Investment Themes Affirmed

Insight
March 27, 2020
Patrick A. Snell, CFA, CAIA
Principal, Portfolio Manager

 

The fact that the government imposed economic shutdown (due to social distancing) has led to reduced expectations for economic activity and extreme equity market volatility, is not new news.  Nor are the Fed’s recent accommodative monetary initiatives and this week’s $2 trillion Senate stimulus bill entirely unexpected.

What may be less obvious, as it relates to M Capital’s investment process, is that recent developments (industry dynamics, behaviors by individuals) across several sectors provide us with a greater conviction in many of our multi-year, industry-related investment themes.

Cloud Computing – C-level suite/government mandates requiring work from home (WFH) and remote learning have highlighted the utility of on-demand applications.  Cloud-based video conferencing and collaboration solutions (a.k.a.  video chat apps: Zoom Video, Microsoft Teams, Google Hangouts, Cisco WebEx, Apple FaceTime, etc.) have increasingly become a daily part of business and consumer activities.  Industry-specific applications have experienced a similar boost in user interest (e.g. remote, application-enabled detailing by pharma sales reps with health care provider clients).  This recent development gives further credence to Cisco’s forecast that 94% of all workloads and compute instances will be processed by cloud data centers by 2021; and IDC’s forecast that global spending on cloud computing IT will double from 2019 to 2023 (from $229B to ~$500B).

Cyber Security – Solutions that provide secure remote access are positioned to benefit from the WFH phenomenon as well as the inherent flaws related to VPNs (virtual private networks) still used by most companies to enable access to their IT networks.  More specifically, cloud-native security solutions deployed via forward proxy servers ensure that no company’s origin server communicates directly with a specific end-user client device that could be infected.  In addition, greater utilization of connected devices should support strong demand for emerging endpoint detection and response (EDR) solutions which utilize machine learning and behavioral heuristics to detect non-signature-based attacks.

Advanced Connectivity – Rapid growth in remote internet users (e.g. WFH, streaming media, online video gaming) and related data transmission levels are creating incremental demand for network and communication system infrastructures that are capable of higher speeds and bandwidths. This demand is in alignment with mobile wireless networks’ multi-year upgrade cycle to 5G, the next generation wireless standard.   Despite near-term economic uncertainty, we do not expect any material slowing in most 5G network rollouts, and in fact, we suspect related infrastructure investments could become an element of economic stimulus packages in many countries over the next year or two.

Video Gaming – The earlier-than-planned return home by college students has generated a spike in online gaming activity, affirming the notion that this recreational activity is still in high demand and a key social connector.  We continue to anticipate market growth will be driven by several factors including: (a) new game releases and enhancements to existing games, (b) a new 2020/2021 console cycle, (c) the emergence of streaming games, and (d) the growth in eSports.

Biophama Innovation Wave – The ecosystem responsible for the accelerated pace of new drug approvals over the last few years includes not only large pharmaceutical companies and smaller biotech players, but also life science companies and clinical research organizations (CROs).

Recognizing the critical need to “flatten the curve” related to COVID-19, a significant swath of major players in the ecosystem are marshaling their resources to rapidly diagnose patients and develop treatments and vaccines.  While trial results could lead to potential treatments as early as April, consensus expectations surrounding the availability of curative vaccines is 12-18 month from today.  That being said, close to 40 companies are racing ahead with early stage development efforts for vaccines that use several different mechanisms of action, some of which are novel.

Elsewhere, life science companies have taken a leading role in diagnosis of COVID-19.  To detect SARS-CoV-2, several of these companies have recently introduced customized reagent test kits that run on top of real-time polymerase chain reaction (RT-PCR) instruments (national laboratories utilize those instruments to process samples).  We expect the COVID-19 outbreak will ultimately accelerate the global prioritization of diagnostics development at the government and commercial levels.

While the pandemic might slow the pace of clinical trial initiations, many CROs are beginning to embrace virtual, site-less trials. In this newer model, virtual visits, phone interviews, self-administration and remote monitoring allow trial participants to avoid public interaction with potentially ill people (during their check-ins at trial sites) and instead maintain participation from their own homes.

Evolving Health Care Delivery System – The federal government recently issued formal guidance recommending hospitals delay non-essential elective surgeries (e.g. knee replacements, gallbladder operations, certain spine procedures) in order to build near-term capacity for COVID-19 cases. While deferral of that high-margin revenue stream will be painful for hospital systems (~25% of hospital admissions are “elective”;  ~15% of hospital revenues are associated with surgeries scheduled >10 days in advance), those same hospitals may seek to discharge vulnerable patients to Home Health, in the event of a COVID-19 surge.  That surge could boost industry volumes for a sector that is increasingly recognized as a lower-cost/high-quality health care setting.  Also, Home Health is shielded from significant volume headwinds since it primarily provides non-elective services.

Elsewhere, the pandemic has raised the utilization of telehealth platforms that provide on-demand healthcare services to consumers.  These 24/7 communication solutions enable doctors to quickly triage patients and better manage potentially dangerous overcrowding in hospital systems.

Managed care companies, through acquisitions, have created vertically integrated delivery models which are now (during this health crisis) in a position to prove they are more convenient and cost-effective.  For example, manned by nurse practitioners and physician assistants, CVS’s HealthHUB stores include workspaces for a respiratory therapists and in-house blood labs, as well as host virtual doctor visits.

Migration to Online/Mobile Media – Social distancing is translating into greater at-home media consumption.  Consumers are recognizing the value/convenience offered by Over-The-Top (OTT) streaming video services (primarily delivered via broadband).  In addition, more people are upgrading to faster and more expensive connection speeds and/or buying larger data plans.

Over the last month, significant growth in remote software downloads, video game streaming, and over-the-top (OTT) media consumption has driven a notable spike in IP traffic.  Expected to carry nearly two-thirds of all internet video traffic this year, content delivery networks (CDNs) appear well positioned to benefit from these trends.

eCommerce Wave – Mandated social distancing and announced store closures have bolstered overall eCommerce activity, with elevated demand in food, household, health, and consumer electronics categories offset by weakness in travel, apparel, and jewelry.   Based on relative low penetration levels, convenience and other factors (e.g. AI-powered smart speakers, social commerce), we continue to expect global eCommerce to sustain double digit growth over the next few years.

 

 

 

If you have a question or need further information, please contact:
Don Keeney, CFA, CFP, Principal & Portfolio Manager in Nashville at 615-866-0882, or don@mcapitaladv.com
Claude Koontz, CFA, Principal & Portfolio Manager in San Antonio at 210-353-0519, or claude@mcapitaladv.com

Mastrapasqua Asset Management, Inc. does business as M Capital Advisors.

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The information and opinions contained in this report should not be treated as fact or as insight that will produce desired investment results over time. Investment conclusions always bear risk, and that risk may not be reasonable for any particular reader. Obviously the writer, even assuming good intentions, does not know of the reader’s particular financial circumstance and therefore is not able to assess the propriety of whether a named security makes sense as part of a given individual, family, or institutional portfolio. Mastrapasqua Asset Management clients may, from time to time, own some of the companies mentioned. We hold out no duty to give readers of this column advanced notification of when we may change an opinion. To our knowledge, none of the information contained in our column would, when it becomes publicly available, have an influence on the valuation of a particular stock. Investors should receive investment advice based on an assessment of their own particular investment circumstances and not on the basis of recommendations in this report. Past performance is not indicative of future returns.