Don’t bank on it



Consumer discretionary stocks were higher, which was ironic given that Amazon officially launched its offering in Australia yesterday. Some have suggested that the initial reception was lukewarm, but I am prepared to wager that that the online behemoth will do well over time. Rome wasn’t built in a day, and a key positive of Amazon’s offering is convenience (and price), and an annual subscription fee will encourage customer stickiness

I think that this will be bad news for many bricks and mortar retailers who are already struggling to adapt digitally, dealing with intense competition and pricing pressures, and faced with an indebted consumer. We expect Amazon (and other disruptors) to make substantial inroads across the retail spend spectrum over time – and many retailers will have to adapt their business models or perish.

The plight of the consumer was also identified by the RBA which predictably left rates on hold for the 16th month in a row. The accompanying statement noted that One continuing source of uncertainty is the outlook for household consumption. Household incomes are growing slowly and debt levels are high.”

Of course one problem here as I have written is low wage growth, but I expect that that a strong employment market will inevitably create some upward pressure.  As the central bank also observed, “… wage growth remains low. This is likely to continue for a while yet, although the stronger conditions in the labour market should see some lift in wage growth over time.”

I think that once we get the wage growth coming through, this will combine with rising commodity prices to push inflation much higher. This will likely catch the RBA (and other central banks) off guard, with inflation running below their target for such a long time.

Until then (and likely late next year), we can get use to a low cash rate which is “continuing to support the Australian economy.” Officials expect “GDP growth to average around 3 per cent over the next few years.We will likely get further clues here when the third quarter numbers are released today.

The  ongoing revival in the resource sector over the past 18 months is certainly helping the economy, and this is evident in the performances (and share prices) of mining sector constituents, many of which are around multi-year highs. We have over-weighted the sector since the lows last year, which has been positive for our performance, but I see further run in the road yet.

One of our favoured exposures has been South32, which was back near record levels yesterday. The company has been impeccably managed since the split from BHP, and the market responded positively to an ‘Investor day’ yesterday. Management reaffirmed FY18 production guidance for its operations, and forecast capex of US$470 million for FY18. This is down slightly from expectations of US$500 million and reinforces what I have been saying as it relates to the restraint the industry is showing in the expenditure side.


The company also provided guidance for the problematic Illawarra Metallurgical coal deposit, with output expected of 4.5MT in FY18 (7MT last year) at an operating unit cost of US$130 per tonne (US$80 last year). Management have deferred underground development at Appin, and intend to ramp up production to 8MT per annum over time. The operational issues that the company has experienced here are being dealt with, and generally other assets are going very well. The company could also get a value kicker as it exits the South African thermal coal business, which is totally the right strategy in my view.

Stocks in focus – AI is set to reshape the Chinese (and world’s) business landscape

Sunday December 3, marked the beginning of the fourth World Internet Conference in China. This is an annual event, which has typically been a Chinese oriented affair and while that is still reportedly the case, Apple CEO Tim Cook and Google CEO Sundar Pichai both attended this year. It was the first time chief executives from these companies have done so and therefore was a coup for Chinese authorities.

Both Apple and Google (via a position in parent Alphabet) are held in the Global Opportunities and US portfolios. Google famously exited China years ago, providing the opportunity for Baidu to become the dominant online search giant in the Middle Kingdom (more on Baidu below). Google CEO Sundar Pichai did not speak publically at the conference, but was on a panel.

Apple has a significant presence in China and recently agreed to toe the line there by removing certain apps from its local online store, including VPN software that can be used to navigate China’s ‘Great Firewall’.

Mr Cook’s address to the conference reportedly touched on Apple’s contribution to the local economy, highlighting how Chinese software developers have earned a total of US$16.9 billion from the app store to date. Naturally, this is great for Apple, which takes a 30% slice of revenues from revenue generated through its online store. Globally, the tally is about US$70 billion for developers from Apple’s store to date.

Apple has just delivered a better than expected quarter, posting revenue of $52.6 billion in the fiscal fourth quarter representing 12% year-on-year growth. It was higher than the $50.7 billion analysts were expecting.

The services business hit another record level of $8.5 billion in sales for the quarter, with revenues up 34% from a year earlier. That sales figure included a one-time benefit of $640 million, but even stripping this out sales were up 24%. Incredibly, its $30 billion in revenue for the year would rank it as a Fortune 100 company if it were a standalone company.

The services segment encompasses the likes of the App Store, iTunes, Apple Music, licensing, Apple Pay and iCloud. The services business’ growth is fuelled by the company’s huge and growing installed base. The App Store set a new all-time record and generates almost twice the revenue of the Google Play store according to research firm App Annie. With the installed base of Apple products continuing to grow, more record levels of sales for the App Store are likely in the quarters ahead. Across all the company’s services offerings, paid subscribers increased by approximately 25 million over the past three months, to hit 210 million.

Net income of $10.7 billion was up 19% year-on-year and translated to $2.07 of earnings per diluted share, up 24%. Apple has shrunk its share count by about 4% over the past year. Apple’s EPS result blew past the average analyst estimate of $1.87. For the full year earnings per share hit $9.21, up 11% year-on-year. Despite pulling back slightly from new highs, Apple shares have had a strong year-to-date and were up 46% as of Tuesday.

Chinese senior executives unsurprisingly featured at the conference and Baidu founder and chairman Robin Li was touting the potential of AI (artificial intelligence). Baidu has been one of the biggest investors in China and globally into AI and Mr Li was enthusiastic about the potential of AI to influence a broad range of sectors, rather than just the often-discussed autonomous driving opportunity.

 Baidu’s Apollo open autonomous driving platform:

Image credit: Baidu

Mr Li provided an example of how the company’s technology has cooperated with a seafood supermarket, reducing waste by 30% and improved profitability by 20%. He said the mining industry, which has accumulated reams of data, could significantly reduce accident rates by adopting AI.

Baidu is helping plan smart cities with world-leading transportation in Xiongan, Baoding and the larger cities Shanghai, Beijing and Chongqing. Baidu is a core holding in the Global Contrarian Fund, along with the Global Opportunities and Asian portfolios.

Baidu revenues in the third quarter came in at RMB 23.5 billion (US$3.5 billion), marking a strong 29% increase on a year ago. Operating profit hit RMB 4.7 billion (US$706 million), representing a surge of 69%. Net income of RMB 7.95 billion more than doubled (+157%) from a year earlier, boosted by RMB 4.23 billion of other income linked to the sale of Baidu Deliveries.

Baidu’s core online marketing business has returned to robust growth after a few soft quarters due to a regulatory scandal and divestment of a business unit. Baidu has the leading online ad platform in China and is therefore well placed to benefit as consumer and advertising spending ticks up in the years ahead.

The group has built a robust business franchise due to its dominance in Chinese Internet search. The company’s strong brand, network advantage, expertise in AI (artificial intelligence) and substantial R&D budget should reinforce its strong competitive position. The company’s video streaming platform is one of the leaders in China and is reportedly eyeing an IPO next year.

China is “all-in” on the AI opportunity and in July, unveiled a national plan to develop a 1 trillion yuan (US$150 billion) AI industry by 2030.

In our view Baidu is set to remain one of the biggest players in the evolution of China’s broader Internet opportunity going forward. The potential applications for AI are vast and Baidu is a leader in China’s self-driving car race.

Disclosure: The Fat Prophets Global Contrarian Fund declares a holding in South32 and Baidu.

Carpe Diem!

CEO | Fat Prophets
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