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Cheap money chasing up stock prices

Asia Analytica
Asia Analytica5/29/2020 06:30 AM GMT+08  • 6 min read
Cheap money chasing up stock prices
The tech sector is also widely seen to be one of the biggest beneficiaries of behavioural changes in the aftermath of the Covid-19 outbreak — such as the shift towards e-commerce.
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(May 29): Global stocks delivered another week of gains as investors cheered the reopening of economies and more positive developments on the Covid-19 vaccine front. Stock prices do appear to be running well ahead of the underlying economic — and quite possibly corporate earnings — recovery, for now. A successful vaccine will certainly accelerate the pace of normalisation.

In particular, the FAANG stocks — the popular acronym for Facebook, Amazon.com, Apple, Netflix and Google (trading under parent company, Alphabet) — have performed strongly in recent weeks, leading the US market higher. These stocks, plus Microsoft, are all trading near or at all-time record-high levels.

Technology stocks as a whole have fared better than the broader market through the Covid-19 pandemic. This is not surprising. For starters, their businesses are more sheltered from a direct impact from the outbreak, given their mostly digital presence and small physical footprint. For instance, Netflix’s video streaming service has capitalised on the millions of captive eyeballs during the lockdown and stay-at-home period.

The tech sector is also widely seen to be one of the biggest beneficiaries of behavioural changes in the aftermath of the outbreak — such as the shift towards e-commerce.

Case in point: Shares in Facebook rallied after the social media giant announced the launch of Facebook Shops, a platform that will help onboard small businesses — to sell their products and services directly through all of the company’s properties. The platform will be launched initially on Facebook and Instagram and will eventually expand to WhatsApp and Messenger.

Facebook Shops is similar to existing shopping platforms such as Lazada and Shopee — with the advantage of sellers having access to the Facebook family’s 2.36 billion daily active people (the number of people who are logged in to at least one of its properties on any one day). Purchases can be completed within the apps.

ServiceNow is another poster child for digital transformation, a secular trend that will now be accelerated. Its share price has rebounded strongly from the initial selloff triggered by the Covid-19 outbreak, rising to fresh all-time highs last week. While this means that valuations are rich, we are holding on to our investments for now, in view of the strong momentum for technology stocks.

ServiceNow is one of the most dominant software as a service (SaaS) brand names in the market, offering digitised workflow management tools for IT, HR and customer relationship management. These have helped ease businesses’ transition to work-from-home, a trend that is likely to persist even after restrictive movement measures are lifted.

Its revenue and earnings are also comparatively resilient. Top line and backlog growth increased 34% and 31% y-o-y respectively in 1Q2020 — with 94% of revenue derived from subscriptions and a customer renewal rate of 97%, on average. Gross margin improved 1%, from 86% in FY2019. About two-thirds of revenue comes from North America and 24% from Europe. It is sitting on net cash of US$2.2 billion ($3.12 billion).

Looking ahead, ServiceNow expects 2Q2020 to be weaker owing to Covid-19 disruptions — for example, in terms of securing and closing new deals and customers downsizing or deferring their renewals as cash flows tighten. It has projected slower revenue growth of 27% for the current fiscal year. On the other hand, operating margin is expected to improve by 2% to 23%, driven by both revenue growth and lower travelling and other operating expenses.

Rather than trying to time the market, we have kept the Global Portfolio fully invested. Nevertheless, there remain plenty of uncertainties and, we think, more volatility in the weeks and months ahead.

Johnson & Johnson (JNJ) is a comparatively defensive stock that has, at the same time, delivered impressive returns in the past. The healthcare giant rarely disappoints in terms of earnings results and has recorded 58 consecutive years of dividend increases.

Although valuations are not at bargain levels — it is currently trading at about 23 times trailing earnings — they are reflective of a quality company that is a global household brand name with a strong cash flow and balance sheet. In fact, JNJ is one of only two US companies that currently have an AAA debt rating.

There are three main divisions — consumer, pharmaceuticals and medical devices — which house an extensive portfolio of products. Some of its well-known consumer brands include Tylenol, Listerine, Johnson, Neutrogena and Acuvue.

Sales in 1Q2020 were up 4.8% y-o-y on an operational basis, excluding acquisitions and divestitures, while adjusted earnings per share (EPS) increased 10.5% on the same basis. Pharmaceuticals accounted for 49% of pre-tax profit and medical devices, 40%, with the remainder contributed by consumer.

The company expects to bear the brunt of the outbreak impact in 2Q-3Q2020, especially for the medical devices business (vision, orthopaedics, surgery) — with many elective procedures being deferred. This is its most profitable business segment.

On the other hand, the expected decline will be offset, to a certain degree, by better sales from consumer and pharmaceuticals, with increased demand for hygiene and health products as well as over-the-counter drugs.

Overall adjusted EPS impact is estimated at about 13%. JNJ’s global footprint and size gives it the advantage of economies of scale, which allows it to be competitive and earn an impressive 66% gross margin.

JNJ has a robust portfolio of pharmaceutical products, both developed in-house — it spent US$11.4 billion on R&D in 2019 — and acquired through mergers and acquisitions, which translates into low dependency risks on a few legacy products. Case in point: About a quarter of sales is derived from drugs released within the last five years. It has a healthy pipeline of products pending approvals.

JNJ is one of the companies leading the development for a Covid-19 vaccine, which, if successful, could be available for emergency use in early 2021. Unless the Covid-19 coronavirus disappears — which was what happened with the SARS virus — the world would need multiple vaccines developed by several companies to meet global demand.

The Global Portfolio fell 0.7% for the week ended May 28. As mentioned, cyclicals are enjoying a return in investor interest while tech stocks saw mild profit-taking after their strong run.

Homebuilder Lennar and building material companies BMC Stock and Builders FirstSource as well as The Boeing Company were among the top gainers in our basket of stocks.

Shares in Alibaba Group Holding, on the other hand, were buffeted by rising tensions between the US and China. In the previous week, the Senate passed a bill that allows it to delist Chinese companies from US stock exchanges based on certain criteria, including inability to audit financial statements.

Total portfolio returns now stand at 11% since inception. By comparison, the benchmark MSCI World Net Return Index is up by 6.5% over the same period.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

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