Identifier: Global Equity

As we write this commentary, the first half of the year is behind us and most stock indices are at all-time highs. Earlier in the year, an inflation scare drove the United States (US) 10-year Treasury yield to 1.74% with a small correction in growth assets like those listed on the Nasdaq. It seems the market has decided to follow the cues of the US Federal Reserve (Fed) that inflation will be transitory, once the effects of the pandemic, the pent-up demand and the disruptions to the supply chain are behind us.  Since March 5, equity markets have been roaring back and the 10-year Treasury yield is now range-bound at around 1.5%. Inflation numbers, however, continue to rise.

What do we think at Global Alpha? Unfortunately, we do not have a crystal ball, nor have we reached a consensus amongst ourselves. However, we believe the risk that inflation will be sustainably higher than the target of 2% established the Fed and many central banks is high.

The table below shows the prices of various commodities. Many would argue that 2020 was an outlier.  That is why we based our comparison on 2019, which was a normal year with a strong economy. The numbers are self-explanatory. In many cases, prices are at multi-year highs. Copper is now at its highest level since 2011, and reached an all-time record this quarter, as did lumber.

Price of (in US$)June 28, 2019June 30, 2020June 30, 2021% increase over 2019
Oil (Bbl)58.4739.2773.9026%
Natural Gas (Mcf)2.311.753.6558%
Gasoline (gallon)1.771.262.2627%
Corn (Bushel)41437358541%
Pork (lb)0.870.751.0420%
CRB Food Index34829048840%
Copper (MT)59936015933556%
Aluminium (MT)18201620255240%
Lumber (MBF)37943671889%
CRB Index40836055737%
Baltic Freight Sea shipping138117993418247%
Sources: USDA, CRB

The broadest measure of commodity prices, the CRB Index, is at its highest since 2011, when it reached an all-time high. Its component, the CRB Food Index, is also at its highest since 2011, near its record high.

Many observers will brush off commodity price inflation, arguing that it is caused by an imbalance between demand and supply that normally reverts within a few quarters. Although true, the supply response can take a lot longer than expected. Oil and gas companies are under enormous pressure and are not increasing exploration. Political uncertainty in South America may slow the supply growth for copper. The effects of weather events seem to have a more permanent effect on the inflation of agricultural commodities. For now, let’s assume that supply will come back and prices will come down. The example of lumber, which has recently retreated from above $1700/mbf to just over $700 may prove this point. In our opinion, what may drive a more sustainable inflation will be wage increases, which are driven by inflation expectations.

What we are witnessing currently, particularly in North America, is a wage inflation between 5% and 10% for the lowest earners. Inflation expectations are running close to 4%. There is a risk that the situation becomes a self-feeding mechanism, like in the 70s. Another big component of inflation is rent. The median asking rent in the US has increased almost 18% from the end of March 2020 to the end of March 2021, reaching $1,226 per month. It is up 22% since March 2019.[1]

Many have stated that a big reason for the low-inflation of the last twenty years was the emergence of China and its vast labor pool of migrant workers as the factory of the world. In May of this year, China’s producer price index reached 9%, its highest level since the summer of 2008. China will no longer be the deflationary force it has been in the last two decades. Between the aging of its population, its internal needs and increasing trade frictions, we can expect price increases from China.

Inflation numbers will continue to be very high, one might even call them scary for the next twelve months. How the Fed, politicians, unions, consumers and investors will react to these numbers will be important to watch, and our job is to forecast. We are already starting to see some divergence between central banks, like those of Norway, New Zealand and Canada, and even within the ranks of the Fed.

How will the market react to increasing signs that inflation will be more than transitory and that rates will rise?

Past episodes have shown that long-duration assets like long-term bonds and high growth stocks will be most affected. US large caps, particularly technology companies, are selling at important premiums versus other markets. They will be most vulnerable. Europe does not have the same labor inflation pressures. That said, inflation in the region may be more contained.

Smaller companies have generally outperformed in periods of inflation. From January 1979 to July 1983, the Russell 2000 Index outperformed the S&P 500 Index by 77%. During this time, inflation rose to as high as 13% and the economy suffered a double-dip recession in 1980 and 1981-82, before staging an extremely strong recovery in 1983 with growth rates as high as 8.5%.[2]

Our portfolio is well positioned for a strong recovery accompanied by higher inflation. With less debt, a rise in interest rates will have a minimal impact. With a more important exposure to the consumer and industrial sectors, economic growth will translate into earnings growth.

As mentioned in last week’s commentary, our companies have been able to maintain their margin despite rising input costs through a combination of price increases and efficiency gains.

[1] www.census.gov

[2] http://www.cmegroup.com/

Monetary trends continue to suggest a slowdown in global industrial momentum in H2 2021, with a rising probability that weakness will be sustained into H1 2022 – contrary to the prior central view here that near-term cooling would represent a pause in a medium-term economic upswing. Pro-cyclical trends in markets have corrected modestly but reflationary optimism remains elevated, indicating potential for a more significant setback if economic data disappoint. Chinese monetary policy easing is judged key to stabilising global prospects and reenergising the cyclical trade.

Global six-month real narrow money growth – the “best” monetary leading indicator of the economy – peaked in July 2020 and extended its fall in May, dashing a previous hope here of a Q2 stabilisation / recovery. This measure typically leads turning points in the global manufacturing PMI new orders index by 6-7 months but a PMI peak was delayed on this occasion by a combination of US fiscal stimulus and economic reopening. A June fall in new orders, however, is expected to mark the start of a sustained decline, confirming May as a significant top – see chart 1.

Chart 1

The magnitude of the fall in global real narrow money growth and its current level suggest a move in the manufacturing new orders index at least back to its long-run average of 52.5 during H2 (May peak = 57.3, June = 55.8).

China continues to lead global monetary / economic trends, as it has since the GFC. A strong recovery in activity through 2020 prompted the PBoC to withdraw stimulus in H2, resulting in a money / credit slowdown that has fed through to weaker H1 2021 economic data. The central bank, however, has been reluctant to change course, partly to avoid fuelling house and commodity price speculation, and six-month real narrow money growth has now fallen to a worryingly low level, suggesting rising risk of a “hard landing” in H1 2022 – chart 2.

Chart 2

Real narrow money growth remains above post-GFC averages in other major economies but has also fallen significantly, reflecting both slower nominal expansion and a sharp rise in consumer price inflation. Six-month inflation is likely to fall back during H2 but nominal trends could weaken further in response to higher long-term rates and as money-financed fiscal stimulus moderates.

The suggestion from monetary trends of a deeper and more sustained economic slowdown could be argued to be inconsistent with cycle analysis. In particular, the global stockbuilding or inventory cycle bottomed in Q2 2020 (April) and, based on its 40-month average length, might be expected to remain in an upswing through early 2022, at least. This understanding informed the previous view here that a cooling of industrial momentum in mid-2020 would prove temporary.

A reassessment, however, may be warranted to take account of the distorting impact of the covid shock, which stretched the previous cycle to 50 months. A compensating shortening of the current cycle to 30 months would imply a cycle mid-point – and possible peak – in July 2021.

This alternative assessment is supported by a rise in the business survey inventories indicator monitored here to a level consistent with prior cycle peaks – chart 3.

Chart 3

The previous quarterly commentary suggested that cyclical equity market sectors and value were less attractive in the context of an approaching PMI peak, while quality stocks had potential to rally. MSCI World non-tech cyclical sectors lagged defensive sectors during Q2, with quality and growth outperforming value – chart 4. These trends could extend if the slowdown scenario described above plays out. Chinese policy easing would support the cyclical / value trade but the impact could prove temporary unless the Chinese shift resulted in an early rebound in global real narrow money growth.

Chart 4

Counter-arguments to the relatively pessimistic economic view outlined above include the following:

1. Fiscal policy remains highly expansionary and will offset monetary weakness.

Response: Economic growth is related to the change in the fiscal position and deficits, while large, are falling in most countries. Even in the US, President Biden’s stimulus package served mainly to neutralise a potential drag as earlier measures expired. The US fiscal boost peaked with the disbursement of stimulus cheques in March / April.

2. Household saving rates and money balances are high, implying pent-up consumer demand.

Response: Savings rates have been temporarily inflated by government transfers and will normalise as these fall back and consumption recovers to its pre-covid level. High money balances probably reflect “permanent” savings. US households planned to spend only 25% of the most recent round of stimulus checks, according to the New York Fed, using the rest to increase savings and reduce debt. The implied spending boost has already been reflected in retail sales, which may fall back in Q3.

3. Services strength as economies reopen will offset any industrial slowdown.

Response: The services catch-up effect is temporary and momentum is likely to reconnect with manufacturing in H2. Industrial trends dominate economic fluctuations and equity market earnings.

4. Profits are rising strongly, with positive implications for business investment and hiring.

Response: Profits are still receiving substantial support from government subsidies, withdrawal of which will offset much of the additional boost from economic normalisation. An increase in net subsidies relative to their Q4 2019 level accounted for 10% of US post-tax corporate economic profits in Q1, according to national accounts data – see chart 4.

Chart 5

5. Inventories to shipments ratios remain low, implying that the stockbuilding cycle is far from peaking.

Response: Economic growth is related to the change in stockbuilding, not its level. Stockbuilding is highest when inventories are low – the subsequent fall is a drag on growth even though stockbuilding usually remains high until inventories normalise. Low inventories to shipments ratios, therefore, are consistent with a cycle peak.

6. Industry has been held back by supply constraints – output and new orders will surge as these ease.

Response: Supply difficulties have probably resulted in firms placing multiple orders for inputs, inflating PMI readings – this effect will unwind as bottlenecks ease. Historically, manufacturing PMI new orders have fallen, not risen, following a peak in supply constraints.

7. Rising inflation will boost bond yields, supporting cyclical / value outperformance.

Response: Last year’s global money surge was expected here to be reflected in high inflation in 2021-22 but six-month broad money growth has moved back towards its pre-covid average, suggesting that medium-term inflation risks are receding. Bond yields usually track industrial momentum more closely than inflation data so would probably remain capped in a slowdown scenario even if inflation news continues to surprise negatively.

The COVID-19 vaccination campaign continues to gain momentum in Europe. According to the European Centre for Disease Prevention and Control, 194 million Europeans have received at least one dose of the vaccine (52.5% of the adult population), and 106 million are now fully vaccinated (28.7% of the adult population). In the meantime, European equity markets have been outperforming other regions since March. After years of capital outflows, European equities seem to have regained some interest from International investors.

We recently conducted interviews with a number of holdings, including Royal Unibrew, Autogrill, and Soitec, and found it notable that most management teams we spoke with mentioned the improving pace of the recovery. European companies continue to acknowledge inflation, but many seem to argue that a combination of price increases and cost cutting can mitigate the impact. Looking the at Corporate Social Responsibility (CSR) agendas of these companies, their sustainability initiatives continue to improve. With the energy transition and digitalization as a source of growth, European companies could be beneficiaries of a new stimulus package.

After months of discussions, the European Recovery Fund (also known as the Next Generation EU) came to life at the end of May after it was ratified by all national parliaments. With the national ratifications completed, the EU can now make funds available and start issuing bonds. The fund was designed to help member states manage the economic and social impact of the COVID-19 pandemic. The fund’s other objective is to ensure that the EU countries’ economies undertake a green and digital transition in order to make them more sustainable and resilient.

The EU Recovery Fund is an important tool for the economic and political perspective in the EU. For the first time, the EU will be able to borrow large amounts for budget purposes. While the larger EU economies are likely to receive more in nominal terms, countries with lower per-capita GDPs should be the biggest recipients. The EU Recovery Fund, which will finance part of the energy transition plan, became the key financial pillar of the EU’s Green Deal. As a reminder, the objective of the EU Green Deal is to achieve climate neutrality by 2050 and to further reduce greenhouse emissions by 2030.

A significant part of that €750 billion European fiscal plan (2018 price) will come from the Recovery and Resilience Facility (RRF), which should capture 90% of the total envelope. The EU Commission has stipulated that governments should spend at least 37% of the RRF on the green transition, and 20% on the digital transformation. The Commission also set up key areas for spending:

  • Clean technologies and renewables
  • Energy efficiency of buildings
  • Sustainable transport and EV charging stations
  • Rollout of rapid broadband services
  • Digitalization of public administration
  • Data cloud capacities and sustainable processors
  • Education and training to support digital skills

Some industries should benefit from that spending program, particularly the capital goods, construction, automotive, and utilities focusing on renewables. The digital transformation objective should drive some IT services and telecommunications companies, especially the ones exposed to 5G, rural connectivity, digitalization/modernization, e-heath, smart cities, and connected education.

We believe that the EU Recovery Fund will be supportive for the European equity market. This, combined with an acceleration of the vaccination campaign, could explain some of the recent catch up of EU equities. Let’s hope that the funds will be used in full and spent wisely over the next few years.

The beauty industry is one of the oldest in the world. For centuries, we have debated the true nature and form of beauty; can it be objectively defined? Or is beauty truly “in the eye of the beholder,” as the saying goes.

Many great philosophers like Plato, David Hume, and Immanuel Kant have tried to define the term beauty, yet a universally valid definition remains elusive. There is, however, one thing most of us can agree on: appearance is the most visible aspect of beauty. Throughout the ages, men and women have striven to enhance their appearance – investing time, energy, and money in the pursuit of beauty’s closest cousin: attractiveness.

Historians can trace our use of beauty products and cosmetics back to 3100 BC, when the ancient Egyptians used kohl to create dramatic eyes. With today’s evolving technologies, we have moved from simple products such as eyeliner, to highly sophisticated serums, Botox, fillers, and laser treatments. And now, the cosmetic industry has moved far beyond the face, offering beauty-seekers a wide variety of non-invasive products and procedures for the entire body.

COVID’s unexpected impact on the beauty business

Since the start of the COVID-19 pandemic, face masks have been mandated across the globe. Over time, we’ve gotten used to wearing them and seeing them on others. But few anticipated how face masks could be a tailwind for the cosmetics industry.[1]

Cosmetic centres around the world have seen a large increase in demand for Botox injections and laser treatments, specifically around the eyes and upper portions of the face – the areas highlighted by the face mask.

Meanwhile, the massive boom in video-conferencing has generated a hyperawareness of facial “imperfections.” Confronted with endless hours of poorly-lit, unflattering reflections of ourselves on Zoom calls, many are investing in aesthetic procedures to enhance their appearance online.

The result? Soaring demand for deep-plane facelifts, resurfacing laser treatments, and other non-surgical procedures across the globe.

Everyone is looking for a beauty boost, a break from lockdown monotony, or a fresh face for the summer terrace. This week, we introduce you to InMode, a portfolio holding that should benefit from the booming beauty market.

Business Overview

InMode was founded in 2008 and is headquartered in Yokne’am, Israel. InMode is an esthetic equipment company that designs, develops, and manufactures minimally invasive (MI) and non-invasive aesthetic medical products.

InMode uses fractional radiofrequency, which allows a more precise delivery of energy to targeted areas of the body with only a small incision. Hence, it is more effective than other non-invasive procedures, offers much faster recovery, and has a lower risk profile than full plastic surgeries.

Their MI product line is used to perform procedures, such as liposuction with simultaneous skin tightening, body and face contouring, and ablative skin rejuvenation treatments. While their non-invasive products can help with procedures, like facial skin rejuvenation, wrinkle reduction, cellulite treatment, and skin appearance and texture.

Target Market

According to Medical Insight, the global professional aesthetic industry is valued at $11.5 billion, and is expected to grow at a 9.9% CAGR in the next few years.

Growth in the medical aesthetic industry is being driven by the following factors:

  • An aging population that wants to remain youthful
  • A flight to out-of-pocket work among doctors and clinicians
  • Growth of social media and video-conferencing
  • Growing availability of non-invasive and minimally invasive procedures
  • Improving efficacy

InMode’s Competitive Advantages

  • First mover advantage in minimally invasive aesthetic market, delivering surgical-grade results with no competitor in sight
  • Strong barriers to entry – patents, development timelines, global regulatory approval, and peer-reviewed published clinical data (56 articles)
  • Brand recognition, feedback from doctors, and a strong safety track record
  • Aligned management team with a proven track record and industry expertise

Growth Strategy

  • Product development, releasing 2 new platforms every year (ophthalmology and ENT in 2021)
  • Distribution in existing and new markets
  • Cross-selling (20% of clients purchase a second platform within 18 months)
  • Growth of consumables from current 10-12% to 25% in the MT

Management

  • InMode is led by an experienced team of entrepreneurs, who have seen a large market potential, given the treatment gap in the industry

Risks

  • The aesthetic laser and light-based treatment system industry is vulnerable to economic trends
  • Increased competition
  • Regulations could delay product launches

Global small cap companies like InMode are not always known by name, but they almost always touch our daily lives in important ways. As life slowly gets back to normal, you may notice a lot more flawless skin and toned bodies, as consumers take advantage of innovative medical aesthetic products delivered by market leaders like InMode.

Perhaps this gives new meaning to the saying — “beauty is skin deep”?

[1] https://www.economist.com/international/2021/04/11/covid-19-is-fuelling-a-zoom-boom-in-cosmetic-surgery

Inflation has been at the centre of attention recently. The most recent core personal consumption expenditure data release, which excludes food and energy, was at a level not seen in decades. Despite this, the Fed has not acted yet, believing that it is transitory due to a combination of low base level and a challenged supply chain. With the economy transitioning from recovery to stability, and no tapering just yet, commodity prices look set to remain at current high levels. Therefore, the question is: are these current commodity prices also transitory, or are we going to enter a commodity supercycle?

A supercycle is hard to define, but can be generalized as a long-term period, usually greater than 10 years, where commodity prices are above their long-term trend. Supercycles are caused by an event that causes a significant increase in global demand. In natural resources, bringing a significant new supply, such as building a large mine or developing a new oilfield to the market (i.e., not just restarting idle mines or oilfields), can take years.

In the last century, there have been three commonly identified supercycles. The most recent was caused by the rapid industrialization of China that consumed raw materials at a pace that oil producers and miners could not keep up with. Before that, there was the oil crisis of the 1970s, which caused an increase in production costs for other commodities, hence lifting their prices. The third was related to rebuilding infrastructure after the Second World War.

Those who believe we are entering a supercycle point to governments needing to focus on job creation and stimulus post-Covid-19, rather than fiscal responsibility in the wake of the great financial crisis. They point to commodity-heavy infrastructure spending and green projects, such as the $2.3 trillion American Jobs Plan and Europe’s Green New Deal as evidence of this. Another reason why we could be heading for a supercycle is the lack of new or expansion projects that could respond to an increase in demand. Each supercycle is followed by an equally long period of low prices as demand wanes and new supply emerges. Recent years of low commodity prices have meant producers have spent less on exploration and production.

A contrasting opinion is that these commodity prices are more of a spike than entering into a new supercycle, with the recovery and fiscal response being the cause for the increase in commodity prices; this opinion is shared by the Fed. They believe this is not the structural change in demand needed for a supercycle and any increase in demand from the green energy transformation will be offset by slowing growth coming from China. Rather, they foresee sustained rallies in certain commodities more highly correlated to energy transition or electric vehicles and a limited new supply, such as copper, cobalt, nickel, lithium, and some rare earth metals.

Whether this is a short-term spike for commodity prices, or the start of another supercycle, Global Alpha has a diversified commodity exposure across its portfolios.

Westgold (WGX:AU) owns and operates three mining centres in Western Australia, a very favourable mining jurisdiction. These three operations have a throughput capacity of over 4 million tonnes per annum production capacity. The potential upside to throughput will come from the Big Bell mining operations, where production is set to go from 250,000 oz per annum to a long life 300,000 oz per annum average. Westgold has a solid balance sheet and will generate strong free cash flow as the company moves from an intensive capital spending phase.

Alumina (AWC:AU) is a leading Australian resource company with a specific focus on alumina, the feedstock for aluminum smelting. Alumina owns 40% of the world’s largest alumina business, Alcoa World Alumina and Chemicals (AWAC) JV with Alcoa. AWAC assets include bauxite mines and alumina refineries in Australia, Brazil, and other countries. AWAC also owns a 55% interest in an aluminum smelter in Australia. AWAC is the world’s largest producer of alumina and has a low position on the bauxite and alumina cost curves.

Aurubis (NDA:GY) is a leading integrated copper group and the largest copper recycler worldwide. The company produces over 1 million tons of copper cathodes per year, and from them a variety of copper products. Aurubis also produces precious metals, lead, nickel, tin, and zinc among other metals, as well as additional products, such as sulfuric acid. Aurubis has production sites in Europe and the United States.

Rayonier (RYN:US) is the second-largest timber REIT, with approximately 2.7 million acres located in  strong softwood timber growing regions throughout the United States, primarily in the south with some operations in the Pacific Northwest, and New Zealand. What differentiates Rayonier is that they are a pure timber play – they do not own any pulp, paper or wood manufacturing operations.

Osisko Gold Royalties (OR:CN) is the fourth-largest precious metal royalty company in the world, with a North American focused portfolio of over 140 royalties, streams, and precious metal offtakes. Their main asset is a 5% net smelter return royalty on the Canadian Malartic mine, the largest gold mine in Canada. Osisko enjoys a diversified cash flow from 17 producing assets in low geopolitical risk jurisdictions.

Limoneira (LMNR:US) is one of the largest growers of lemons and avocados in the United States. In addition, the company grows oranges and a variety of specialty citrus and other crops. Demand for fresh citrus continues to grow steadily, driven by a growing middle class with disposable income and changing consumer preferences. Limoneira is vertically integrated due to its packing facilities, and its real estate portfolio could be another source of realizing value for shareholders. 

Eagle Materials (EXP:US) is a leading supplier of heavy construction materials, such as cement, concrete and aggregates, and light building materials, such as gypsum wallboard in the United States. The company is a low cost producer, with between 30 and 50 years of raw material reserves. The majority of Eagle’s revenues are generated in markets where population growth, highly correlated to construction activity, is expected to be greater than the United States as a whole.

ARC Resources (ARX:CN) is a leading Canadian oil and gas company with high quality assets in the Montney region. After a merger with Seven Generations Energy, ARC is the Montney leader in production, land base, and condensate output.

Additional country releases in recent days confirm that global six-month real narrow money growth fell further in April, to its slowest pace since January 2020 – see chart 1. The decline from a peak in July 2020 is the basis for the forecast here of a significant cooling of global industrial momentum during H2 2021.

Chart 1

The April fall reflected both slower nominal money growth and a further pick-up in six-month consumer price momentum – chart 2. The latter is probably at or close to a short-term peak and the central scenario here remains that real money growth will stabilise and recover into Q3. The risk is that nominal money trends continue to soften – the boost to US numbers from disbursement of stimulus payments may be over and this year’s rise in longer-term yields may act as a drag.

Chart 2

Six-month growth of real broad money and bank lending also moved down in April, with the former close to its post-GFC average and the latter considerably weaker – chart 3. Forecasts last year that government guarantee programmes would lead to a lending boom have so far proved wide of the mark; monetary financing of budget deficits, mainly by central banks, remains the key driver of broad money expansion.

Chart 3

Charts 4 and 5 shows six-month growth rates of real narrow and broad money in selected major economies. The UK remains at the top of the range on both measures, supporting optimism about near-term relative economic prospects, although slowing QE and a sharp rise in inflation promise to erode the current lead.

Chart 4

Chart 5

Eurozone real money growth, by contrast, is relatively weak: monetary deficit financing has been on a smaller scale than in the US / UK, while six-month inflation is higher than in the UK / Japan. Bank lending has been expanding at a similar pace in the Eurozone and UK. The recent step-up in ECB PEPP purchases could lift Eurozone broad money growth although the change is modest and could be offset by an increased capital outflow – see previous post.

China remains at the bottom of the ranges and monetary weakness was expected here to trigger PBoC easing by mid-year. Policy shifts usually proceed “under the radar” via money market operations and directions to state-run banks. The managed decline in three-month SHIBOR continued this week, while the corporate financing index in the Cheung Kong Graduate School of Business survey stabilised in April / May after falling over October-March, which could be a sign that banks have been instructed to increase loan supply.

The PBOC’s quarterly bankers’ survey, due for release later this month, could provide further corroboration of a policy shift: the differential between loan approval and loan demand indices leads money growth swings – chart 6. Monetary reacceleration in China remains the most likely driver of a rebound in global six-month real narrow money growth – required to support a forecast that H2 industrial cooling will represent a pause in an ongoing upswing rather than a foretaste of more significant weakness in 2022.

Chart 6

Travel and tourism has been one of the hardest hit sectors during the COVID-19 pandemic. Prior to the pandemic, this sector accounted for a quarter of all new jobs created globally, and contributed 10.4% to global GDP in 2019. In 2020, 62 million people working across the travel and tourism sector lost their jobs, and many are still supported by government wage subsidies. Domestic visitor spending decreased by 45% and international visitor spending declined by 69%. As a result, the sector lost US$4.5 trillion, or 49% compared to 2019, and only accounted for 5.5% of global GDP last year.

With the help of rapid vaccine rollouts in several economies, we are beginning to see some light at the end of the tunnel. In the United States (US), more than half of all adults have now been fully vaccinated. States are easing restrictions; some are aiming to fully reopen in July. Although business trips are unlikely to match pre-pandemic levels until 2023 or 2024, demand for leisure travels rebounded strongly. About 1.9 million travellers passed through airport security checkpoints on May 27, 2021 – that is six times the volume on the same day a year earlier, and about three quarters of the 2019 level. US domestic air travel has also returned to 75% of pre-pandemic levels.

A similar trend has been observed in the restaurant industry. According to OpenTable, restaurant bookings in the US were almost back to normal in the last week of May. Data released by the Bureau of Economic Analysis shows consumer spending on services in April 2021 had reached US$10.1 trillion, surpassing the US$9.95 trillion in April 2019, and approaching the previous peak of US$10.3 trillion in Feb 2020.

The European Union is also gradually reopening, and is working on the plans to welcome fully vaccinated travellers from abroad, including Americans, as soon as this summer. Most people have been staying within their local areas for over a year, and cannot wait to take that long awaited trip.
A recent survey shows nearly 9 in 10 American travellers have plans to travel in the next six months.

Many names in our portfolios are set to capture the pent-up demand in the leisure and tourism industry, and we would like to highlight a few in this commentary.

Autogrill (AGL IM)

While we do not invest directly in airline operators, we own Autogrill, the largest food and beverage provider at airports and motorways. Autogrill operates in 142 airports around the world, and manages 548 service stations along motorways and in railway stations. North America accounts for over 50% of the company’s total revenue, and the faster vaccination progress in this region will help the business to recover as passengers resume domestic travels.

Melia Hotels International (MEL SQ)

Headquartered in Spain, Melia operates more than 367 hotels in 41 countries. It is the third largest hotel group in Europe. First quarter results were still weak, but the company has seen a ramp-up in bookings for several key markets. Bookings of its resort destinations from domestic tourists in Spain have shown favourable recovery. US customers’ bookings for the Caribbean, particularly Mexico, have reached 2019 levels. With many quality assets, Melia should be able to benefit from the return of leisure travellers this summer.

Samsonite International (1910 HK)

Founded in 1910, Samsonite is the world’s largest lifestyle bag and travel luggage company. It owns many brands including Samsonite, Tumi, and American Tourister, and the products are sold in over 100 countries. The US and China accounted for 46% of total sales in 2019, and domestic travels have begun to pick up in both countries. The worst should be behind and the company targets to break even in the second quarter and return to profit from the third quarter onwards.

Ariake Japan (2815 JP)

Based in Japan, Ariake is a leading producer of natural seasoning concentrates based on animal bones. It has over 3,000 products used in soup, bouillon, broth and sauce bases. Customers are all commercial users that include hotels, restaurants, and makers of instant noodles, frozen foods, and prepared meals. Convenience store and food manufacturer channels remained resilient last year. Ariake continues to launch new products and gain market share. Yet the restaurant and hotel channel, which takes about 30% to 40% of total revenue, was hit due to dining restrictions and ordered closures of operators by the government. The restaurant related business is expected to catch up, with easing restrictions.

Limoneira (LMNR US)

Based in Santa Paula, California, the 127-year-old company is a leading producer of lemons, avocados, and oranges, with lemon being the largest revenue contributor. In the US, more than half of lemon production goes to food services, so the company was inevitably hurt by COVID-19. However, starting from the first quarter of fiscal year 2021, demand for lemon has recovered and pricing is performing well in comparison to 2020. The company also expects strong results for avocado and oranges sales in fiscal year 2021.

It is encouraging to see countries and cities coming back to life following a year of restrictions and confinement. However, caution is warranted as it takes time for the economies to fully recover due to uncertainties with vaccine rollouts, new COVID-19 variants, labour shortages, and supply chain challenges. Our portfolio remains balanced across regions and sectors. Companies in our portfolios are in great financial positions, and continue to deliver strong results.

Occasionally we are reminded that cybersecurity decisions have real-world impacts. In early 2021, news of a cyber attack at a water treatment plant in Florida was made public, in which one of the employees lost control of his mouse and watched as the hacker increased the level of sodium hydroxide 111 times from its intended level, making it dangerous to even touch the water. Luckily, the computer’s owner was proactive in rectifying the situation and escalating the case to the FBI. Even though many security checks were in place, making it unlikely that the contaminated water would reach the population, this case illustrates how ill equipped modern infrastructure is to deal with cybersecurity threats.

On May 7, Colonial Pipeline announced that it became the victim of a ransomware cyber attack that forced the company to halt all pipeline operations for a full week, making it the largest successful cyberattack on an oil infrastructure target to date. As the largest refined oil pipeline system in the eastern United States (US), the consequences were felt immediately. An estimated 12,000 gas stations faced shortages, fuel prices rose to more than $3/gallon, and panic buying surged to levels not seen since the toilet paper mania at the onset of the pandemic last year. As is usually the case with ransomware attacks, management did not know exactly how severe the breach was or how long it would take to have the systems work again on their own. As such, the company went ahead and paid the full ransom of 75 bitcoins, worth roughly US$4.4 million, and its operations were able to resume several days later.

Ransomware and other forms of cyber attacks are much more frequent than one would expect. In its annual “State of Email Security” report, Mimecast Ltd. found that 61% of organizations surveyed had been impacted by ransomware in 2020, an increase of 20% over 2019. On average, these companies lost six working days of system downtime and for 37%, the downtime lasted a week or more. One of the worst parts is that more than half of the victims paid the ransom demand but only 66% of them were able to retrieve their data afterward. This means one third never saw their data again despite paying the ransom.

In past commentaries we discussed how email is the most frequent and vulnerable attack vector, even more so since work from home became the norm. Since the beginning of the pandemic, it has been found that employees are three times more likely to click on malicious emails than they had before, while the number of email threats rose 64% year over year. This implies that working from home is also leading to employees being less vigilant about potential threats. Meanwhile, companies have been slow to adapt. Cybersecurity training is provided by only one out of five companies, despite almost half of technology chiefs believing that their biggest weakness stems from their employees’ lack of cybersecurity knowledge. Furthermore, one in ten companies do not even have an email security system.

With this in mind, it is not difficult to understand why Global Alpha has maintained continuous exposure to the cybersecurity sector over the years. In the past, we owned names such as Sophos, Nice Systems, and we currently own Mimecast Ltd. (MIME US).

Business Overview

Mimecast is a cloud-based platform that offers email security solutions. They provide a range of services, including targeted threat protection, encryption, large file sending services, and data leak prevention. Peter Bauer is one of the co-founders of the firm and has been CEO since its inception in 2003. Insiders own about 7% of the shares outstanding.

Competitive Advantages

Given the sticky nature of the business, Mimecast enjoys very high retention rates. They also have the fastest search service-level agreement in the industry because their service architecture was designed for the cloud from the beginning.

Mimecast processes over 400 million emails every day, and has more than 300 billion emails under management. They are the only email security provider to guarantee 100% continuity on Office 365.

Growth Strategy

  • Cross sell opportunities as the average customer owns around 3.5 products (up from 3.2 in 2019)
  • New product launches (6 products at its IPO in 2015, currently 11)
  • Increased penetration in the enterprise business

We are always on the lookout for new investment opportunities with secular growth opportunities. Our ability to be highly selective and nimble in our portfolio holdings leaves us well positioned to add some exposure to the online security industry at attractive valuations.

As most of you know, fundamental research informs Global Alpha’s stock selection, as it identifies equities with growing earnings that will meet or exceed our expectations. The pandemic challenged this philosophy in 2020, due to the volatile and unpredictable nature of corporate earnings. With low rates and subsidies, cashed-up investors looked elsewhere and flocked to non-earning companies, sending the Nasdaq 45.1% higher versus the S&P 500 at 18.4%.

A company with no earnings typically supports its stock price with material events that can de-risk future earnings. Investors gravitate to this approach as it can provide substantial short-term returns given the timelines around material events are well understood. Global Alpha tends to focus more on the entire capex cycle, smoothing out the volatility of a single event. For example, the technology and biotechnologies industries hold many event-driven companies. 

Hedge funds are a class of investors that commonly use event-driven strategies. According to the Hedge Fund Research (HFR) Database, the highest-returning hedge fund strategies in 2020 were event-driven funds, which gained 9.3% for the year. Macro hedge funds returned 5.2% for the year, while HFR’s own relative value index ended 2020 up 3.3%. The hedge fund industry’s total assets stand at $3.8 trillion, a 21% growth in one year. This occurred while the industry has had net outflows of -1.9% in 2020, according to Opalesque, a hedge fund publication.[1]

Interestingly, the Financial Industry Regulatory Authority (FINRA) reports that margin debt has jumped 51% since February 2020, to $823 billion in March 2021.[2] The $340 billion change is three times greater than any annual change in the last decade. It is therefore arguable that hedge funds, as well as many investors, are highly levered and exposed to event-driven companies.

Following the debacle of Archegos Capital Management, which faced massive margin calls from its prime brokers, Federal Reserve Governor Lael Brainard stated, “The Archegos event illustrates the limited visibility into hedge fund exposures and serves as a reminder that available measures of hedge fund leverage may not be capturing important risks.”

Where is all the new levered money (or at least part of it)?

According to PWC, the United States (US) equity and IPO capital markets in Q1 kicked off with yet another record, driven by the continued SPAC attack, with 389 IPOs raising $125 billion; 2020 raised $150 billion in total. A lot of this money is in newly issued, event driven, technology and biotechnology companies. The money is used to develop new products and services at an accelerated pace to catch up to their rich IPO valuations.  

These amounts materialize as capex and revenues to the subcontractors of technology or biotechnology companies, commonly known as the picks and shovel of an industry. Global Alpha is invested in these types of companies, which stand to benefit from the capital exuberance described above.

Additionally, our companies are profitable and diversified. They also are of lesser interest to event-driven hedge funds. These companies could be at a lesser risk of mass sell-off due to an Archegos Capital Management type liquidity crunch. Rich in pharmaceutical history, Europe holds many excellent contract research organizations that appear in our investment universe and have the biopharma industry as clients.

Evotec (EVT:GR)

Based in Hamburg, Germany, Evotec operates multiple scientifically driven contract research centers for the biopharma industry. The company has extensive scientific knowledge to assist in genetic and biochemical drug development programs.

With the large biopharma market growing at a compound annual growth rate (CAGR) of 13.5%, Evotec has been gaining market share with a 20% growth rate. The company recently launched a low cost biological drug production platform that is expected to grow revenues considerably in the mid-term. Evotec also signed an agreement with the Japanese giant Takeda for the development of RNAi drugs.

Oxford Biomedica (OXB:LN)

Global Alpha also owns Oxford BioMedica, a biopharmaceutical company engaged in the production of viral vectors, a key component of delivering a genetic drug.  Without vectors or other delivery systems, genetic material decays extremely quickly in the body. Oxford BioMedica offers a variety of vectors, including adenoviruses that are used in the present coronavirus vaccination program with AstraZeneca. However, it specializes in lentivirals, which have proven very efficient with biologics.

The FDA is predicting a wave of cell and gene therapies coming to market in the next few years, which is set to drive the overall end market to exceed $20 billion in the mid-term. The lentivirus vector market is expected to grow in excess of $1 billion by 2026, from $350-400 million today.

[1] https://www.opalesque.com/

[2] https://www.finra.org/