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Stock ideas in an online bloodbath

In a harsh environment for retailers, compounded by the lacklustre growth in consumers’ disposable incomes, there are some companies benefiting from the disruption caused by the internet to traditional business models, says Nick Clay, alternate manager in Newton’s Global Higher Income team.

Rising online sales were credited with improving profits at a number of retailers in the first half of 2014, including John Lewis and Next, but at the other end of the spectrum, former darling of the e-commerce space ASOS has fallen out of favour with investors following numerous profit warnings.

It is difficult to predict which of the retailers will surmount the challenges posed by the internet and come out the other side a stronger company, explains Clay. For this reason, the team prefers to invest in companies that are beneficiaries of the increase in e-commerce as a whole and do not have to rely on the strength of any one brand or type of merchandise resonating with consumers.

An example of this is German-listed Deutsche Post, which owns delivery service DHL.

“This company has been a huge beneficiary of the increase in delivery volumes and global distribution after online shopping became popular. It is a safer and easier way of playing this theme than trying to bet on which retail companies are going to survive,” says Clay.

“Obviously there are a whole host of household names that have gone by the wayside in recent years — HMV and Woolworths — and that is why DHL is a safer investment,” he adds.

A particularly disruptive characteristic of the internet is the way it has increased transparency on prices and allowed consumers to become more price conscious. Other factors have also prompted this to happen, such as the state of the economy and lack of income growth, and ultimately there has been a move towards discount shopping, whether in food with Aldi and Lidl or clothes with Associated Food’s-owned Primark.

But it is not just the consumer this has affected; it has also led to businesses sourcing products differently, and the combination is having a deflationary impact on economies.

“It is not surprising that, despite all the money we have thrown at economies, inflation is still not going up. Companies that used to supply goods with a healthy profit margin suddenly were faced with an end consumer with greater visibility of that same product from lots of other sites. If a product is easy to manufacture or duplicate, that can leave businesses very exposed,” Clay says.

Companies with specialised products are therefore much more resilient in the face of these forces.

Publishing firms Reed Elsevier and Amsterdam-listed Wolters Kluwer could have been hurt by the increasing importance of the internet in traditional industries because their businesses were originally focused around the production of paper-based journals.

“Naturally these were open to disruption from the internet distribution model,” says Clay. “But both were able to see that and realise the future would be online and not print anymore.”

The fact the companies dealt in journals on specialist subjects such as tax, legal issues and science gave them enough breathing space to get the new models in place. After a few years of heavy investment in online distribution, their cost bases have lowered because of the greater emphasis on digital publishing, and it is now the online element of their businesses that drives the returns and growth.

“The fear was that scientists and accountants would use the internet to self-publish, but in reality they lacked the distribution network and reputation of both Reed and Wolters Kluwer,” Clay says.

“They were able to survive because of the attributes of the content — forever changing — and also the strength of their brands in being the ‘go to’ place to get all this information,” Clay adds.

In the UK, e-commerce grew from one per cent of total retail in 2004 to 11 per cent in 2012*, which means those companies that get it right are posed to do well.

“This exponential growth is linked to the penetration of PCs, tablets and smartphones,” says Clay.

Such figures are behind one of Newton’s big themes ‘net effects’, which aims to give the teams perspective on the potential pitfalls but also the opportunities of disruption caused by the internet.

“We need to be mindful of the stocks we invest in and their ability to defend against such disruption. However, the companies that have managed to weather this threat and have now become the lead businesses in this environment are particularly interesting.

“There are industries you feel it is only a matter of time before they are disrupted by the internet, but that is another story,” Clay concludes.

*Source: Euromonitor, Centre for Retail Research, yStats.com, Forrester Research 2012

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