Yarra's 3 big themes, 11 stocks (and the AI arms race)

After almost two years in the doldrums, the global technology sector has roared back since January, with the NASDAQ-100 index in the US growing by more than 40% (in US-dollar terms) in this period.

Much of the re-rating of the sector during this time has been driven by the buzz surrounding AI and the notably weak starting point following the sell-off in late 2022. There’s no doubt the theme is a game changer, however, in many instances, the fundamentals behind the share price growth of the perceived winners are less clear.

“In some cases, that’s been backed by earnings to a reasonable degree such as with Nvidia (NASDAQ: NVDA) and in some other names such as Meta (NASDAQ: META),” said William Low, head of global equities, Yarra Global Share Fund.

“There’s been a lot of hype about the potential of AI but we’re yet to see the clear evidence of who will be the genuine winners,” Low said.

He noted that there has been an almost overnight spike in news about the theme, but the AI tsunami that has swept markets in the last eight months has been nascent for many years. The rapid acceleration since the launch of OpenAI’s ChatGPT at the end of 2022 and the scale of adoption has surprised nearly everyone, even many professional investors.

The winners and losers

Low acknowledges that some of the investment team’s initial expectations around the challenges facing technology firms, in the tougher economic environment since inflation began rising late last year, were being offset by the unexpected scale and pace of the boost AI provided. However, his team believes that the theme has only begun playing out and has gradually increased its exposure to the sector, including a couple of new additions, as detailed later in this wire.

It has been a rollercoaster ride in markets in recent years. In US tech, the rotation into these names – including the likes of Nvidia, Amazon (NASDAQ: AMZN), Apple (NASDAQ: AAPL) and others of the so-called “magnificent seven” was most pronounced in the second quarter of this year, explained Low.

“Nearly two-thirds of the total returns of the benchmark globally came from just seven companies, the other 2,900 actually delivering a very modest amount. That is deeply unusual,” said Low.

He suggested a clearer picture of the “winners and losers” of this new AI arms race will only emerge once the dust settles after the US earnings season in the back-end of August. This is one of the reasons Yarra is proceeding more cautiously in its approach to the technology space and the affiliated communication services sub-sector.

“We’re still moderately underweight technology and communication services overall but have added to it more recently, where companies meet our Future Quality thesis,” Low said.

The team has added a couple of tech firms to the portfolio, in somewhat related areas where they are confident that AI (and other allied structural shifts) will underpin stronger-than-expected long-term demand and where those companies’ market positions are exceptionally strong:

Synopsys (NASDAQ: SNPS)

Market cap: US$69 billion

This Silicon Valley-based firm provides software for the design of electronics that support the development of AI technologies. “It’s a great, high-quality, compounding business,” said Lowe

Synopsys builds software products and provides consulting services in the electronic design automation industry. Its main products are pre-designed circuits that engineers use as components of larger chip designs, as well as software and hardware. 

The company works in several industries including electronics, financial services, energy and industrials. Synopsys is the leader in design technology and services for the semiconductor market. Traditionally this was composed largely of semiconductor companies but has expanded to include end-manufacturers that increasingly demand custom designs for their products. 

With chip complexity increasing quickly (partly driven by AI), Low expects this to translate into faster and more durable revenue growth and ongoing margin expansion at the company.

Netflix (NASDAQ: NFLX)

Market cap: US$190 billion

The streaming company that’s become part of the vernacular was added to Yarra’s portfolio for reasons apart from the AI effect – though it has almost certainly seen at least a small share price bump on the back of broader investor enthusiasm.

Netflix’s latest quarterly result on Wednesday in the US revealed the company added 5.9 million subscribers, making it the company’s second-best quarter, despite the market’s disappointment with lower sales growth.

Low cited Netflix’s business model changes as a key appeal, with management indicating it expects to reap more benefits from its new “paid sharing” functionality, which has been rolled out to 80% of its existing revenue base in more than 100 countries. A significant shift in the subscription model and plans to stop password sharing and introduce ad-supported subscriptions could lead to a reacceleration in revenue growth and likely a greater expansion of profit margins than is reflected in market expectations.

Ex-technology, how is the Yarra global share fund positioned?

Low’s priority is always to find individual companies on a path of sustaining or improving returns on capital over the long term. These companies often have a common theme, with the much-needed energy transition one that the team is focusing on.

“The picks and shovels companies that will enable that spending and the efficiency gains of that transition, we believe, have a tailwind of revenue growth and margins and the classic improvement we look for in terms of future quality,” said Low.

“Future Quality” is an underpinning of the team’s investment philosophy, which identifies and invests in companies that will attain and sustain high returns on investment. The companies should also have high-quality management, sustainable competitive advantage and growth that is appropriately financed.

Under the energy transition theme, a few names Low believes offer future quality include:

Worley (ASX: WOR)

Market cap: A$8.9 billion

The ASX-listed energy services company, first listed in 2002, provides project delivery and consulting services, primarily to the resources sector. The transition toward renewable energy is a key focus for the firm – alongside its traditional oil and gasfield services businesses – having already delivered some 2,500 projects in solar, wind, geothermal and other fields.

SLB (formerly Schlumberger) (NYSE: SLB)

Market cap: US$82 billion

The world’s largest offshore drilling company by revenue, Texas-based SLB is also pivoting more toward projects in the energy transition space, through its New Energy business unit. This follows a significant restructuring in 2020 after its CEO started a transformation of the company in 2019. 

As part of the restructuring, SLB exited the capital-intensive pressure pumping business and prepared the company to deliver low-cost and efficiency for clients while also enabling the move to new energy sources.

Linde plc (NYSE: LIN)

Market cap: US$191 billion

UK-headquartered Linde plc is a global industrial gases and engineering company. It designs and builds equipment that produces industrial gases. The company was formed by the 2018 merger of Linde AG of Germany (founded in 1879) and Praxair (founded in 1907 as Linde Air Products Company) of the United States. 

The industrial gas industry is uniquely well-placed to benefit from increasing investments in energy transition and the de-carbonisation of heavy industry. Importantly, it stands to benefit from a suite of potential solutions, including hydrogen and carbon capture and storage.

Healthcare efficiency providers

A ticking economic timebomb, the 65-plus age group is growing faster than any other demographic across Europe, East Asia and North America. In addition to dwindling working-age populations and the attendant productivity crunch, on the cost side, national healthcare a social security networks are already straining under heightened demand for healthcare services, long-term care facilities, and social welfare programs.

“We believe those companies that can deliver more efficient healthcare to solve that problem, while maintaining quality, have got tailwinds,” said Low.

Abbott Laboratories (NYSE: ABT)

Market cap: US$196 billion

Illinois, US-based medical devices and healthcare company Abbott Laboratories operates in the Americas, Asia, the Middle East, and Africa. Its core businesses span nutrition, diagnostics, and medical devices, having also made multiple acquisitions over the years, its latest being Cardiovascular Systems in February. The company is focused on innovating new products that can be used outside the hospital setting, making healthcare more affordable and accessible.

Tenet Healthcare (NYSE: THC)

Market cap: US$7.9 billion

A Texas-based company, Tenet runs 65 hospitals and more than 450 healthcare facilities. Its largest business is United Surgical Partners International, the US’s largest hospital and clinic network. Reducing the cost of healthcare remains a pressing issue for the US. Part of the solution to this problem is moving the delivery of healthcare to less costly settings. Tenet’s ambulatory surgery centres offer equivalent surgical outcomes for patients at a significantly lower cost. The future will likely see an increasing number of therapies offered in this setting, with the growth potential for Tenet not reflected in the stock’s valuation.

Travel

For Low, the appeal of this theme is the anticipation of a huge wave of spending from emerging nations in the next five to 10 years, especially on a per capita basis from China and India.

Three names Low believes are strong beneficiaries of this long-term trend are:

Booking Holdings (NASDAQ: BKNG)

Market cap: US$108.7 billion

The online travel company provides platforms for flight ticketing and travel reservations alongside accommodation and car rental booking. Booking is one of the largest online travel agents in the world, with a strong market share in Europe and the US. As COVID-19-related travel restrictions are lifted, consumers are set to spend less on goods for the home and more on the experiences that have been denied to them for the last two years. The valuation looks very attractive given this pent-up demand and the company’s strong market position.

Amadeus IT (BME: AMS)

Market cap: €30 billion

Based in Madrid, Spain, Amadeus IT Group SA provides transaction processing solutions to the travel and tourism industry. Its Global Distribution System (GDS) is the world’s largest, connecting travel providers (i.e. airlines and hotels) with travel buyers (i.e. travel agents). As COVID-19 restrictions continue to ease and consumers return to foreign holidays, this platform should see an enduring pick-up in demand.

Samsonite (HKG: 1910)

Market cap: HK$34.6 billion

A designer, manufacturer and distributor of luggage, Samsonite is a well-known global brand. Founded in 1910 in Colorado, the Hong Kong-listed firm has operations globally and a stable of brands including Samsonite, American Tourister, High Sierra and Tumi. 

Low and his team continue to see the gradual normalisation of global travel volumes (post-COVID-19) as a source of relatively secure growth through 2023 and beyond. With demand for Samsonite’s products closely linked to the recovery in travel and a more efficient cost base than existed pre-COVID, Low expects a substantial uptick in profits and returns from here.

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