Factory automation, pharmacy and the retail sector are three areas already undergoing fundamental, structural changes from the growing pressures of disruptive innovation (DI) across markets and geographies, according to Quaero Capital investment manager Eurof Uppington.
“We think Disruptive Innovation is taking thematic investing to the next level,” he explains. “We want to invest in enablers and beneficiaries of technological disruption, and short stocks under pressure. We understand fast moving sectors and apply that experience to non-tech sectors where company managements, analysts and investors aren’t used to dealing with radical and sometimes devastating change.”
Uppington is running a model portfolio as a springboard for a Disruptive Innovation strategy to be implemented in the next few weeks. He has already explored some of the opportunities offered by increasing factory automation, through holdings like Honeywell and Siemens.
“Siemens has spent years and many billions developing what seems to us to be the pre-eminent end-to-end factory automation product suite, from software to the machines. If capital goods companies can add a higher software component it could be transformative to margins, multiples, and valuation.”
Some non-industrial companies can also gain a competitive advantage by adding agility from automation. “We’ve long been fascinated by Adidas’ “Speedfactory” and the seemingly growing gap with Nike,” Uppington adds. “Athletic footwear may therefore be ripe for Disruption, look out for more on this.”
The strategy would be backed by a powerful Advisory Board with the global expertise and connections to flag up potential opportunities and risks. Pharmacy is another sector attracting their attention.
“The US health care system is a Byzantine riddle, filled with intermediaries whose roles could easily be disaggregated and simplified by the internet,” notes Uppington. “Overall the US retail pharmacy market is a $1 trillion opportunity, and speculation is rife that Amazon has ambitions there, either by acquisition or organic growth. Even outside the US, in single payer systems, there seem to be online opportunities.”
However, Uppington is not ready to engage in this sector quite yet. “There are a lot of hurdles. The main target market is elderly, and perhaps online-resistant. Highly secure data and the need for precise, error free dispensing could be an initial challenge for automation but, equally, it is a catalyst for constant innovation and new market opportunities, and that is how we should approach it.”
The Advisory Board is a proponent of the notion of a “bullwhip effect” in supply chains, where the effect of a mild upstream disruption can amplify down the chain until at the most downstream point where it becomes much more powerful and dramatic. Like a bullwhip, it magnifies the initial arm movement into the tip, moving so fast it breaks the sound barrier – thus the “crack”.
The model portfolio is shorting the offline retail food chain, from retail chains themselves to mall owners and REITs. Potentially the most shattering effect could be felt by those who finance the REITs, nearly all of whom are heavily indebted. The first short in this area is BOK Financial, a local US bank with around 15 per cent exposure to mall operators.
Uppington has been mildly surprised by the non-seasonal stock market strength. The last two months seem to have delivered less signal and more noise. Markets were strong, with the MSCI World +7 per cent and the S&P500 +2 per cent. However, surprises came from Amazon, Target, TomTom and Paysafe.
Amazon activated “spending mode” in their Q2 results, warning investors to prepare for a possible loss in earnings per share (EPS) in Q3. Fixed costs on fulfilment (e.g. warehouse capacity) data centre capacity and content (e.g. new TV shows, AI assistants) rose. “Yet revenue growth is also accelerating, the main reason to keep us in the stock,” Uppington noted. “Cloud business grew at 42 per cent, and US e-commerce picked up again. Ultimately this is also going to put more pressure on offline retailers and is beneficial to our conviction in our short positions there.”
He believes Amazon remains a “jam tomorrow” story. “CEO Jeff Bezos could solve for profit, reward shareholders now and turn it into jam today, but he clearly thinks he can get a lot more jam in the future if he keeps investing. We’re inclined to give him the benefit of the doubt.”
Target, meanwhile, pre-announced better traffic metrics and EPS. Clearly the numbers have improved, or perhaps the original Q4 profit warning was overly conservative. Is “short retail” now too crowded a trade? “The offline “retail apocalypse” is a well-known phenomenon,” Uppington said. But he added, it doesn’t look too crowded just yet. “Our analysis of short interest in key retailers shows no consistent pattern and no extremes over the past few months.”
A truism of disrupted markets is that we over-estimate the time it takes for the change to come, and under-estimate the impact when it does. We think the change is upon us, so we’ll keep playing the retail sector short for now.”
