06 FEB

2018

Equities , Geoffroy Goenen , Asset Class

Darwinomics: capturing the growth of tomorrow's winners

In a macroeconomic environment of moderate global growth, persistently low interest rates and attractive European equity valuations, the best strategy for capturing growth and profitability over the medium and long term is to invest in innovative European companies. The gap between value and growth stocks is old news: only tomorrow's winning bets are the real attractive investments. Innovation points the way.  

After several years of widespread and virtually uninterrupted market rallies, investors no longer have a choice: they owe it to themselves to be selective. Sitting on the fence and being passive will be expensive for investors and companies alike. The cycle for adopting products, services and technologies is getting faster and faster, shooting some to the top and dragging others to the bottom. In this Darwinian economy, where only the strongest, most flexible and above all the fittest can survive, innovation is the best indicator of how well companies are able to adapt.

Against this backdrop, Candriam has developed a new approached based on the following strong conviction: high-quality innovative companies are the only ones with a lasting competitive advantage, guaranteeing growth and profitability in a global economy offering less potential than in previous decades. Welcome to the Darwinomics era: adapt or die...


Ageing of the population and weak productivity gains

As is true all around the world, Europe's population is growing older and, barring an (unlikely) change in Euro zone Member State immigration policy, will be a burden on growth (charts 1 and 2). Furthermore, considering how low business investment has been since the Great Recession, productivity is unlikely to be quickly restored to higher rates of growth. 



A confining debt ratio

As shown in Chart 3 - Debt ratio of Euro Zone Member States - current debt ratios are on average 50% to 100% higher than 30 years ago, except for Belgium. The most glaring case is, of course, Greece.

Such a massive debt burden, combined with Maastricht Treaty criteria, leave most States with little leeway in their budget to stimulate growth. 




Only one possible outcome

In these conditions, only high-quality innovative companies capable of generating growth and new markets by themselves will come out ahead.

This is why we firmly believe that investors need to be selective when it comes to their portfolio investments and demanding in terms of the growth outlook of the companies in their portfolio.

 

Value creation

The “Quality/Growth” portfolio management style should be at the forefront in the coming years; companies offering little value creation and overly dependent on external growth (as is the case with the “Value” style) have a rough road ahead of them.


Changing perspective

Furthermore, the gap between growth stocks and value stocks is outmoded over the long term, in our view. Today, no sector is safe. What might appear to be a Value stock could actually end up being expensive because it won't last. Conversely, today's “high-multiple” pick could prove to be a big winner in the future.

With the product life cycle accelerating and disruptions coming more and more often, innovation is the best indicator of a company's probability of survival and growth.


Analysis and selectivity

To be sure that a portfolio's profitability will last, the key is not only to identify companies that are growing today, but also will keep growing in the future. Only an active portfolio management approach, based on a fundamental analysis of each existing or prospective investment, can detect high-potential companies and rule out fading or soon-to-be extinct business models. Analysis and selectivity are crucial when it comes to investing in innovative companies with the potential to be the winners of tomorrow.

Several sectors are particularly exposed to innovation.

For example, big changes are taking place in the Food & Beverage sector. Consumers are clamouring for more natural colours and preservatives. They are more aware of the impact of diet on their health, and are demanding antibiotic-free meat, preservative-free yoghurt, ready-made meals with less fat, salt and sugar, etc. These trends are creating more fragmentation on the market, increasing the importance of ingredient suppliers in the production chain. In turn, suppliers are having to develop increasingly complex and innovative solutions of their own. Companies like Kerry and Chris Hansen are specialists that have succeeded in this area.

Meanwhile, the automotive industry is rapidly trending towards cleaner, smarter cars. In this sector as well, specialist and innovative suppliers have the most to gain. While the general public is well aware that diesel-fuelled cars are on the decline, the all-electric solution that will usher in the end of the thermal engine's long reign is closer than they may think. Some observers predict that 70% of the world's cars will be electric by 2050 [1]. Major car manufacturers are in the market for lighter, more energy-efficient materials and smaller, high-performance batteries. Self-driving, connected cars also call for their share of technological solutions in terms of sensors, algorithms, mechatronics, artificial intelligence and connectivity. The Internet also has its place in the sector: ride sharing and rental platforms now pose a real threat to traditional car rental agencies.

The industrial sector is also changing fast. Industry 4.0 is now the standard. Production processes are digitised from start to finish. Products are designed virtually, in 3D, and smart factories are taking the lead in mass production. This transformation is bringing manufacturing and jobs back to Europe, while promoting shorter, more efficient and more economical production times.

These sectors are just a few examples of the growing number of changes taking place throughout the Economy.

Companies have their eye on the ball

The strong wave of M&A activity, led by major-league Chinese and US buyers, is squarely focused on innovative European targets. China's current liquidity surplus, combined with the lack of any real alternative in today's low interest rate and moderate growth environment, will continue driving this activity with sights firmly set on European know-how, just as Japanese buyers were 30 years ago.

Recent examples of mergers and acquisitions are plentiful. Kuka, the forerunner of Industry 4.0 and the leader in automated production solutions for the automotive industry, was bought by China's Midea Group, and ARM, the world leader in smartphone and tablet processors, was snatched up by Softbank.

 

Conclusion

In light of current macroeconomic conditions (moderate global growth, persistently low interest rates, attractive European equities), we recommend investing in innovative European growth stocks.

The gap between value and growth stocks is old news: only tomorrow's winning bets are the real attractive investments. Innovation points the way.  

We adamantly believe that investing in this theme today is one of the best, if not the absolute best strategy, for capturing growth and profitability over the medium and long term.

 


[1] Harald C Hendrikse, Morgan Stanley, “Autos & Shared Mobility: One billion BEVs by 2050”, May 5, 2017