S.T.E.P. Changes to Sustainable Growth
27th July, 2020
In our fast-changing “new normal” world, we believe that evaluating companies against four trends can provide valuable insights on where to invest for sustainable growth and the “triple bottom line” of planet, people and profits.
We live in a fast paced and ever-changing world. New technologies appear and disappear seemingly overnight and companies and their investors are increasingly looking beyond just profits to a “triple bottom line” that also focuses on the welfare of people and the environment.
How can we ensure that the companies we invest in will be disruptive innovators able to ride secular trends while also being mindful of their impact on society and the planet? In our experience, four trends can reveal valuable insights on companies that are well placed to flourish in the new environment. These are Social Change (S), Technological Disruption (T), Next-Generation Economies (E) and impact on the Planet (P). Together, these form our S.T.E.P. Changes ethos that seeks to identify companies likely to deliver consistent, sustainable growth.
The S.T.E.P. Changes ethos complements and informs the overarching QUALITY, QUANTAMENTAL, ESG (QQE) philosophy and process that underpin our investment platform.
Quality: We believe companies that are long-term winners demonstrate high quality in their profitability, persistence, protection and people. Quantamental: We seek to capture the best insights from different investment styles by combining the consistent, wide breadth of coverage of our quantitative model with the in-depth fundamental analysis of individual companies. ESG: We seek a further investment edge from assessing how companies are responding to growing environmental, social and governance business risks.
We believe that the secular trends driving sustainable growth often involve some form of Social Change (such as ageing populations, sustainable consumption or diversity & inclusion) or Technological Disruption (such as artificial intelligence, food technology, fintech or privacy & cyber security). These have the capacity to drive Next-Generation Economies, for example, the growing trend of working from home, a virtual & sharing economy or regenerating circular systems. At the same time, Social Change and Technological Disruption can have a positive impact on our Planet through better resource management, sustainable consumption or sustainable energy.
It is our view that companies aligned with these S.T.E.P. Changes are best placed to capture today’s trends. From an investment perspective, the S.T.E.P. Changes point to several of the themes addressed by us, such as Health & Wellness, Smart Cities & Living, Automation & Artificial Intelligence, and Agriculture & Food Technology.
Figure 1: S.T.E.P. Changes; Source: Davy Global Fund Management, 2020.
We view Social Change and Technological Disruption as enablers of Next-Generation Economies and ways to find solutions to issues affecting the Planet.
SOCIAL CHANGE (S)
Population growth and changing demographics are driving Social Change. The OECD and other governmental agencies expect the global population to grow by one billion (13%) by 2030. The fastest growing segment will be the over 60s age group, which will comprise about 20% of the populace! This segment will continue to grow as cleaner drinking water, better sanitation, improved hygiene and innovations in vaccines and antibiotics lead to greater life expectancy. By-products of this trend will create opportunities for companies in areas such as health & wellness. An example is consumers using technology to improve and monitor their wellbeing.
Garmin Ltd. is a high-quality, debt-free, cash-generative smaller company operating in this space. Its wearable outdoor lifestyle products tap into these themes in a sustainable way. Management ensure that the materials used in its products are sourced responsibly, and that staff in its supply-chain companies are treated fairly. It is the combination of these different facets of its business model which we believe makes it a long-term sustainable growth story.
Urbanisation is another key social trend with approximately half the global population now living in cities. The UN expects this to rise to two-thirds by 2030, creating some very large cities. Cities whose populations are greater than 10 million people are often referred to as megacities. Although COVID-19 may alter the pace of this trend, 33 megacities already exist today. These population centres are increasingly evolving into smart cities in which infrastructure, transport and utilities are digitally interconnected. This is achieved in the planning stages using building information management (BIM) software, which design teams of architects, engineers and construction firms use to share virtual models of projects.
Nemetschek Group AG is a high-quality business and one of only two firms globally that is able to change human interaction using this type of cutting-edge technology. Barriers to entry are high and this capability has become a requirement of firms tendering and working on public sector projects. The BIM market is expected to grow over 14% annually to 2027 in the drive to create smart cities.
TECHNOLOGICAL DISRUPTION (T)
Technological Disruption is innovation that significantly alters the way consumers, industries or businesses operate. It comes in many forms, from e-commerce to artificial intelligence, and is facilitated by vast increases in the volume, variety and velocity of data. According to market intelligence firm IDC, data creation will swell to 175 zettabytes (1 zettabyte = 1021 bytes) by 2025. Information provider IHS Markit estimates that there will be over 125 billion internet-connected devices by 2030, versus 17 billion today.
The exponential increase in data is creating new markets that in many cases can only be handled by advances in machine learning and robotics. Companies will need to rapidly innovate to take advantage of this new world. An example of such innovation is collaborative robots or “cobots”. These are robots that work uncaged alongside humans and fill gaps in the labour force by automating repetitive tasks. They enable man and machine to work in harmony.
Teradyne, through its Universal Robotics (UR) division, is a leader in this market. Teradyne acquired UR in 2015 when management realised the growth rates in its end markets were maturing. Management decided to invest free cash flows in a high-growth adjacent market – cobots. With these machines having a payback period of about 6 months, the market is growing at over 40% annually and is expected to be worth $7.5 billion by 2027.
NEXT-GENERATION ECONOMIES (E)
Social Change coupled with Technological Disruption is helping to create Next-Generation Economies (E). These are often referred to as “circular” economies given that they seek to regenerate natural systems by design. They are driven by sharing rather than ownership and focus on sustainable consumption and non-exploitative practices, such as conserving resources, reducing waste and lowering carbon emissions.
Companies operating in this new environment will have to re-think current manufacturing practices and find ways to do more with less. One solution we are enthusiastic about is additive manufacturing. This simplifies the production process by basing it on digital files. These are sent to a printer, from which the parts are printed and the unit is built. This allows manufacturing to be flexible, since firms only make what they need, when they need it, with virtual teams sharing designs over video calls. During the COVID-19 pandemic, firms have digitally ordered and manufactured products for immediate use. Digital manufacturing integrates a variety of tools, such as simulation, 3D visualisation and analytics. The addressable (potential) market could be worth over $1.4 trillion by 2030, according to technology consultant Cap Gemini, from $685 billion today.
Protolabs Inc. is a digital manufacturing services platform that has enabled customers to quickly produce components for life-saving equipment, diagnostic systems and personal protective equipment (PPE). Its fast-turnaround manufacturing capabilities have allowed clients to operate through the pandemic lockdown. Enabling engineers to design, order and manufacture equipment from home has allowed social distancing protocols to be maintained. As a consequence, its 1Q20 results beat market expectations while many larger manufacturers around the world were closed.
Next-Generation Economies are increasingly concerned with their impact on the Planet (P). This is also true of consumers who are pivoting to more sustainable consumption. Awareness of mankind’s impact on the planet is steadily increasing, which is shifting people’s consumption practices. As the world population increases, we are seeing a resurgence of farming in and around cities, which is known as urban farming. People are reconnecting to agriculture, growing their own food and visiting farmers’ markets. This fast-growing phenomenon makes fresh produce more affordable, promotes sustainability and encourages health and wellness. It is quickly becoming an important part of a city’s food system, especially as this is where half the world resides.
The Scotts Miracle-Gro Company is one way to invest in this industry. It sells fertiliser, seeds and nutrients for lawns and gardens and has around a 50% market share. Its hydroponics systems are used by urban farmers as they offer a complete solution for growing plants, including lights, nutrients, media and tools. Its specialised products generate double-digit returns and margins, while its hydroponics and vertical farming products are achieving double-digit top line growth. This reduces the seasonality of the business.
The way we think about everything, from public policy to product design, is changing profoundly as we move away from a society that “takes, makes and wastes” towards a more circular economy. The S.T.E.P. Changes ethos we outlined above helps us to contextualise opportunities that align with the major drivers of Social Change (S), Technological Disruption (T), Next-Generation Economies (E) and impact on the Planet (P).
Warning: Past performance is not a reliable guide to future performance. The value of investments may go down as well as up. Returns on investments may increase or decrease as a result of currency fluctuations.
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