Tuesday 04 July 2017 by FIIG Securities sears Opinion

Real assets, less prone to disruption

As published in The Australian on 4 July 2017

The digital space is expanding rapidly – it’ll be difficult to predict where the next disruptor or advance comes from. So where does that leave investors? History tells us that bonds are more resilient to change than shares

Disruptors are coming thick and fast and investors unaware of technological and social changes will be left taking stock of losses, wondering how tried and tested high dividend payers started losing ground to new, more agile technological adopters.

There is a long line of disruptors and technological advances that have put companies out of business – email and Google putting traditional post, yellow page directories and encyclopaedias out of a job, digital cameras leaving the inventor Kodak in the dark, Uber, AirBnB, and now online US shopping colossal Amazon is coming to Australia.

The retail sector is perhaps the best case study of these changes. A generation of investors did very well out of Woolworths and Coles (through Wesfarmers) not to mention a string of related retail stocks at other times, such as Harvey Norman, JB Hi-Fi and others.

Now this paradigm is changing. The sheer might of Amazon, its online distribution model, cutting costs and delivering cheaper end goods has Australian retailers shaking in their boots and with good reason.

Last Christmas holiday season in the US, online shoppers spent USD91.7 billion, with Amazon dominating sales with circa 40 percent of all online purchases. It is ruthless in its approach, cutting costs wherever possible and reinvesting in making goods cheaper. It’s a winning strategy for Amazon and its shareholders, with the company’s shares having increased by five times in five years and market capitalisation now at USD478 billion. However, it’s not so good for competitors, with thousands of store closures and job losses.

Some of the big name stores to announce closures include: Sears and Kmart 246 stores, J.C. Penney 138, Macy’s 68, Radioshack 1,000, Gymboree up to 450 and Payless ShoeSource 500 plus, as it enters Chapter 11 bankruptcy.

There lies a warning to any business – embrace technology and plan to survive, or suffer the consequences.

Where does that leave investors?

Successful share investing is based on picking companies that will grow, but investing in bonds is more about survival as companies that survive will pay interest and return principal at maturity.

Some successful bond issuers are companies that are in declining industries but management are managing to downsize, consolidate and survive. Better to be a bond investor in that instance than a shareholder.

Best practice portfolio allocation suggests investors should always hold a mix of stocks and bonds, but the allocations should change depending on the market, the company’s performance and individual circumstances.

If you are worried about the performance of your retail stocks you could look to exit and buy the bonds of retailers instead. There is a long list of Australian retailers thought to be impacted by the arrival of Amazon – Woolworths, JB Hi Fi, Harvey Norman and Wesfarmers to name a few.

Wesfarmers shares have done little over the last four years since February 2013 when they were priced around $40, where they traded again this week. Dividend yield is attractive though at 4.89%, but you would expect Target and Kmart to be hit hard by Amazon.

Woolworths has performed better than many expected after fierce competition from Aldi. Its shares have rebounded from circa $20 to $25 over the last year, but the dividend yield is low at 2.63%. It’s hard to see how it can achieve significant growth in the face of such big competition.

Woolworths and Wesfarmers have bonds on issue and both are considered very good quality companies that are low risk, so the bonds pay low returns.

Wesfarmers has a floating rate bond, maturing November 2020 with a yield of 2.80% per annum. Woolworths has a shorter dated fixed rate bond maturing March 2019 with a yield of 2.42% per annum. The returns are low and we don’t trade these bonds often, although if one of your main concerns was not losing capital, these bonds would be good options, both companies are quality businesses that I expect will survive, but growth will be tough.

Another retail bond, paying greater returns is from health and beauty, consumable retailer, McPhersons. The company is ASX listed with a market capitalisation of $125 million. While small, it has two high yield bonds available – a floating rate bond due March 2019 yielding 4.91% per annum and a fixed rate bond maturing March 2021 with a yield of 4.65% per annum.

Real, monopoly infrastructure assets that are hard to replicate or be disrupted could be good additions to your portfolio. Sydney Airport comes to mind either the shares or the bonds and there are a number of indexed annuity bonds with state government cashflows that appeal – Melbourne Convention Centre and NSW Schools. Neither are listed. But they are linked to inflation, real assets and great diversifiers.

Another option might be to jump on the disruptor or tech bandwagon, and buy shares in Amazon or Apple. The trouble will be in deciding if valuations are accurate and whether growth can continue. Amazon shares trade at a whopping price/earnings of 186 times. Apple looks more attractive with a market cap of USD778 billion and a more respectable P/E ratio of 17 times.

If all else fails, exit and avoid the industries you think might be affected.

The pace of change will be unrelenting. So much of our lives will be online and many resources will be directed to the rapidly expanding digital space. It’ll be difficult to predict where the next disruptor or advance may come from.

History tells us that bonds are more resilient to change than shares. 

*Note: Prices accurate as at 30 June 2017 but subject to change.