Looking Past Delta: Recovery Themes in Play

2Q21 earnings crushed expectations

The US market saw a robust 2Q21 reporting season with S&P 500 firms reporting EPS growth of 86% yoy, against consensus forecast of 61% yoy growth. 2Q21 earnings results also showed the highest number of EPS and sales beat since at least 1998, with Financials and Information Technology sector powering the bulk of the aggregate earnings surprise.

Megacap Tech names reported results that were strong beats on revenue and earnings (with the exception of a major e-commerce company), with advertising-driven names exhibiting the strongest revenue growth momentum as these companies reap the benefits of re-opening trends. Names  geared to the COVID-economy had more muted performance and forward guidance, as the pandemic-related boost fades out – though as base comparison gets easier as we move into 2022, there is potential for renewed rerating in these stocks.

Looking ahead we remain constructive on the Megacap Tech space, given its still-reasonable valuation and intact structural fundamental drivers.

Re-opening plays look attractive after recent correction on Delta variant concerns

The travel and leisure sector has pulled back due to concerns around the Delta variant, as COVID-19 cases rise in the US and in other parts of the world.

Overall, we see the disruption as modest and likely short-termed. Vaccinations in the US continue to progress well, with 58% of the population having received at least one COVID vaccine, while ~50% have been fully vaccinated (Chart 1). We do not see a high risk of renewed draconian shutdowns.

Moreover, market overhang around re-opening sectors may begin to lift as COVID cases start to peak – analogous to what we have seen in India.

Hence, we see opportunities in the following sectors, which have corrected decently in the last couple of months:

• Airlines
• Online Travel Agents
• Gaming
• Mobility

Read US Equities Perspectives, August edition: Pivot to Quality and Income 

Airlines

During airline earnings at the end of July 2021, no airline in the US or Europe mentioned seeing a Delta variant impact on its bookings. However, in the first week of August 2021, travel companies started to report modest impacts.

While the Delta variant will continue to have a near-term impact on bookings across the travel sector, it appears to be disrupting near term bookings more as compared to longer term bookings.

Nonetheless, corporate recovery may be pushed out, given numerous companies have pushed back return to office plans, with some now targeting October 2021 (vs September 2021) and others delaying to 2022.

We think the correction in airlines has priced in Delta variant expectations, with the catalyst path becoming more balanced and midterm revenue outlook remains intact. Nonetheless, we think the domestic/leisure segment will be more resilient than the international/corporate segment.

Online Travel Agents (OTAs)

The stalwart US-listed OTAs have reported solid 2Q21 results driven by recovering momentum in both US and European bookings. Beyond a short term Delta-related air pocket, we remain positive on potential strong pent up demand which can drive bookings upside in 2022/23.

We also like the opportunity in alternative accommodation bookings, which still accounts for a low percentage of the global lodging total addressable market, with significant runway for increased penetration given demographic trends (Gen Z/Millennials are much more likely to consider alternative accommodation).

Gaming

Within the gaming sector, we prefer companies that are more heavily exposed to the domestic market. Other than more resilient gaming trends, domestic-levered names also have upside from US digital gaming proliferation (Charts 2 and 3).

Meanwhile in Asia, gaming trends will be impacted by resurgent COVID infections, lower vaccination rates and tougher travel restrictions.

Mobility/Ride-sharing

We like ride-sharing companies as we think pressure from increased driver incentives have peaked. Meanwhile, driver supply should improve as more US states pull back unemployment benefits.

Adding to these positive developments, the key US ride-sharing companies are inflecting in terms of profitability. We expect demand for ride-sharing to continue to normalise as the economy re-opens and more workers return to the office.

Video gaming sector – Let the games begin!

Video gaming stocks have been lagging the market on worries around re-opening and the negative impact on gaming engagement. With their recent underperformance, we think a window of opportunity may be opening up.

While 2020 represented a pull forward of gaming and engagement demand, and 2021 seeing some deceleration given difficult compares, the secular backdrop remains strong, with the US gaming industry expected to add 12 million users in 2021 (in-line with annual growth from 2017-19, even after outsized growth in 2020) (Chart 4).

We think 2H21 may see sentiment on the video gaming industry take a turn for the better. Recent stock underperformance indicates low expectations; while investors may shift their focus to CY22, where growth should accelerate on easier yoy comparisons and strong gaming pipelines.

Of note is the durability of this video game cycle which has been pretty impressive. This may be in part due to the fact that lifestyles have changed, with working from home becoming a mainstream phenomenon, which we think increases recreation time—including playing video games. 

For younger players, video games have become an acceptable form of entertainment in many households that had stricter controls on game time before. We think many of those new and returning lapsed players will stick with gaming, even after economies fully reopen.

In addition, an emerging trend within the sector is the blurring of social media and gaming. A recent sell-side survey showed that ~50% of Americans play video games on PC, console or mobile. While most play for entertainment, ~30% now come to gaming platforms to socialise, with those under 35 most likely to prefer games as a social medium. In fact, we think gaming companies fit snugly into the emerging theme of the “metaverse”.

Valuations for the sector look reasonable, with the established large cap names trading below their 3-year P/E averages.

Senate approves infrastructure bill

The US Senate has passed a ~US$1.2 trillion “Infrastructure Investment and Jobs Act’’ in a 69-30 vote that provides for US$550 billion in new spending over five years.

History suggests that the output “multiplier” from infrastructure investment is more significant comparing to other fiscal spending initiatives. One literature finds that the multiplier is between 0.5-1.2*. This means for every US$100 spent on infrastructure, GDP will be boosted by US$50-120 in the medium term.

After several decades of relatively low infrastructure spending from the public sector, the Bill will provide much needed support.

What's in the Bill?

The Bill is broad in nature and targets several significant areas, including:

• US$110 billion for roads and bridges; US$39 billion to modernise public transit; US$66 billion for trains; US$42 billion for port infrastructure and airports
• US$65 billion for high speed internet
• US$73 billion to rebuild the electric grid, including building new power lines and expanding renewable energy
• US$17.5 billion for green buses and ferries; US$7.5 billion to build a nationwide network of electric vehicle (EV) chargers
• US$55 billion to upgrade water infrastructure; US$50 billion to makes these systems more resilient – protecting them from drought, floods, and cyber attacks

What’s the next step forward?

The Bill will face a vote in the House of Representatives likely at the end of September 2021.

Speaker Pelosi has indicated that the House will not take up the ~US$1.2 trillion infrastructure package until the Senate also passes the separate US$3.5 trillion reconciliation bill, which includes an antipoverty and climate change plan. Nonetheless, it is likely that something will be concluded before the expiration of the FAST Act extension at the end of September 2021.

We expect the massive US$3.5 trillion reconciliation bill to likely include: extending benefits for families and education, add-on climate change initiatives e.g. tax credits for low carbon technologies, funding for green and sustainable housing, workforce development and job training programs, extending federal healthcare benefits, and not forgetting, the accompanying tax increases to fund these initiatives.

What’s the impact?

With the bulk of the Bill geared towards surface transportation, we think the largest and most direct beneficiaries include aggregate producers, as well companies exposed to the construction equipment supply chain.

Spending to modernise power generation and deliver clean electricity will benefit utilities aggressively pivoting towards renewables.

Bolstering high speed internet access with increased focus on 5G coverage could be positive for 5G infrastructure vendors, telco tower companies, network equipment companies as well as the 5G infrastructure supply chain e.g. semiconductors.

Plans to upgrade water infrastructure should benefit water treatment and technology plays; while greater electrification and a stronger EV infrastructure network would help support EV demand, benefitting EV auto manufacturers and the related EV supply chain.

Conclusion/Strategy

With the busy 2Q21 reporting season mostly behind us, we highlight several actionable themes within the US market to focus on in the months ahead. On the Tech sector, we remain constructive on Megacap names; and for the patient investor we highlight the video gaming sector which we think will see stronger momentum in 2022. Nearer term, with the likely passage of a meaningful infrastructure bill in September 2021, infrastructure beneficiaries will likely be in play. In addition, re-opening plays (particularly in the travel and leisure sector) look attractive after the recent correction on Delta variant concerns.