Your Quarterly E-Zine
Edition 11 • December 2019

This website contains the latest edition of Forsyth Barr Focus, a quarterly on-line magazine written by senior members of Forsyth Barr's investment team.

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DIGITAL DYNASTY

Technology has been the best performing sector over the past few years, having increased just over +50% since the end of 2016 while the broader market has risen by a more modest +28%. NVIDIA, Salesforce.com and Flex are three upcoming technology leaders that give investors exposure to four new areas of accelerated growth: Artificial Intelligence (AI), Automation, Big Data and Gaming and Content.

We continue to favour exposure to innovative companies that can benefit from technology advancements across these growth areas. In the diagram below we illustrate companies that provide exposure to these areas of innovation. Three emerging leaders, highlighted in red, NVIDIA, Flex Technology and Salesforce, are using their core competencies to transform their businesses and take advantage of these new business opportunities.

The universe of AI, Big Data, Automation & Content

NVIDIA (NVDA)

NVIDIA is a market leader in the development of graphics processing units (GPUs) which crunch a lot of data while consuming minimal power. This core strength positions NVIDIA well to transition from its past focus on PC components to providing diverse gaming, data centre, and automotive software platforms.

NVIDIA has established a significant head-start in the race to capture market share as new technologies revolutionise a number of end markets, such as Level 5 autonomous vehicles, virtual reality, gaming-as-a-service, blockchain, and smart cities.

Many of NVIDIA’s end markets have the potential to become very large:

  • Gaming-as-a-service, “total addressable market” or TAM of US$30bn by 2020
  • Virtual reality, TAM of US$16bn by 2020
  • Data-centre deep learning silicon, TAM of US$10.5bn by 2021
  • Smart cities and surveillance, TAM of $2bn by 2021
  • Blockchain, TAM of US$18bn by 2025
  • Level 4/5 autonomous vehicles, TAM of US$5bn by 2025

In the near-term, NVIDIA’s earnings will be bolstered by strong momentum in its gaming and data-centre segments. The company will be supplying its AI focused GPU hardware to several of China’s largest cloud-computing providers and server-hardware manufacturers, including Alibaba Group, Baidu and Tencent. Automotive and smart-cities are longer-term opportunities. NVIDIA has signed automotive partnerships with Tesla, Volvo, Audi, Mercedes, Bosch, and Toyota.

Favourable industry outlook

The following factors underpin our positive view on NVIDIA:

  • New developments in the machine learning chip market: In 2017-18, sales of hyper-scale and GPU servers increased faster than expected.
  • Growth in artificial intelligence applications (which require a lot of processing power) favours NVIDIA, as its processors are both powerful and efficient.
  • Fears the semiconductor market is at a cyclical peak are overdone: End demand for semiconductors may slow in the near/medium-term, but new semiconductor applications should support further growth in the longer-term.

Salesforce.com (CRM)

What do Amazon.com, Google, Cisco and IBM all have in common besides being some of the largest tech players in the world? They all have strategic partnerships with Salesforce.com (CRM.N), the largest pure-play vendor in the front-office Software as a Service (SaaS) space. Given the need for many businesses to implement digital transformations, Salesforce is well positioned thanks to its easy to use platform which enables customers of Salesforce to develop their own unique “in-house” applications.

Successful take-off on a long runway

Salesforce has solidified its dominance in the Customer Relationship Management space, having been voted the number one CRM provider for five consecutive years. It is one of the top five fastest growing enterprise software companies, delivering +25% revenue growth in FY18. The company has more than doubled its operating cash flow over the past three years from US$1.2bn in FY15 to US$2.7bn in FY18. In the same time revenue has almost doubled from US$5.4bn to US$10.5bn.

Salesforce’s customer base is significant, and evidences the quality of the company’s product. A number of industry leaders rely on the Salesforce platform, including 18 of the top 20 European and US banks, 16 of the top 20 global pharmaceutical companies, seven of the top 10 hospitality companies, eight of the top 10 global telecom companies, and 12 of the top 15 global technology companies.

Salesforce leads the sales automation market with 45% share, but a 17% and 22% share in Marketing and Service Clouds respectively, suggests more room to sell product into the installed base. Customer relationship management is now the fastest growing enterprise software segment, and Salesforce believes its total addressable market will grow from US$72bn today to US$123bn by 2021.

Global expansion

Salesforce plans to aggressively expand globally through its relationships with the “Big 5” global system integrators: Accenture, Deloitte Consulting, Cap Gemini, IBM and PWC Consulting. This underpins our confidence in Salesforce being able to maintain medium-term revenue and profit growth of +25-30% p.a.

Salesforce has also integrated its Service Cloud Einstein with Amazon’s AWS cloud service as part of its international expansion initiative, and has entered a strategic partnership with Google to deliver new integrations that connect Salesforce with Google Analytics 360 and G Suite.



Competition playing catch up

In our view the risk to Salesforce from a lift in competition from legacy vendors (e.g. Microsoft, SAP and Oracle) is offset by Salesforce’s broadening of its revenue base through new cloud-based services. Salesforce is developing new services to add value via its database and add new business-to-consumer marketing revenue streams for its business customers. Cross-selling across its large-customer base, international expansion, and the migration of on-premises customer relationship management software to the cloud will be additional growth drivers.

Flex (FLEX)

Flex Technology (FLEX) is a US-based multinational technology manufacturer that designs, builds, ships and services packaged consumer electronics and industrial products for original equipment manufacturers (OEMs). It has around 200,000 employees across more than 100 sites in 30 countries. Flex has a bright future as it transitions its business towards offering clients its “Sketch-to-ScaleTM” integrated product design and automated manufacturing process. This shift in Flex’s business away from traditional OEM manufacturing should see Flex achieve higher margins and more predictable earnings, which we believe are not yet priced into the stock’s attractive valuation.

Flexing strategy towards more profitable clients

Three years ago Flex announced an important shift in strategy. It moved towards design-led interaction with clients and shifted its customer base away from lower-margin electronics manufacturers towards more profitable industrial, automotive and medical industry customers.

By way of example, Flex has co-invested with Nike to invent a new, fully automated process to manufacture Nike’s shoes in Mexico. This new plant can potentially reduce Nike’s “design-to-market” period from the present 18 months (with shoes being hand-made in Vietnam and China) to less than one month. Nike generates around $13bn in global shoe sales. Flex’s new Mexico plant for Nike is expected to eventually generate an annualised sales run-rate in excess of US$500m.

If Flex’s new automated manufacturing process is successful in substantially lowering Nike’s “design-to-market” time, then Flex should be able to emulate this success across other sectors.

Rob Mercer
Head of Private Wealth Research

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