It’s worth watching technology and communications companies that thrive in tough times – they should also be forces come fair weather. Indeed, their prospects continue to remain strong and growth may accelerate, argues Jonathan Mzengeza, co-manager of the 5-star rated $278.1 million CIBC Global Technology Fund.
“The reason I am bullish is that technology and communications companies have shown significant resilience during this period,” says Mzengeza, portfolio manager and information technology analyst at Toronto-based CIBC Asset Management Inc. “In most cases, they have been able to sustain their revenue growth. In some cases, they have actually accelerated revenue growth, as secular trends that they are exposed to have accelerated.”
Mzengeza cites three factors driving the sector:
First, e-commerce and digital advertising have gained momentum. “They are here to stay and will continue to grow at a fast pace,” says Mzengeza, a native of Zimbabwe who joined CIBC in May 2012, three years after moving to Canada and earning a bachelor of engineering, electrical and computer engineering at University of Capetown. He assumed the portfolio in 2017.
Second, many companies have sustained revenue growth even in a grim economic environment. “Recently, we saw large-cap companies such as Apple Inc. and Facebook Inc. report robust growth despite what was a very depressed economic environment. Even as things open up in the second half, and the lockdown eases, we should see that performance accelerate further.” Overall, he adds, expectations for revenue growth for the S&P 500 are quite muted. “Outside communications and tech, most sectors expect declines in revenue growth. But if you look at the large-cap tech companies all expect revenues to grow this year. Many will show significant operating leverage.”
For example, Apple reported roughly US$60 billion in revenues in its third-quarter results, which were higher than the pre-COVID revenue expectations. Similarly, Facebook experienced double-digit growth in digital advertising despite significant declines in advertising segments such as travel.
Third, new technology and innovation in the second half of 2020 will be an additional driver. “We will have innovations such as 5G mobile technology. For example, Apple will introduce their latest model smartphone in the second half, which is expected to have new 5G technology.”
Ultra-low interest rates have not been a factor supporting technology stocks, argues Mzengeza, who looks after about 80% of the portfolio, while co-manager Michal Marszal, a medical doctor by profession, looks after the balance in healthcare names. “The fact is the fundamentals continue to be strong. The underlying robustness of these businesses is what underpins these stocks, more than low-interest rates.”
Too Big to Topple?
Mzengeza also brushes off suggestions there is a risk that many tech stocks, which are trading at high multiples, are vulnerable to the kind of bubble that blew up in 2001. Rather, he worries that the risk that could spell trouble is greater government regulation and points to recent Congressional hearings in the U.S. that could trigger enforcement of anti-trust rules.
Although Mzengeza is largely a bottom-up investor, he is favouring U.S. companies, as they represent about 68% of the portfolio, followed by 22.5% in international firms, 4% Canada and 6% cash. From a sub-sector standpoint, the top five areas are 17.5% healthcare, 16% information technology services, 15.5% software, 10% semi-conductors, and 9% technology hardware and storage.
In selecting stocks, Mzengeza looks for companies that have four key attributes: a sustainable and competitive moat, a large and growing customer base, the ability to generate accelerating growth, and operating leverage. One of the top names in a concentrated portfolio with 30 stocks is Twilio Inc. (TWLO), a San Francisco-based information technology firm that allows software developers to perform a variety of communication functions using its cloud communications platform. Twilio’s technology is used by messaging providers such as WhatsApp.
The stock is trading at a lofty multiple of 20 times enterprise value (EV) times sales. “The firm is not profitable yet,” admits Mzengeza, “But we see growth in their revenues.”
Another favourite is Shopify Inc. (SHOP), the Ottawa-based firm that began as a start-up in the e-commerce industry and has emerged as a leader that has served a slew of merchants both big and small. “It continues to attract new merchants. It saw a 71% increase in new web sites on its platform in the second quarter, driven by e-commerce retail. This should continue over the longer term,” says Mzengeza, noting that the stock has acquired about three years ago. “They have turned out to be one of our best investment ideas”
Shopify’s stock is also trading at a high multiple of 20 times EV to sales. “But their revenue growth has been very significant.”
In contrast, Mzengeza has shunned some technology stocks, such as Intel Corp. (INTC), a leading maker of semi-conductors. “They have over-promised and under-delivered. They have fallen behind their competitors in terms of their technology transitions.”
From a performance standpoint, CIBC Global Technology returned 30.18% for the year-to-date (as of July 31), compared to -0.51% for the median fund in the Global Equity category. On a three and five year basis, the fund averaged 27.74% and 19.71%, respectively, compared to 6.32% and 5.66% for the category. But not every year has been stellar, as in 2016 the fund returned lost 3.46%, versus the median fund which gained 3.31%.
Double-Checking for Downside
Cognizant of these challenging periods, Mzengeza says that he and Marszal mitigate the risk by conducting extensive due diligence on each holding. “We do downside analysis on how much we might lose if the stock doesn’t work out. But we take a long-term view and carefully weigh our thesis before taking a position.”
Indeed, the longer-term view is shaped by the COVID-19 pandemic crisis, which has only accelerated the growth of digital advertising, among other trends, and firmly entrenched it. “Large social media players like Facebook (FB). Snapchat (SNAP) and Twitter (TWTR) are showing significant increases in revenues, quarter over quarter, while the global advertising market is expected to be down about 5-10%. We expect this shift to continue in the second half of the year.”
:quality(80)/cloudfront-us-east-1.images.arcpublishing.com/morningstar/Q3KIND5VXRCNHHH6JQHCCYBSSA.png)
