Dear Clients and Colleagues:

Last week, the Lunar New Year was celebrated in Asia and beyond, and we entered the Year of the Tiger. Additionally, the 2022 Winter Olympics commenced in Beijing. As Asia appears more in headline news these days, you may wonder how it has been doing during the pandemic. The short answer is: resilient. Asia remains the fastest growing region in the world.

In 2020, global GDP contracted by 3.3% year-over-year, while Asia contracted by 1.5%. For 2021, the International Monetary Fund (IMF) forecasted that global GDP would grow 5.9%, while Asia would grow faster at 6.5%, including Hong Kong at 6.4% and Singapore at 6%. China grew 8.1% in 2021, and is expected to continue leading the Asian growth.

However, in the short term, Asia undoubtedly still faces many challenges.

• China: Although China rebounded strongly last year, thanks to robust exports, there are signs of fading momentum due to weakening consumption and a property downturn. The zero-COVID policy may continue to cause lockdowns that hurt local economies. 
• Slow COVID recovery: Although the vaccination rate is increasing in many Asian countries, the rise in new COVID cases, along with other supply chain issues, are causing production disruptions. Many countries are seeing an increase in cases following Lunar New Year celebrations. In Japan, where cases have reached record highs, the Prime Minister announced today the extension of its COVID-19 quasi-state of emergency in Tokyo and 12 prefectures; the restrictions are extended for three weeks, until March 6.
• High debt burden: The Federal Reserve System’s (Fed) interest rate increase trajectory will add financing pressure. The debt in Asia has increased significantly in the past 15 years. Back in 2007, Asia accounted for about 27% of global debt. In 2021, it accounted for almost 40% of global debt.

Geopolitical tensions: The rise of China has complicated the old post-World War II international order by challenging the United States’ (U.S.) dominance in Asia. Tensions between the U.S. and China have been escalating for years, with Taiwan being the key issue. There is no sign of easing from both countries.

However, looking forward, the future of Asia’s growth remains bright.

• High consumption growth: According to McKinsey, by 2030, Asian consumers are expected to account for 50% of global consumption growth, representing a $10 trillion opportunity, driven by rising incomes and changing consumption habits.
• Closer intra-Asia ties: The Association of Southeast Asian Nations (ASEAN) is a priority in China’s foreign policy. Since 2009, China has been ASEAN’s largest trading partner. In 2020, ASEAN became China’s largest trade partner for the first time, overtaking the European Union (EU). Regarding Foreign Direct Investment, China is ASEAN’s fourth largest source, after the U.S., Japan, and the EU.
• Accelerating digitization: Asia continues to vividly embrace the new digital world with Internet users far exceeding numbers in other regions. The trend is easily reflected by a high penetration of e-commerce, widespread e-payment systems, and active innovation carried out by companies.
• Vigorous R&D investment: Asia is the largest R&D investing region in the world, with more than 44% of the global R&D share, mainly due to the escalating investment by China’s government, industries, and universities.
• Renewable energy boom: Among the world’s installed renewable capacity, Asia has the largest share at 45%, vs. 25% in Europe, and 16% in North America, according to the International Energy Agency. Asia is also expected to account for 64% of new renewable capacity additions globally between 2019 and 2040.

At Global Alpha, Asia has been a very important market for our investments. It carries about 20% of the weight in the global small cap strategy, 45% in the international small cap strategy, and 75% in the emerging market small cap strategy.  

The valuation of Asian Small Caps is cheaper than peers in the U.S. and Europe. Based on the MSCI index data, as of January 31, 2022. Forward P/E of MSCI AC Asia Small Caps is at 12.8, vs. Europe Small Caps, at 15.8 and U.S. Small Caps, at 18.6. 

Our top three holdings in Asia are a good representation of diversification by region and sector, benefiting from the secular growth trends of consumption and healthcare.

L’Occitane (973 HK)

L’Occitane is a global retailer of skincare and beauty products made with natural and organic ingredients. Originally from France, it is a truly global player present in over 90 countries and 3,000 retail locations. Its key brands are L’Occitane en Provence, Elemis, and Limelight. Recently, it acquired Sol de Janeiro, an innovative leader in the global premium body care market, inspired by the Brazilian philosophy of self-love and joy. L’Occitane’s sales have surpassed the pre-pandemic level and last month, it raised full year revenue and profit guidance. We expect consistent growth, margin expansion, and synergies through sharing distribution channels and product development know-hows.  

Sega Sammy (6460 JP)

Sega Sammy is a Japanese entertainment company established through the merger of the game maker Sega and pachinko machine maker Sammy. It provides comprehensive products, including commercial video game machines, home video game software, and pachislot and pachinko machines. The company has many video game IPs. For example, Sonic the Hedgehog’s all time unit sales exceeded 1,380 million globally. Other popular titles include the Total War (37.8 million unit sales) and the Puyo Puyo series (35 million unit sales). There are a few exciting catalysts in 2022: the movie Sonic the Hedgehog 2 will be released on April 8, 2022; Sonic the Hedgehog animated series will be on Netflix; and a new title, Sonic Frontier, will be released in the winter of 2022.

Raffles Medical (RFMD SP)

Raffles Medical is a leading private healthcare group in Asia, with primary care, inpatient care, and specialist care. It was the first healthcare group in Asia to join the Mayo Clinic network back in 2015. The company has one hospital, and more than 60 clinics in Singapore, and three hospitals in China. Although the pandemic reduced regular patient visits, thanks to its excellent reputation, the company was chosen by the Singaporean government as the only healthcare provider to conduct COVID-19 screenings at the Changi Airport. It also provides COVID-19 PCR and serology testing and runs several vaccination centres in Singapore. We expect its China business to become the main growth driver going forward.

Have a nice week.

The Global Alpha team

1 World GDP 196 0-2022 | MacroTrends
2 IMF downgrades its growth forecast for Asia, says Covid still ‘ravaging’ the region (msn.com)
3 Coronavirus cases spike across Asia after Lunar New Year celebrations | LA Times
4 Japan to extend COVID-19 curbs for 13 regions by three weeks | Reuters
5 IMF says the Fed’s rate hikes will ‘definitely slow down Asia’s recovery’ (msn.com)
6 Meet your future Asian consumer | McKinsey
7 China and ASEAN: Flourishing at 30  | ORF (orfonline.org)
8 Global R&D investments unabated in spending growth – Research & Development World (rdworldonline.com)

Dear Clients and Colleagues:

The last time we wrote about renewable energy was in February 2021, right after the deep freeze in the United States (U.S.) that created havoc in energy markets, particularly in Texas. At the time, many criticized wind and solar as not being reliable sources of power, and over the last year, a lot has happened.

Clean energy stocks are down, and the U.S. has seen its first increase in coal-fired electricity generation since 2014. Additionally, the market is selling off, which creates some uncertainty; will we see a repeat of the clean tech bust that occurred more than a decade ago? In short, we do not think so, but rather believe the current correction is an opportunity.

The chart below shows the Wilderhill Clean Energy Index. It is a dollar-weighted index of publicly traded companies whose business stands to benefit from society’s move to cleaner energy and conservation. It is down 28% year-to-date and down over 65% from its peak in February 2021.

As you may know from reading our weekly commentaries, we believe in the present and future role of renewable energy. An important milestone occurred in 2013 when the world added 143 gigawatts (GW) of renewable electricity capacity, compared to 141 GW added from new plants that burn fossil fuels (including nuclear).

A new record for clean energy capacity was anticipated for 2021, as 290 GW was added, which is double what we saw in 2013. The International Energy Agency (IEA) notes, “By 2026, global energy renewable electricity capacity is forecast to rise more than 60% from 2020, to over 4,800 GW, equivalent to the current global power capacity of fossil fuels and nuclear combined.”

Solar power was the most important source of new capacity in 2021, with around 160 GW

In terms of growth for 2021-2026, China should add 1,200 GW of new capacity, four years earlier than its target of 2030. India will double its rate of growth for the period 2015-2020 and will have the highest rate of growth. The U.S. and Europe will also see higher growth rates than what we saw in the last five years.

This is driven by ever-stronger government commitments. The rising cost of fossil fuels also makes clean energy more competitive. In fact, 2021 saw the first increase in coal-fired electricity generation in the U.S. since 2014 due to the strong demand and the high cost of natural gas.

In terms of costs, despite rising raw material costs, renewables remain the most competitive options.

Renewables Downtrend Costs

Bloomberg Powder River Basin 8800 BTU Coal Spot Price FOB/Gillette Wyoming

New York Mercantile Exchange Natural Gas Future contract

In last year’s commentary, we noted that at the end of 2020, 27 U.S. states had renewable energy targets, including eight that had a 100% clean energy target. In 2021, five more states were added to the 100% club.

In the U.S., renewable energy sources increased from 19% to 20% for all of 2021, and should increase to about 24% in 2023.

We hear a lot about hydro, solar, and wind, and we have exposure through a few companies, such as Innergex (INE:CN), Schweiter (SWTQ:SW), and Landis+Gyr (LAND:SW). Less discussed are other forms of renewables, such as deep geothermal (note, we do not consider nuclear power to be a renewable source of energy).

Deep geothermal

Geothermal power is a key component of our energy future, as it is endless, green, and most importantly, base loaded to counterbalance solar. The caveat has been the scarcity of geothermal beds close to the earth’s surface. If only we could go deeper and longer. We have had the answer for a decade. Companies are now perfecting the adaptation of oil and gas fracking techniques to create deeper and longer geothermal looping systems to access the earth’s endless source of heat. Refer to last year’s commentary, published on May 6, 2021 for more details.

Ormat Technologies (ORA: US)

Since 2008, we have held Ormat Technologies (ORA US, ORA IT) in our portfolio, a world-leading geothermal energy company. Ormat Technologies was founded in Israel in 1965 to pursue its objective to further develop renewable energy. Active in the geothermal field since the early 1980s, the Integrated Two-Level Unit (ITLU) was a vital development in maximizing the thermodynamic efficiencies of lower-temperature resources. The patented ITLU design revolutionized the industry, and to this day, distinguishes Ormat from other companies. The company has been public since 2004, and has established its headquarters in Reno, Nevada. Further, Ormat is an energy producer with 1,015 megawatts (MW) of production globally (up from 933 MW last year). In addition to its geothermal expertise, Ormat is now a leading player in the field of energy storage and management with 83 MW of installed power. Its 2023 goals are to increase electricity production to about 1,265 MW and its energy storage to about 325 MW.

Gas capture

Methane is produced from decaying organics (i.e., food waste, livestock, and fracking). Methane negatively produces 25 times more heat capturing units in the atmosphere than carbon dioxide (CO₂). Converting captured methane into a natural gas equivalent (renewable or redeem gas) and then using it for transportation is actually carbon emission negative if we account for manure emissions. A mix with regular natural gas provides a complete carbon neutral gas, offering the U.S. energy infrastructure a potential carbon neutral future. As such, the five largest U.S. utilities have committed to zero carbon emission by 2050, renewable natural gas being core to the strategy.

Clean Energy Fuels (CLNE: US)

Based out of Newport Beach, California, Clean Energy Fuels Corporation owns and operates more than 560 natural gas fuelling stations across the U.S. and Canada, with over 1,000 fleet customers like Amazon, UPS or Waste Management. Clean Energy is a leading Renewable Natural Gas player with about 65% market share.

Biffa (BIFF: LN)

Biffa plc is a waste management company headquartered in High Wycombe, United Kingdom (UK). It provides collection, landfill, recycling, and special waste services to local authorities, and industrial and commercial clients in the UK. Biffa is the second-largest UK-based waste-management company.

The company is a leading player in capturing organic gases and turning them into energy. Biffa operates over 90 MW of generation capacity. In addition, the company is building two energy from waste (EFW) facilities; the first one will be ready in 2023 and will produce 42 MW, enough to power around 80,000 homes. The company is also investing in solar power with a goal to produce up to 100 MW by the end of the decade.

Hydrogen

The greenest of all molecules certainly holds great promise. Fuel cell, coupled with an electric motor, is two to three times more efficient than an internal combustion engine running on gasoline. Fuel cell costs have decreased by 70% since 2006.

A few of our companies, other than Clean Energy Fuels, participate in the hydrogen economy include Iwatani (8088:JP) and Hexagon composites (HEX:NO). You can read more about these companies in our commentary on May 6, 2021.

Have a great weekend.                                                            

The Global Alpha team

The Omicron variant of COVID-19 has caused some short-term weakness in the travel industry. The reintroduction of lockdown measures in some parts of the world, and the continuation of travel restrictions have once again penalized the industry. After a slightly tougher start to the year, we still expect the travel industry to begin its recovery by March or April.

One area of travel that surpassed the pre-pandemic era is the overall outdoor living and leisure products sector, and with it, recreational vehicles (RVs). Demand for RVs has remarkably increased over the past two years. Even before the pandemic, this market segment benefited from favourable structural changes.

We believe that future demand for RVs and outdoor products should remain strong, in part because of sustained consumer interest, as well as the fact that the profile among RV owners and outdoor enthusiasts has changed. The RV Industry Association (RVIA) noted that half of the 11.2 million households that own RVs are less than 55 year old, with the 18-34 years old category representing 22% of the market. The RVIA’s survey also showed that an additional 9.6 million households said they were considering buying an RV in the next five years, combined with over 10 million households that camped for the first time during 2020.

Thanks to the growing popularity of leisure vehicles among younger consumers and families, there has been an increased preference for local destinations, and more interest in eco-friendly vacations. We anticipate demand for outdoor products will remain strong.

Companies offering sustainable solutions designed for consumers interested in outdoor adventures and exploring nature more frequently, should do well in that context. Dometic, a company we initiated at the end of 2021 in our international portfolios, could benefit from that trend.

Dometic is a Swedish manufacturer of products within the climate, hygiene and sanitation, and food and beverages sectors. The products are used in recreational vehicles, pleasure boats, work boats, trucks, and premium cars. Some of Dometic’s products include: refrigerators, barbecues, heating solutions, air conditioning, blinds, power solutions, safety solutions, and much more.

Dometic operates 28 plants in nine countries, and 85% of products sold are manufactured in-house. The products are sold in close to 100 countries through Original Equipment Manufacturers (OEM), aftermarket, and distributors. The company generates 32% of its sales in Europe, 30% in the Americas, 9% in Asia, and 29% in global markets such as marine, residential, hospitality, mobile deliveries, coolers. During the last 12 months, the company reported sales of SEK 20,187 million (USD 2,229 million) and an EBIT of SEK 2,937 million (USD 324 million).

Market size

• Spending on outdoor recreation products in the United States (U.S.) represents US$185 billon per annum.
• Global Industry Analysts estimates that the global camping and caravanning market will grow from US$49.8 billion in 2020 to US$71.2B in 2026, growing at 6% per annum.

Growth strategy

• Signing more customers and increasing its product portfolio by developing new products.
• Entering new product categories or new applications.
• Growing the distribution network.
• Bolt-on acquisitions.

Strengths

• Strong market leading position (number 1 or 2 in most markets).
• Growing share in aftermarket channel, which carries a higher margin profile.
• High barriers to entry due to high product requirements and tailor-made product dimension.
• Strong relationships with clients.

Sales diversifications amongst RV, recreational boating, and commercial vehicles. 

January has the reputation of being the most disliked month. In many parts of the world, it’s a long, cold period without any festivities and not much to look forward to. And in the aftermath of Christmas, it’s also a month of financial reckoning. For a lot of people, money stresses are high as the credit card bills from December begin to roll in.

All the exuberant spending on Christmas and New Year’s comes due in January, adding an extra bite to an already frosty month. But not to worry. A brand new business model has emerged to help consumers keep on spending, despite the post-Christmas budget crunch.

We’re talking about a new generation of Buy Now, Pay Later (BNPL) services, which are “helping” consumers push that age-old IOU even further down the road. The tantalizing draw of instant gratification and delayed payment have helped BNPL companies flourish in recent years, but at what cost? While the BNPL industry is indeed growing quickly, high user fees, ballooning consumer debt, and lack of collateral, point to another financial crisis – and an unviable business model for the long term.

What is BNPL?

BNPL is simply a spin on the lay-away plan, wrapped in the latest technology and artificial intelligence to make it sound more appealing to young online shoppers. In a traditional lay-away plan, you have to finish making all the payments before you get the item. With the new BNPL model, consumers get their items right away, and make the payments later. The basic concept is the same: lure and nudge consumers to spend more on things they can’t immediately afford today, with the promise to pay in the future.

The big difference? In the past, lay-away was used to purchase mostly bigger ticket, tangible items, such as washing machines. Nowadays, online shoppers can use BNPL to pay for almost anything, from massages to t-shirts.

Source: Urban Outfitters

Who are the main BNPL players?

Four companies in the BNPL industry have built scale: Afterpay, Klarna, Affirm and Zip. Many other small players are more focused on a geography (e.g. Sezzle in the United States) and/or verticals (Brighte in home improvement).

The business model

In the BNPL world, there are no credit checks on customers. The merchant is paid upfront and the BNPL company collects the installment payments.

Cost can be incurred in three ways when using BNPL products:

1. Interest payments (if all payments are not made by specified deadlines);
2. Late fees; or
3. Account fees.

Costs differ for each provider. For example, Afterpay and Klarna don’t charge account keeping fees, whereas Zip collects a monthly account fee.

The maximum amount of purchases one can make varies depending on the company. On paper, credit loss is mitigated as the book turns anywhere from nine to 15 times a year, depending on the terms and loan balances.

What is driving BNPL industry growth?

Consumer

The massive shift to online shopping has naturally led to a growing increase in online transaction volume. There is also a structural shift away from credit cards to online payment methods, like BNPL. Penetration of BNPL is merely 1% of United States (U.S.) e-commerce and 1-3% in most parts of Europe, compared to 10% in Australia or 25% in Sweden, so there is a strong secular tailwind.

At a combined 140 million, Gen Z and Millennials now comprise the largest portion of the U.S. population. They are the driving force in e-commerce growth, and the primary target customers for BNPL operators. This is because many of them do not have credit cards, with a major concern being the fees and penalties associated with having one. Interest-free instalment payments offer an appealing alternative, and have quickly gained traction among younger consumers. Even older Generation X adults are starting to adopt BNPL products.

Merchant

There is an obvious value proposition for merchants, namely access to a large, engaged, and rapidly expanding online customer base. BNPL provides higher conversion from leads to sales, increased average order value, and improved online and in-store traffic. Many BNPL companies also provide customer insights and benchmarking data to retailers. The average merchant fee can range anywhere from 2-6%, depending on the provider and the services rendered.

The looming risks of the BNPL industry

Historically, recessions are almost always triggered by problems in the credit market. BNPL could very well be that trigger. For now, the consumer balance sheet is in great shape, but the question is for how long? What happens when government handouts stop, and all these installment payments come due? We could be setting ourselves up for the next global financial crisis.

Take credit scores, for example. As BNPL in most cases is not considered conventional credit, it does not show up on credit scores. This in turn paints a distorted picture of the consumer’s true financial health. 

Where is the collateral in case of default? Many consumers are using BNPL to pay for clothes, vacations or other services which do not have any resale value as they are not tangible. How will the lenders recover the unpaid debts?

There is also regulatory risk. The rules differ from country to country. In Australia, the BNPL industry is allowed to self-regulate. In the U.S., regulations are lax and differ by states. For example, the State of California requires BNPL providers to obtain a license from the Department of Business Oversight (DBO). But this is not the case in other parts of the country. In the United Kingdom (UK), the Financial Conduct Authority (UK) is currently reviewing the regulation of unsecured credit, including BNPL arrangements.

At some point, customers will have to come up with the funds to pay their loan, and if they don’t, they will be on the hook for late payment fees and/or high interest payments. Many customers might even default. One thing seems certain: BNPL loans will make the collective debt burden worse.

Portfolio impact

At Global Alpha, we do not invest in BNPL. Our focus is on finding high-quality companies with defensible business models and strong balance sheets that should outperform the small-cap benchmark.

However, one of our holdings, ACI Worldwide (ACIW), is benefitting from increased transactions online. Every time a customer uses a credit or debit card, a number of systems are involved, including the merchant processor: Visa, Mastercard, or the ATM and the card issuer systems. ACIW software essentially provides the “electronic handshake” that connects these systems.

Every second a purchase is made using BNPL, we can rest assured in some way or another that ACIW is benefiting from it without the inherent risk of the “buy now, pay later” industry. As the saying goes, ACIW is enjoying both the cake and the cherry.

Have a nice day.

The Global Alpha team

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2022 is already upon us and the New Year often brings up some resolutions, usually based on some form of self-improvement such as living a healthier lifestyle or picking up a new hobby. It is believed that the first resolutions were made about 4,000 years ago by the ancient Babylonians. The Babylonian New Year was actually in March, when crops were planted, and the festivities lasted for 12 days. Part of the festivities were making promises to the gods to repay debts and return any borrowed objects.

More recently, the link between the New Year and debt comes from consumers assessing their spending habits for the holiday season. A survey of 2,000 Americans by LendingTree showed that 36% of those surveyed spent more than they could afford during the holiday season, and went into debt with an average sum owed of just over $1,200. Putting debt onto a credit card remains the most popular option, and with the shift to online shopping, we saw an increase of almost 40% of “buy now, pay later” financing to spread out expenses. Whether this encourages consumers to spend more than they can afford is a different question. Credit cards remain an expensive way to borrow, and over 80% of holiday borrowers will be unable to clear their debt within a month.

During the early stages of the pandemic, credit card balances were paid down at record levels. During 2020, when American consumers were receiving more stimulus checks but had fewer ways to spend discretionary income, $83 billion was paid off in credit card debt.

However, as many predicted, there was a surge in consumer spending once vaccination campaigns progressed, COVID-19-related restrictions eased and the economy reopened, which meant people slipped back into old habits and credit card use increased during 2021. The latest data from the Federal Reserve Bank of New York saw a $17 billion increase in credit card balances.

The trend continued into the fourth quarter, fuelled by the holiday season. It was estimated that Americans were on pace to add $70 billion in credit card debt throughout the year. The expectation is that this number will continue to rise in 2022. TransUnion is expecting a further 10% increase in debt based on more applications for credit and increased spending.

By the end of this year, the balance is forecasted to reach over $800 billion, attaining its highest level since the start of the pandemic.

On a larger scale, a recent blog by the International Monetary Fund (IMF) observed that global debt was at $226 trillion at the end of 2020, which represents 235% of GDP. Debt was already high going into the pandemic, but actions were taken to protect lives and jobs and avoid significant bankruptcies.

There was a distinct difference between developed and emerging markets. Developed markets (and China) were responsible for over 90% of the $28 trillion debt that was added in 2020, primarily due to low interest rates and central bank actions. Emerging markets, faced with higher interest rates and more limited access to funding, added significantly less debt.

The problem going forward is finding the correct balance of fiscal and monetary policies in the current high debt, inflationary environment. The two combined well during the pandemic, with lower interest rates facilitating government borrowing. However, central banks are now signalling a rise in interest rates to combat inflation but this, combined with high debt, puts a brake on how governments can support the recovery and the private sector’s future investment prospects. Central banks are also reducing asset purchase programs. Fiscal responses have historically been less effective in times of rising interest rates. The greater risk is interest rates rising faster than expected, hurting economic growth. This would place heightened pressures on the most highly leveraged governments, households, and firms. If everyone has to deliver at the same time, growth will stumble.

Global Alpha has some exposure to the debt industry via two companies.

PRA Group (PRAA US)

PRA is one of the largest acquirers of non-performing loans in the world. PRA returns capital to banks and other creditors to help expand financial services for consumers. The main business consists of the purchase, collection, and management of portfolios of non-performing loans. These are typically unpaid obligations of individuals owed to credit originators: e.g., banks and other types of financing companies. The portfolios of non-performing loans are bought at a discount in two broad categories being core and insolvency operations

Core operations specialize in the purchase and collection of non-performing loans, which PRA is able to buy as the credit originator and/or other third-party collection agencies have not succeeded in collecting the full balance owed. Insolvency operations differ slightly as they seek to purchase and collect on non-performing loan accounts where the customer is bankrupt.

doValue (DOV IM)

doValue is a manager of loans and real estate assets for banks and investors. It is the market leader in Italy, Spain, Portugal, Greece, and Cyprus, which are attractive markets with significant growth opportunities because of high levels of non-performing loans and the strong interest from international investors. doValue is an independent servicer with an asset-light business model. It differs from PRA in that it does not make direct investments in loan portfolios or real estate assets. Revenues are earned from fixed and variable fees. doValue operates in high-value-added activities including the management of medium to large corporate loans secured by real estate assets (the non-performing loans), helping banks in the early stages of the loan management cycle (Early Arrears and Unable to Pay) and also in the optimization of real estate portfolios from credit recovery actions.

Have a nice day,

The Global Alpha team

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In the early days of the Covid-19 pandemic, the banking industry faced great challenges when the economy came to an abrupt stop. However, banks have weathered the pandemic well so far, and proven their value and contribution to the economy and society by ensuring ongoing funding to businesses and households. Unlike previous economic crises, banks’ profitability held up well. The largest lenders in the United States being JP Morgan Chase, Bank of America, Wells Fargo, Citigroup, and Morgan Stanley, have all beaten earnings expectations in the latest quarter and expect continuing economic rebound from the pandemic, despite many challenges the world is still facing.

While large banks help keep financial markets moving and support large company debt, the thousands of community and regional banks are a crucial source of funding for families and small businesses in the U.S. Small businesses are key to the U.S. economy, representing the vast majority of all businesses, and employing almost half of the private sector workforce. As of the end of 2019, the U.S. had 4,750 community banks with more than 29,000 branches throughout the country. Together, they represent 15% of the banking industry’s total loans, but make 36% of all small business loans and 70% of all agricultural loans, according to the FDIC’s 2020 Community Banking Study.

Many big and profitable companies obtained loans from the Paycheck Protection Program (PPP), which was intended to help small businesses keep employees on their payroll. Yet, many small businesses were let down by large banks’ slow responses and complicated application processes. Community and regional banks, on the other hand, responded quickly and proactively. In the first round of the PPP, community banks processed 60% of the program’s funding. Even after the large banks began to participate in the second round, community banks still accounted for 45% of the funding. As a result, many community and regional banks have fortified their relationships with clients and gained new customers during the pandemic.

Wintrust Financial Corporation (WTFC US)

Wintrust Financial Corporation (a holding in our portfolios), has over 150 Wintrust Community Bank locations, primarily in the Chicago metropolitan area, southern Wisconsin, and northwest Indiana through its 15 community bank subsidiaries. The company was founded in 1991 by current CEO Edward J. Wehmer, with the goal to provide an alternative to big banks. Over the years, they stayed true to their mission. In 2020, less than a week after the launch of the PPP, Wintrust built a customer-facing loan inquiry system, and created a new underwriting process to meet businesses’ needs. In the first week, the company took in 7,700 inquiries for $3.1 billion worth of loans. By the end of June 2021, it funded over 19,400 PPP loans for $4.8 billion. Despite the global pandemic, Wintrust had their record growth in 2020, total assets increased by 23% compared to 2019, and total loans increased by 20%. The bank’s consistent and conservative approach to credit and liquidity helped the company remain resilient during the tough times, and the nonperforming loan ratio actually improved to 0.4% in 2020, from 0.44% in 2019.

UMB Financial Corporation (UMBF US)

We also own UMB Financial Corporation in our portfolios. Headquartered in Kansas City, Missouri, UMBF offers commercial, personal, and institutional banking. Regional banking accounts for 37% of its total deposits. Its loan mix is more diversified than peers, across commercial & industrial, commercial real estate, residential real estate, and others. In 2020, its total loans increased by 10.4%, much faster than peer median loan growth of 2%. During the pandemic, the company works actively with customers by offering payment deferrals and loan modifications. The company also recorded over 5,000 loans totaling $1.5 billion under the PPP. Nonperforming loan ratio remained low at 0.55%, below peer average of 0.79%. With over 50% of its loans being variable, UMBF is well positioned to benefit from the eventual rate hikes projected in 2022.  

A major trend accelerated by the pandemic is the adoption of digital banking. As a result, the industry has seen an accelerated number of bank branch closures. In the U.S., there were 2,284 net closures in 2020, up from 1,391 in 2019, leaving the total number of branches to 74,928. In the United Kingdom (UK), 368 branches were shut down in 2020. 736 bank branches have closed permanently so far in 2021, and another 220 are already planned for 2022. The situation is no different in Japan. Mitsubishi UFJ Financial Group, Inc. (MUFG), the country’s largest lender by assets, plans to close 40% of its domestic branches by 2023 to cut costs. With the declining number of branches, ATMs have become an even more important touch point with end users. To improve operational efficiency, banks are increasingly sharing their ATM infrastructure or outsourcing the ATM operations.

Seven Bank (8410 JP)

Seven Bank (a holding in our portfolios), an ATM bank, is a beneficiary of this trend. It has the largest ATM network in Japan, with over 25,000 ATMs installed across the country. It also has over 9,000 ATMs in the U.S., 1,400 ATMs in Indonesia and close to 700 in the Philippines. With respect to ATMs, people may simply think of cash deposits or withdraws as transactions, as commonly seen in North America. However, Seven Bank ATM is a lot more than that. The company is upgrading all of its ATMs to the fourth generation, which incorporates advancements in biometrics, artificial intelligence (AI), Internet of Things (IoT), and other technologies. The next-generation ATM is capable of face recognition for identity verification, settlement with QR codes, optimized operations through AI and IoT, and there is a 40% decrease in electricity usage and CO₂ emissions. Seven Bank is also partnering with banks and non-bank institutions to provide financial services, including topping up e-money cards, international money transfers, refund issuances, bill payments, advancing wages, and much more. For example, during the pandemic, many musical and sports events were cancelled, and customers were able to get a refund through Seven Bank’s ATMs; residents in Japan were also able to get Covid-19 cash handout from the government through these ATMs. With the digitalization of the economy, ATMs are not becoming obsolete, but proving to be indispensable.

As this will be our last weekly commentary of the year, we would like to thank you for your continued support, and wish you a joyful and prosperous 2022.

Happy Holidays!

The Global Alpha team

Recent headlines have been focused on the energy sector to lead the global transition to a low-carbon economy. However, one sector that hasn’t been getting the attention it deserves is the consumer discretionary space. Current consumer spending habits are responsible for about 60-70% of global emissions. Consumerism has been deeply rooted in the current culture, but perhaps it’s time for some change. During the most recent Paris Fashion Week, a climate activist walked out onto the runway holding a banner stating consumerism = extinction. Although this might be a bold statement and doesn’t necessarily represent consumer sentiment, shoppers are in fact looking for more responsible alternatives in their day-to-day purchases. Consumers will thus need to have access to more recycled and reused products to satisfy their desire to make a difference and contribute to the circular economy.

The fast-fashion industry has been growing at a rapid pace and is expected to increase by 63% in 2030, which would be the equivalent to producing 500 billion t-shirts.1 The excess production is largely due to shorter wearing cycles. On average, consumers are buying about 60% more goods and are wearing them for 50% less time. As a result, they are simply thrown away, and 85% ends up in landfills.2 The Global Fashion Agenda recently published a new report about scaling the circular economy and the need to reduce barriers to mass recycling programs, specifically for textiles. In order to achieve this, fashion manufacturers need to focus on the following factors: their materials need to be used more, made to be made again, and made from safe and recycled or renewable inputs.

“Used more” entails producing goods that have greater longevity. It has long been known that certain companies count on planned obsolescence to push consumers to purchase more and boost sales consistently. However, there are benefits to higher quality and lower production volumes. Inventory levels can be limited, thus requiring less storage capacity and less inventory is thrown away or destroyed, minimizing fees paid to landfills and incineration facilities.

“Made to be made again” is a class of products that are manufactured to be disassembled at the end of their life-cycle with the aim of being repurposed or reused. The packaging component of the product is also meant to be minimal to avoid additional waste generation. Alternatively, it may be produced from reusable materials.

“Made from safe and recycled or renewable inputs” involves production that uses these inputs efficiently by optimizing resource consumption, as well as limiting or avoiding hazardous waste. Hazardous waste is often discharged into the environment, causing harm to both humans and ecosystems. Limiting the use of virgin materials is a key component, because it often leads to the irreversible degradation of the world’s limited natural capital.

Global Alpha currently holds two companies who are leading the way by innovating in the circularity of the fashion industry.

Asics

Asics is a global sports and lifestyle brand that manufactures a wide range of products. Since its beginning, the company’s ethos has been, A Sound Mind in a Sound Body.To achieve this, the company is also focusing on a sound environment. Earlier this year, Asics launched their Earth Day Pack, a collection of shoes made from recycled plastics using a circular manufacturing process. Through this method, the company was able to use the equivalent of 25,000 t-shirts to produce the entire shoe collection. Today, 95% of their new running shoes already contain some recycled materials. By incorporating circular manufacturing processes, they are able to help reduce their own footprint, while reducing the amount of waste sent to landfills. In the company’s most recent materiality assessment, stakeholders identified circularity as one of their top concerns in which Asics will use this as a guiding target to improve and shift their strategy to a cleaner and more sustainable one. Their VISION 2030 roadmap will help them achieve these specific goals. Some of these ambitions include creating a circular business model, both internally and externally with suppliers, as well as increasing the percentage of recycled materials within each of their products.

Coats

As a leading industrial thread manufacturer, Coats has been an example of what a company in the textile industry should strive to achieve. Sustainability is a core part of their operations, and as a key input for more than 30,000 apparel and footwear manufactures around the world, they are able to make a positive impact in numerous supply chains. Plastics account for a large part of their footprint, and this is where they are looking to make the biggest difference. Currently, the company’s threads are manufactured using 95% virgin plastic, but by 2024, they are looking to completely switch to 100% recycled plastic inputs. Additionally, they want to switch their energy consumption throughout their global operations to largely come from renewable sources.

Due to the company’s dedication to sustainability, they have been attracting many new customers who are looking to improve the quality of their suppliers. The company’s EcoVerde line, which came out in 2018, offers 100% recycled alternatives to virgin polyester by reusing PET water bottles. Since the line’s inception, they have recycled 240 million plastic bottles and avoided about 5600 tonnes of CO₂ in the process.⁵ Now that’s impressive! In our February 4, 2021 commentary, Untangling the threads of sustainability in fashion, we further highlight Coats’ focus on sustainability in fashion.

ESG is an integral part of Global Alpha’s company assessment and we reward companies that show excellent practices and take initiative to advance their sustainability journey. We will continue to look for leaders paving the way in the consumer discretionary industry, fighting climate change, and contributing to a positive future.

Have a nice day.

The Global Alpha team

As we approach the two year mark of COVID-19, there is little doubt of the impact this pandemic has had on how employees and managers think about life in the office. The onset of COVID-19 revealed that many businesses were ill-equipped to deal with going completely remote, investments in technology soared, and platforms Zoom, Teams, Slack and Webex became household names. In the early days, predictions from experts ranged from a revolution in our working lives to a return to normal within months. Individuals were quick to adapt by either buying homes, sometimes far away from the city, or renovating to create their own office space at home.

Managers and business owners were faced with answering new questions: how do you assess remote workers’ productivity? Who is liable if employees injure themselves at home? How late in the evening is too late to reach out to your employees? Now, with a significant portion of the developed world fully vaccinated and able to return to working from the office, we find that many of these questions are yet to be answered. However, we are starting to see some trends.

The peak of working hours spent at home in the United States (US) was over 60% in May 2020, a significant increase from less than 5% pre-COVID-19. It is estimated that current working hours spent at home are over 40%, indicating that the “remote-first” philosophy is still alive and well in many parts of the labour market. Numerous academic studies on the matter of productivity concluded that productivity was either equal or better when working from home, although the definition of productivity differs from one study to another. A survey by Statistics Canada found that roughly half of the remote workers reported completing as much work from home as they previously did in the office, and another third reported they got more done. One explanation for these results is that it is easier to focus on tasks at home than in the noisy office, where distractions can be plentiful. Another explanation focuses on the benefits of technological tools on teams’ coordination and effectiveness.

There is a risk, however, in having workers self-report on their productivity, as feeling more productive does not necessarily mean they actually are. Studies that did not rely on surveys often found mixed results. For example, in many cases, the increase in total productivity was the result of an increase in hours worked, which, is often not sustainable in the long term and might have other impacts on quality of life. In other pieces of research, the increase in productivity for standardized tasks increased, whereas innovation and more creative tasks were penalized due to a lack of interaction and exchange of ideas. Indeed, observers have noticed that virtual work led people to be “siloed” and interact mostly with a small group of their peers, compared to individuals working in the office. This reduction in contact among networks led to many inefficiencies that are not as easily noticed, but are just as damaging to the quality of output in environments that require a more creative and collaborative approach.

One of the more impactful downsides of working from home that many young professionals are not fully realizing yet, is related to career development. It is much more difficult to move up the corporate ladder without the in-person coffee chats or getting to be known around the office, and no amount of Zoom meetings with your supervisor can compensate for this. The counter-argument that promotions will be based more on merit and the work done as a result of work from home is idealistic at best. While output and knowledge of the business matters, managers tend to prefer promoting people they want to work with, therefore people who are not able to market themselves well will be penalized. Considering that many people who finished school in the last year and started their first job have yet to meet their colleagues in person, one can wonder if they will face the same long-term hurdles in their careers as recent graduates faced during the 2008-09 recession.

Given the current state of the labour market, employees seem to be holding the bigger end of the stick for now, and “remote-first” is likely to stay for some time. It is difficult for management to request that employees go back to spending 1-2 hours commuting every day when some of them are already getting unsolicited job offers from competitors and talent is difficult to attract. Working from home is now a perk and not a small one either. A widely thrown around number is that the average employee views being forced back to the office full time as being equivalent to a 5% pay cut. For companies already dealing with material and labour inflation, not forcing their employees back to the office is an easy way to retain and attract talent without exorbitant salary increases.

Now, going back to the usual question: how does Global Alpha get its exposure? We aim to obtain it through a few different angles.

IWG (IWG LN)

We have previously written multiple commentaries about IWG. IWG is a global leader in flexible workplaces with a portfolio of over 3,300 locations across 100 countries and known for its many brands, including Regus. Before COVID-19, the flexible office businesses only had a 5% market share, which is estimated to almost double over the next five years. The company saw its share price suffer at the onset of the pandemic, but has since then been lauded by investors as a strong play on the reopening and a true beneficiary of the modern hybrid workplace post-COVID-19.

Mimecast (MIME US)

Mimecast is a cloud-based platform that offers email security solutions ranging from targeted threat protection to large file sending services and data leak prevention. Mimecast benefitted significantly from the move to working from home as companies were looking to invest to modernize their cybersecurity architecture, and should continue to benefit as the corporate world has to strike a balance between work from home and on premise.

The push and pull we describe above between employers and employees is likely to outlast the pandemic by a long shot, and the resulting hybrid model will bear some difference to the pre-pandemic corporate model. Already, hot desking reservations are becoming the norm across bigger companies looking to downsize or optimize their space given their workforce will not return to the office full time in the near future. The standard 9-to-5 will become less standard as people are now set up to work from home and will have more leeway in making their own hours. Others will realize they need more human contact or a better split between work life and home life, thus will go back to spending a majority of their working time in the office. One thing is for sure: remote-only is not the new normal.

Have a nice day.

The Global Alpha team

The planet is 70% covered by water. Freshwater, which is what we drink and irrigate our farm fields with, represents 3% of the world’s water; two thirds of that number tucked away in frozen glaciers.

According to the World Health Organization (WHO), 33% of the global population finds water scarce for at least one month of the year, exposing them to diseases such as cholera, typhoid fever, and other waterborne illnesses, resulting in two million fatalities. At the current consumption rate, 66% of the world’s population may face water shortages by 2025. As these changes occur, water consumption will further become a strategic asset negotiated for agriculture, industrial use, and personal consumption.

Many coastal agglomerations have been able to plan personal water consumption with natural gas fueled desalination. This strategy can be onerous given the ongoing present energy crisis. Inland rural developments, which have exploded with COVID-19, are more affected by severe droughts. Australia is the poster child for this situation. Australians have been dealing with economy-changing droughts for decades and are already experts at rationing water. Rural expansion continues to be an important growth driver that further stresses the effects of droughts.

On August 16, the United States (US) federal government declared a Colorado River water shortage for the first time as water basins reached critical levels. This will have a material impact on agricultural goods in North America as the region produces a large percentage of winter crops. Companies with better water strategies will outperform.

Global Alpha holds Limoneira (LMNR:US), a leading citrus grower in California, a state that uses an excess portion of its share of the Colorado River. Their plantings are located in Ventura, Tulare, San Bernardino, and San Luis Obispo Counties in California and Yuma, Arizona and La Serena, Chile. The plantings consist of approximately 5,000 acres of lemons, 900 acres of avocados, 1,600 acres of oranges, and 1,000 acres of specialty citrus and other crops.

Unlike many growers, Limoneira owns important water rights, including rights on 17,000 acre-feet of water in California and 11,700 acre-feet of water sourced from the Colorado River, of which only 8,600 acre-feet are currently used for irrigation. The majority are categorized as priority rights, and these rights will increase in value as we start to restrict the usage of the Colorado River outflow.

Other North American Global Alpha holdings that play an important role in water distribution include Lindsay (LNN:US). The company pioneered crop irrigation with the Zimmatic pivot irrigation systems. We also own Primo Water Corporation (PRMW:US), the leading distributor of non-disposable drinking water in North America.

Continuing on crop performance, Global Alpha holds Sakata Seeds (1377 JT), an agriculture seed developer based in Japan. One of their leading technology efforts is developing seeds that can grow in arid environments. We also hold Horiba (6856 JT), which makes testing equipment, part of their environmental franchise. Also, water testing is set to grow in their portfolio of products.

Droughts not only affect crops but also hydroelectricity generation, which is notably 17% of China’s energy generation, 65% of Brazil’s, and 60% of Canada’s. Norway reached 95% of internal electrical generation (Statista 2021), enough for the country to recently complete large hydro export investments (PowerTechnology, 2021).

Norway had a grand scheme of being the green battery of Europe with its abundant water reservoirs to export electricity. These plans are on hold as droughts has dwindled the Norwegian water supply enough to exacerbate the European energy crisis. Hydroelectric power is critical to base load power.

Global Alpha holds Landys and Gear (LAND SW). The company is a key player in smart metering with the largest install base outside of China. We expect regulations to increase drastically in the future as water and electricity output become highly managed resources. Landys and Gear markets should continue to grow at an above-average rate.

More than a quarter of Australian homes collect and store rainwater for domestic use. It will become interesting how dry countries, such as Australia and Israel, can transfer their expertise to regions who are now experiencing droughts such as Western Europe.

According to a January 2020 report by Markets and Markets, the global smart water management market size is expected to grow to USD 21.4 billion by 2024, at a compound annual growth rate (CAGR) of 12.9%.

Desalination represents a potential solution to many water issues despite its negative environmental footprint from energy usage and residual effluent. Reverse osmosis is also reaching its limits in terms of performance. Inexpensive green power and desalination technologies are therefore required. The use of wastewater has also reduced the cost of desalination to $1,500 per acre-foot from $2,500. By comparison, a San Diego agglomeration needs to pay $1,200 per acre-foot for fresh water from the Colorado River.

Globally, more than 300 million people now get their water from desalination plants, from the Southwest US to China. The Middle East accounts for 47% of all desalination, while East Asia Pacific and North America hold 15% of desalination capacity.[3]

As we can clearly see, water consumption, agriculture, and electricity generation are key interlinked industries that can provide important growth drivers in our investment universe. As always, Global Alpha remains keen to benefit from these growing trends.

Have a nice day.

The Global Alpha team