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Investing through lockdowns - three shares that could withstand disruption

Lockdowns mean tough times for lots of companies, but not all. Here are three shares that don’t dread disruption.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Coronavirus has changed our way of life. That’s a pretty uncontroversial statement. But what might surprise you is there are some companies out there that don’t dread lockdowns. Millions of people holed up at home is good news for some.

We’re not saying the current situation will make for a smooth ride, even for the companies we’ll discuss here.

But one thing’s for sure. We think there are some genuine nuggets of opportunity for investors prepared to take on some extra risk. Remember though, nothing’s guaranteed.

This article is not personal advice. If you’re unsure whether an investment is right for you, please seek advice. All investments fall as well as rise in value, so you could get back less than you invest.

Sending revenues upstream?

Coronavirus or no coronavirus, there’s something a lot of us still enjoy – listening.

Be it podcasts, playlists or even meditation sessions – streaming giant Spotify has them all. Monthly active users were a whisker under 300m last quarter. We can’t see a stay at home culture being anything but good news on that front.

Spotify's model depends on people signing up to its service, whether that's through a free trial, or the free-to-use ad supported service. A decent proportion of these users then ultimately become paying users, which boosts revenue and margins. Lockdowns don’t interrupt the flow of users into the top of that funnel.

Subscriber Growth

Source: Spotify quarterly results accessed 14/10/2020

The other thing to keep in mind is the business of music is more cost efficient than video. Video productions require millions in upfront costs, before knowing if it’s a hit. Spotify’s content costs are largely variable. It pays record labels a flat fee as music is streamed.

Spotify controls the demand for music rather than the supply too. The group has a close relationship with its customers, which advertisers are willing to pay for. But while subscription revenues have proved resilient over the pandemic so far, ad revenues have deteriorated as advertisers pull back in light of the global economic challenges.

That meant ad revenue fell some 21% in the second quarter to EUR131m. This trend should stabilise in the third quarter, and things looked to be picking up back in June. We should get a clearer idea on how things are looking in third quarter results on 29 October, but it’s something to keep in mind – ad revenue will continue to wax and wane with the economy.

Spotify’s also up against giants Apple and Amazon. This is serious competition and not to be ignored, but streaming is just part of the package, rather than their raison d'être, for the tech giants. That makes them less of a threat, but they’ve got big enough pockets and customer bases to turn up the dial if they wanted.

Big pockets is something that Spotify is working on. A cash generative model means it’s self-sufficient and doesn’t need to borrow, unlike some. But rising operating costs to fund marketing campaigns, promotions and new products mean Spotify hasn’t been consistently cash flow positive.

Current conditions are likely to benefit Spotify – although short-term disruption should be expected. As we’re forced to become a nation of homebodies, it stands to reason we’ll continue to lean on audio-entertainment more than ever – and stay accustomed to the habit. It’s not going to be smooth from here, but we think Spotify’s in a good spot.

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GPs still need software

GP’s and pharmacies need to manage their practices and patient records.

That’s where medical software specialist, EMIS comes in. In its own words, the group is “the UK leader in connected healthcare software and systems”. Chances are your local GP used it to book your last appointment.

We can’t see coronavirus hurting the status quo too much for EMIS. Those telephone bookings still need to be orchestrated somewhere, even as GP surgeries have been forced to lower the number of face-to-face appointments.

There are real benefits to being a software business. Namely that once the platform is up and running, adding new customers is essentially free. That means margins tend to stay high, supporting profits and cash generation.

Historically that’s led the group to pay out increasing dividends – with the pay-out increasing 10% for the ninth consecutive year in 2019. At the time of writing the shares offer a prospective yield of 3.2%. Compared to the swathe of companies forced to scrap dividends during the crisis, that’s not to be sniffed at but please remember dividends aren’t guaranteed, and past performance isn’t a guide to the future.

The NHS is EMIS’ biggest and most important customer. A focus on improving technology across the service offers a structural tailwind in our view. Long-term contracts also mean a lot of EMIS’ revenue, and therefore profit is reliable. 78% of revenues were recurring last year. That’s an invaluable asset in current conditions but shouldn’t be seen as a guide to the future.

EMIS Revenue Analysis 2019

Source: EMIS annual report 2019

Looking ahead the group wants to focus more energy on the private sector. This will diversify (read “de-risk”) its revenue streams, providing a bigger opportunity for growth. Gearing up to tackle a new market place doesn’t come cheap though, and until the division builds scale it will struggle to be really profitable.

The other thing to keep in mind is that until the private sector makes up for a more meaningful chunk of EMIS’ £160m yearly revenue, it’s pretty much beholden to the NHS. While it's a reliable customer, there's always a risk a competitor muscles in and decimates your revenue stream. There’s also a risk of NHS spending becoming a political football.

EMIS is in a fundamentally strong position in our view. What makes the group tick hasn’t, and won’t, be changed by coronavirus. As with any investment there are some risks, but with that comes potential long-term growth opportunities. A price to earnings ratio of 19.7 isn’t low though – although it’s broadly in line with the average – signalling confidence from the market. But this could change if growth disappoints.

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Online food shopping isn’t going away

The UK is buying over 45% more goods online than before the pandemic. The trend has tempered slightly since the headier days of peak lockdown, but this change in consumer behaviour is here to stay.

Supermarkets are at the sharp end of this shift. Food is an essential purchase, so those unwilling to risk going to the shops in person are forced to do it digitally.

Many of these will be first time users of the service, and now they’re accustomed to it. Not everyone’s going back to physical food aisles.

We think one of the more traditional names is in a great position to benefit from this shift. Tesco’s huge national footprint and gold-standard brand puts it ahead of the pack for us and should help it get a meaningful piece of the online pie.

Online capacity has more than doubled, and 1.5m slots are churned through each week. Digital sales now make up for 16% of Tesco’s till-ringing, compared to 9% a year ago. That’s expected to rise further, with 25 new fulfilment centres planned to boost delivery efficiency expected by the end of the year.

We’ve been particularly impressed by Tesco’s work to improve its core proposition too. Savvy new product lines and pricing means it’s stealing customers from Aldi for the first time in years. That suggests Tesco’s core business is in a sturdier position, which is important while the pivot to online bubbles away in the background. Considering up to 90% of food bought still requires a trip to the supermarket, that’s very important.

A lot of work’s been done to improve margins in recent years too, meaning the group had more breathing room to stomach disruption.

Covid related costs – including that huge ramp up in online capacity and hiring of 47,000 extra staff at the peak of the crisis, means margins are expected to dip in the short term. But starting from a higher place means the effects won’t be as harsh as if the outbreak had hit back in 2016. A strong balance sheet (boosted by the £8.2bn disposal of the Asian business) means the group has some fire power to continue investing for growth too.

Tesco Operating Margins

Source: Refinitiv, accessed 16/10/2020. 2021 is an estimated figure

The biggest question from here is going to be how new CEO Ken Murphy plans to generate another round of growth, following years of good progress. We’re also mindful that the recent sale of ASDA could rejuvenate the brand and spark a resurgence in competition. That could reignite another price war and put pressure on Tesco’s margins.

All-in-all Tesco’s in a strong position to pounce on the new digital opportunity. The biggest hurdle to clear will be one of execution. Crucially, while that comes to fruition, the existing core business has a lot of strength and we’re impressed with the way the brand’s been re-positioned. As ever though, please remember nothing’s guaranteed.

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The Chair of Hargreaves Lansdown is also a Non-Executive Director at Tesco.

Unless otherwise stated estimates are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments and income they produce can rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.


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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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