Are there still investible themes in the US equity market?

US Healthcare – Vaccines getting a boost

With the Delta variant driving a resurgence in COVID-19 cases globally, we see two new drivers for vaccine stocks:

Full FDA approval in the US

Until recently, the three vaccines used in the US (from the three major US pharma companies) were only available under the FDA’s “emergency use authorization” (EUA) standard. In August 2021, one of the three US vaccine companies received full approval for its vaccine for those aged 16 years or older. The outcome of the FDA’s rigorous analysis of clinical data means the regulatory status of COVID-19 vaccines is now equivalent to any other vaccine approved by the agency.

This is important because, as highlighted in a Kaiser Family Foundation national poll [1], more than 30% of unvaccinated adults said a full FDA approval of one of the vaccines would address most or all of their concerns about the vaccines’ safety and effectiveness.  Therefore a full FDA approval should support push for vaccine mandates.

Booster shots

The US Centers for Disease Control and Prevention (CDC) indicated the effectiveness of vaccines among front-line workers declined to 66% after Delta became dominant vs. 91% before it arose. Fears of decline in vaccine effectiveness have supported calls for booster shots.

On 24 September 2021, CDC officially recommended a booster shot of one of the vaccines for certain population segments and those with a high occupational risk.

Overall, the combination of full FDA approvals and booster shots could provide a shot in the arm for the vaccine story.

Riding the emerging buy-now-pay-later opportunity

Fintech powered buy-now-pay-later (BNPL) options are gaining prominence in retail, with many consumers perceiving the solution as a budgeting tool. Typically linked to debit cards, BNPL offerings allow consumers to purchase items and pay them off in instalments over 4-10 weeks.

In terms of business model, BNPL providers primarily rely on merchant fees rather than consumer fees, with ~2.5-4% merchant take rates, higher than debit/credit fees but lower than platform fees charged by online marketplaces.

Take-up rate amongst merchants have been increasing, as offering BNPL provides the advantage of increasing conversion rates and access to the millennial demographic (given that millennials have a lower take-up of credit cards and higher take-up of BNPL offerings), even though it comes with higher payment costs.

Large market potential

According to a sell-side estimate [2], the BNPL market size can potentially be ~USD0.6-1 trillion by 2025. That is 10-15x the gross merchandise value (GMV) processed by pay-later fintechs currently.

In terms of penetration rates, according to Worldpay [3], BNPL’s share of ecommerce in 2019 in Sweden and Australia was 24% and 8% respectively. Newer markets such as the UK and the US were at 3% and 1% respectively – with much runway for growth.

Typically, consumer receivables in BNPL have durations of 25-45 days – i.e. capital can be turned over 8-10x per annum. Funding is from a mix of equity, receivables facilities and customer deposits. The capital structure can therefore support USD0.6-1 trillion of GMV with ~USD50-100 billion of incremental receivables finance.

How to play this theme?

To play this theme, investors can consider investing in pure-play or diversified fintech BNPL payment solution providers, ecommerce platforms which have adopted BNPL offerings, as well as card network operators.

US Utilities – Tailwinds from infrastructure spending and push towards de-carbonisation

We see relative value in the Utilities sector given the group has lagged the broader market. The S&P Utilities Index has returned 6.7% year-to-date vs. S&P 500’s 19.1% return.

While Utilities’ average forward price earnings ratios (P/Es) remain elevated in absolute terms, with current levels in the low 18s, relative valuation of the sector is below levels seen in most of the last 10 years, at 0.9-1.0x vs. the S&P 500 Index. This means that multiple expansion across the Utilities sector has not kept up with that seen in the broader market, suggesting potential for further upside.

Utilities are known for their predictable profitability and income generation, and will benefit from potential rotational flows should investors seek a more defensive portfolio positioning heading into the coming months. Increasingly, there is also a growth angle as Utilities will be one of the key beneficiaries of the upcoming US infrastructure plan, and the structural push towards de-carbonisation (the Biden administration aims for 80% clean power generation and 50% carbon emission reductions by 2030 [4].

What’s in it for Utilities in the infrastructure plan?

Biden’s infrastructure plan includes USD73 billion to rebuild the electric grid, including building new power lines and expanding grid flexibility to accommodate renewable energy generation. The bill also includes USD6 billion for “struggling” nuclear plants that are in danger of closing. This is positive for Utilities with a more significant nuclear fleet. In addition, the upcoming massive USD3.5 trillion reconciliation bill will likely include more climate change initiatives e.g. tax credits for low carbon technologies.

Will rising bond yields be a problem?

Part of the concern around Utilities revolves around rising bond yields, so it is helpful that bond yields have been trading sideways over the last few months. Nonetheless, we think the sector can likely absorb a gradual rise in bond yields given the increasing focus on the earnings growth angle. 

Conclusion/Strategy

Despite near-term muted investor sentiment, we continue to think there are investible themes in the US equity market. In addition to re-opening plays we had highlighted last month, we think investors can also consider vaccine names, US Utilities as under-appreciated infrastructure plays, as well as companies benefitting from the emerging buy-now-pay-later theme.