlessly straddle both the offline and online worlds – otherwise known as omnichannel operators.
A good example is a retailer like Ulta Beauty, one of the largest specialty beauty chains in the US. It’s a similar beauty concept to Sephora or Mecca here in Australia but stands apart for providing both mass and prestige brands to consumers under the one roof.
The beauty industry grows at a fairly predictable rate of 3-4% p.a, but we think Ulta can do better than that by taking more market share, largely at the expense of department stores and a very long tail of smaller market participants. COVID forced Ulta to shut down its 1,200 stores, but the business was well placed from earlier ecommerce platform investment. Its online sales have grown triple digits but Ulta also remains a reopening beneficiary as customers get back to their stores for the unique advice and experience from testing products and getting treatments.
Another retail holding is Simon Property Group, a premium outlet centre and mall REIT in the US (think Westfield in Australia).
Our view is that retail space in the US will consolidate into distinct formats that enable omni-channel retailing. Premium malls and premium outlet centres will be survivors of this and we think Simon Property Group is a good way to capture exposure to this because of its scarce premium real estate assets.
In terms of the US retail market, premium A grade or better malls represent less than 25% of total malls and more than 30% by selling space. Simon Property Group has over 40% share of the premium malls and outlets in the US making it a go to partner for US retailers. The Simon portfolio earns over 80% of its Net Operating Income from A grade or better rated premium properties.
Adjustments are occurring in the retailing industry. Some Simon tenants will disappear, as they have during prior retail cycles, but they’ll be replaced by retailers looking for access to high traffic real estate. Currently the mall and outlet space is dominated by apparel retailing, however, we believe that over time this will adjust, and you will see alternate categories emerge. Whilst waiting for sentiment to improve, Simon pays a sustainable 6% cash dividend yield.
Coca-Cola is another great reopening play. Coke generates just over 40% of its global revenue from on-premise consumption – which is cafes, restaurants, bars and entertainment/sporting venues. These have all been shuttered thanks to lockdown and social distancing.
As well as a reopening opportunity, Coke is distinctive from most other consumer staples by retaining strong influence over its bottler supply chain, right up to delivery and stocking customer shelves. This helps the business keep distribution costs low, maintain customer relationships and sustain pricing power.
As reopening gathers pace, we think Coke grow faster than its peers again and should benefit from a relative re-rating.
Antipodes has grown its travel related exposures to around 4% of the portfolio. But investors need to be selective when considering this sector. In our view, domestic travel comes back before international, and we don’t think business travel mean reverts – so companies that are overly dependent on business travellers may end up being future value traps.
GE is a stock we have had in the portfolio for some time, and we’ve always liked it for its global aerospace engines business which, prior to the pandemic, accounted for around two-thirds of earnings. The jet engine business is a lucrative global oligopoly, where GE has 70% share of smaller, narrow-bodied planes – which makes it well positioned for a revival in domestic travel.
The company also has a 50% share of the wide-bodied plane market.
We think Booking.com will also be a key travel beneficiary in the re-emergence of travel as it’s not dependent upon a return to international travel. We used the sharp sell-off in that stock as a great opportunity to include it in the portfolio.
We have focused on robust retail banking franchises where credit costs have been low, as consumers have been well-supported by income stimulus and government support, and franchises which aren’t being disrupted by savvy fintechs.
Capital One Financial and ING are two compelling investment propositions. Both dominate their respective markets – credit cards in the US for Capital One and mortgages in Northern Europe for ING – with incredibly cheap valuations.
Capital One is the only large US bank fully transitioning to the cloud, which will be completed in 2021. This will give Capital One greater ability to innovate its product offering and better assess the credit risk of its customers.
ING was arguably the original technology disruptor, with its predominantly online business model.
Both companies are valued at potential sustainable payout yields of more than 10%, which includes dividends and buybacks. Once regulatory approval to restart capital distributions has been granted, this should be a clear catalyst for re-rating in the new year.