Five global themes we think will deliver strong returns
Amid all the noise and volatility in global equity markets are some powerful structural shifts that should provide solid investment returns for many years to come. Here, I’d like to present five of them, and some strong businesses that are riding these industry tailwinds.
The following is an excerpt from our June 30 letter to investors in the Montaka funds and the Montgomery Global funds.
Notwithstanding the return of volatility in global equity markets, our global strategies seek to provide investors with exposures to a set of undervalued, high-quality global businesses which are experiencing industry tailwinds which are structural in nature.
Digital music streaming
For example, consider Vivendi (Euronext: VIV), owner of the world’s largest record label, Universal Music Group (UMG). As consumer behaviour continues to evolve from purchasing individual music tracks to subscription-based digital streaming, UMG’s revenue growth continues to accelerate at a significantly higher incremental profit margin. And this dynamic is structural with a long runway still ahead. Consider that only around 13 per cent of adults in the US subscribe to a paid digital streaming service. In countries like France, Germany and the UK today, this penetration rate is less than 10 per cent. And in China today it’s around 1 per cent. This will underwrite structural growth in global digital streaming revenues of around 20 per cent per annum, well into the next decade.
Or the structural migration of advertising spend onto digital platforms that offer highly-targeted forms of advertising – thereby driving the highest rates of ad spend ROI for the digital marketer. The world has really divided into two distinct digital advertising markets: (i) the world, ex-China, which is dominated by Google, owned by Alphabet (NASDAQ: GOOGL), and Facebook (NASDAQ: FB); and (ii) China, which is dominated by Alibaba (NYSE: BABA) and Tencent (HKEx: 700). In studying the quarterly disclosures of numerous consumer facing businesses, including nearly all the major CPG companies, it is clear that marketing budgets are being significantly re-weighted towards higher-returning digital channels all around the world. Here is what Kimberly-Clark (NYSE: KMB) CEO, Michael Hsu, had to say earlier this year: “Today, digital is approximately half of our working media mix – and that percentage is growing… the ROIs are a multiple of what our traditional ROIs are…”
Cloud IT spend
And this is not the only technological transformation taking place inside the enterprise. Readers will know that substantially all businesses today – both large and small – are moving at least some of their technology infrastructure to the cloud. You can think of the cloud as an external source of storage, compute, services and applications. There are enormous cost, efficiency and security advantages in outsourcing this technology infrastructure. Today, Bernstein estimates the total addressable market for cloud services to be approximately US$1.9 trillion. And yet, aggregate cloud spend is less than 10 per cent of this total addressable market, meaning there is a very long runway ahead for growth in cloud related revenues. Microsoft (NASDAQ: MSFT) is arguably the most well-positioned business to take advantage of this structural growth in cloud related spend. Its offering spans the cloud-based compute/storage infrastructure as well as the enterprise applications that sit on top of this infrastructure. Indeed, Microsoft is in a particularly well-suited position given that Windows is installed on around 90 per cent of the world’s PCs and Office is used by around 85 per cent of enterprises. This creates a high degree of customer captivity that Microsoft is in the very early stages of monetising.
Demographic changes are structural trends to which we seek to be positively exposed. In the US, for example, the aging population sees 10,000 Americans turn 65 years old every day. This is creating enormous demand for healthcare services. UnitedHealth (NYSE: UNH), the largest health insurer in the US, is particularly well positioned to grow its insurance business – particularly its highly-popular Medicare Advantage offering which is available to Medicare recipients aged over 65 years old. But it is actually UnitedHealth’s underappreciated healthcare delivery platform, Optum, which has the greatest opportunity of profitable, structural growth. Optum is a technology and data-enabled healthcare delivery platform, not only for UnitedHealth’s own insurance business, but for more than 80 third-party payers. Optum is seeking to use data and technology to deliver healthcare more efficiently and effectively to drive better outcomes for patients and at lower costs, creating value in which Optum will share.
At the other end of the demographic spectrum in the US, readers may be interested to know that the children of the baby boomers – known as the “echo-boomers” – are around 28 years old today. Over the next 10 years, population growth in the all-important 35-44 year old cohort in the US will be around six million. By comparison, growth in this cohort was negative over the last 10 years. This favours demand for housing and those businesses exposed to demand for home renovations. We own Floor & Décor (NYSE: FND), a specialty retailer of surface flooring – the preferred supplier of flooring products to professional customers and known for its 1,500 SKU in-stock, job-ready inventories.
Finally, Asian demographics represent another structural trend that is providing great opportunities to the disciplined investor. Over the next 15 years, more than 80 per cent of the growth in middle-class spend will stem from the Asian-Pacific region. And private financial wealth levels in Asia will continue to grow at around 10 per cent per annum for many years to come. In China, Ping An (HKEx: 2318) is an industry leader in life insurance and wealth management offerings. It is a leader in technology and data-enabled design and distribution of insurance and wealth products. And given that its average customer age is only around 38 years old, it is set to grow structurally with the wealth of its customer base.
Outside of China, Prudential (LSE: PRU) is a clear leader in Asian life insurance with a top-two market position in Indonesia, Singapore, Hong Kong, Malaysia, Vietnam, India and elsewhere. Asian insurance markets are around half the size, on average, of western insurance markets as a percentage of GDP, suggesting there is substantial penetration ahead. And Prudential’s Asian business has delivered circa 20 per cent post-tax economic returns consistently for years – and we expect this performance to continue for many years to come. The growth in the wealth levels of the Asian middle-class will also drive structural demand growth for services like travel.
It is important to observe that each of our theses not only identifies the sources of business quality and structural growth opportunities; but also makes the important assessment as to whether (or not) the business in question remains undervalued today. After all, not even the greatest growth story in the world can stop you from losing money if you overpay for an asset.
The Montgomery Global Funds and Montaka own shares in Google, Facebook, Alibaba, Tencent, Microsoft, United Health and Floor & Décor. This article was prepared 31 July with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade any of these you should seek financial advice.