Investing in Robotics – Nanuk Asset Management

Visions of the future often depict a world full of robots – robots that help us around the house, that drive us autonomously and that run entire production lines. For some time now those visions have been coming to life, certainly in factories around the world where automation has revolutionised the production line in an environment that rewards greater efficiency and productivity. While robotics has been a familiar investment theme, there have been many advances in the technologies and applications which have complemented the secular growth and indeed the investment theme associated with robotics.It’s helpful to begin with some context. We think of robots as machines which are programmed to perform a complex series of actions. They can vary dramatically in size and application, they typically operate in an autonomous manner with limited human guidance and they are typically housed in cages for safety reasons. In the current decade we have seen the rise of the collaborative robot, or “cobot”, which is designed to perform specific tasks in physical interaction with humans in a shared workspace. They are typically smaller in size, having built-in sensors which enable them to safely work alongside humans and receive human instruction.

So where does robotics fit it investment-wise?

The Nanuk New World Fund is wholly invested in companies and industries associated with and contributing towards greater environmental sustainability and resource efficiency. The Fund invests globally in companies involved in clean energy, energy efficiency, agriculture, water, waste management, recycling, pollution control and advanced manufacturing and materials. Robotics and automation improve resource efficiency, and fall within the broader theme of Industrial Efficiency. Robotics is a broad space with many interesting areas of development. We have chosen to focus on three core themes. The first is strong structural growth – always a prospective source of investment opportunities. The second is the development of applications beyond the traditional (‘caged’) industrial setting, such as ‘cobots’ – collaborative robots.

The third is the transition of these industrial technologies to consumer products and applications.

Robots are becoming increasingly more common, simply because robotics technology itself is improving rapidly. Key to this growth is the development of artificial intelligence and machine vision, which is allowing machines to navigate independently and adapt to non-standard and changing environments. This moves robots from being limited to a production line and a repeatable action – for instance, attaching a bottle cap – to move around a warehouse for example. In addition to improved use, the cost of components of a robot are rapidly declining. Robotics, like many digital technologies involving software, has benefitted tremendously from Moore’s Law (“the number of transistors on an integrated circuit doubles approximately every two years”). This has led to a massive drop in the cost of computing power and related core components: since 2010 the average robotics sensor cost has dropped by 50%. For context, the cost of lithium-ion batteries has fallen 75%  over the same period.

In its Q3 2016 report, the International Federation of Robotics forecast that the number of industrial robots deployed globally will rise to 2.6 million units by 2019, meaning that more than one million units will be added from 2016 to 2019. The sale of traditional industrial robot machines (in units) has grown multiple times in the last decade, with emerging applications such as cobots growing at double digit figures. Teradyne, a company whose primary business is making automatic semiconductor test equipment has seen revenue from its cobot business (it acquired Universal Robotics in 2015) grow 6.5 times over the last four years. This growth has been driven by the improving cost competiveness of cobots vs wage growth in historic manufacturing hubs, particularly China. As cobots become cheaper, they’re gaining market share and this enables a virtuous cycle of increased economies of scale. A great example of a robotics application beyond production lines is in the area of logistics, where deployment has been critical to the rise of ecommerce, allowing denser, more efficient warehousing and expedited order fulfilment. Amazon, for instance now only requires one minute of employee time per order it ships. Amazon and Dematic have bought logistics robot companies over the last few years. Extending the concept further is Ocado, the online supermarket that runs giant automated warehouses that can each support A$2 billion in sales. Ocado’s most advanced and large warehouse operation contains a 3-dimensional grid around which 1000 robots, all controlled by a sophisticated algorithm, select and place items into customers’ shopping baskets. As warehouses become more automated, the idea of a ‘dark warehouse’, where there is no need for lighting because the only
workers are robots, comes to mind.

Medical robotics is another key application seeing tremendous growth.

Intuitive Surgical is a US company that pioneered medical robotics in 1995 for minimally invasive surgery. Its main product, the “da Vinci” Surgical System, has been utilised in a variety of surgeries including urology and gynaecology for over three million patients already. The product has been amazingly successful in improving patient outcomes and its market share in its core applications is up to 90%. Although the industry is still quite nascent, new players are joining the medical robotics market such as the joint venture Verb Surgical, a collaboration between Google and Johnson & Johnson. In the consumer market, robotics is becoming more and more common. IRobot’s Roomba robotic vacuum cleaner was once seen as a gimmick for the “tech-obsessed”, but you can now find one in 11 million US households. The robotic vacuum market is growing by 18% p.a., while traditional vacuums
are growing at just 5%. Vacuum is far from the only household task amenable to automation: robotic lawnmowers are already available and development on further applications is well underway.

We’re seeing robots move from industrial applications to consumer applications in our homes. We’re seeing strong trend growth at a global level for both these end markets. We’re seeing greater sophistication and application of technologies. And we’re seeing sharp declines in the cost of making robots, leading to rising affordability and a prospective virtuous cycle of increasing demand. In short, they’re cheaper, faster, safer, smarter, more applicable and nimble day by day. This is attractive to us as fundamental investors. Adding to the secular growth story, there is a wide range of companies in which we can invest, some clearly of better quality and value than others. And that’s the investment challenge, to be in the right company in the right area at the right time, to benefit from the robotics
thematic as it plays its part in the global transition towards a “new world” of more environmentally sustainable and resource efficient activities in the decades to come.

Nanuk’s investment expertise is focused on industries related to the secular theme of environmental sustainability: a large and increasingly attractive investment universe often overlooked by traditional fund managers. The Fund invests globally in companies involved in clean energy, energy efficiency, agriculture, water, waste management, recycling, pollution control and advanced manufacturing and materials. All of these industries are undergoing significant changes as the world tries to reconcile economic growth with longer term sustainability and are a potentially rich and ongoing source of investment returns.

New tool for the tool bag

Retirees have just been given a new tool for their strategy tool bag. The downsizer superannuation contribution (DSC) legislation was just passed just before Christmas.

The DSC is exactly as the name suggests, the ability for retirees to contribute proceeds to superannuation from selling their home and buying a smaller/cheaper [1] one (Downsizing) The new rules allow a fourth way to contribute to superannuation( the other three are concessional, non-concessional and Small business capital gains) will come into a affect from 1st of July 2018.   The good news is the eligibility for making a DSC is not means tested, nor aged tested.  So as long as you are over 65 and have owned your home for more than 10 years you are able to make a contribution of $300,000 each or $600,000 in total. The one-off contribution will not be affected by a person’s transfer balance cap, so if you have more than $1.6 million you still be eligible for the contribution.

It opens up lot of news strategies as previously anyone post 75 was severely disadvantaged as they couldn’t contribute to the most tax effectively entity structure in Australia.

Let’s work through a practical example;

An Example

George and Ruth are both aged 78 and decide to sell their $1.2million home for a townhouse next to the daughters place, worth $600,000.  They each already have a pension balance of $1.6m.  Meeting the eligibility (see below re the exact eligibility that needs to be met) allows them to make a downsizer contribution of $300,000 each, a total of $600,000.  It is now irrelevant that George and Ruth don’t satisfy the age and work test for superannuation contributions (these tests don’t apply to DSC’s) It is also irrelevant that they have a superannuation balances in excess if $1.6m (normally superannuation rules stop any contributions to super if you are over $1.6million) even though they are 3 year older than the previous aged cap (75).  So George and Ruth are able to sell their home, buy a town house next to their daughter and contribute the remainder (up to $600,000) to superannuation.

The Fine Print

There is some finer print to the legislation, but essentially it is governed by the following seven conditions:

  1. They must be 65 or older at the time the contribution is made.
  2. The contribution must be in respect of the proceeds of the sale of a qualifying dwelling in Australia.
  3. A 10-year ownership condition must be met.
  4. Any gain or loss on the disposal of the dwelling must have qualified (or would have qualified) for the main residence CGT exemption in whole or part;
  5. The contribution must be made within 90 days of the disposal of the dwelling, or such longer time as the commissioner allows.
  6. The person must choose to treat the contribution as a downsizer contribution, and notify their superannuation provider, in the approved form, of this choice at the time the contribution is made.
  7. The person cannot have had DSCs in relation to an earlier disposal of a main residence.

For a property to be classed as a qualified dwelling in Australia, it must have been a fixed structure. Proceeds from the sale of houseboats, caravans, and other forms of mobile homes, even if they were a main residence, do not qualify for a DSC.

The 10-year ownership condition is flexible and covers situations where:

  • One member of a couple may not have been shown on the title of the property sold
  • A property was used for both business and principle place of residence
  • A person has owned a property for less than 10 years as a result of having had a former residence compulsorily acquired.

A very powerful tool that can be used for Good or Evil 

A word of caution:  even though this is a wonderful change in superannuation legislation, it is very powerful tool, especially when you consider your eligibility to the Aged Pension. The problem is simple one, your home value, what-ever it is, is exempt from assessment for the Aged Pension, however superannuation is not.  So the amount that you contribute to superannuation will be assessed in the assets test and income test, and could change your eligibility substantially.

So as per usual seek some great advice before pulling this one out of your strategy tool bag.

[1] Note, the legislation doesn’t actually say you have to buy a new home, so the name is a little miss leading.

The Australian Healthcare sector: Where are the opportunities for investors?

In part two of our Healthcare sector update with Daniel Moore, Senior Equities Analyst and Portfolio Manager at Investors Mutual, Daniel discusses those stocks that he believes are the best long-term investment opportunities, which ones he is cautious on, and what the future holds for the sector as a whole.

Do you think it’s worth investors owning Healthcare stocks, given the current environment?

When looking at stocks to buy within any sector, there are two key factors to consider:

  1. Are there good quality companies within the sector?
  2. If so, are they good value?

The answer to the first question is easy – yes, as there are many high quality healthcare companies listed in Australia that are actually global leaders in their field. These companies possess the criteria that IML always looks for in a stock i.e. a strong competitive advantage, recurring earnings and capable management. These include CSL, Cochlear, Sonic Healthcare, Ramsay Healthcare and Ansell, to name a few.

The harder question to answer today is whether these companies represent good value, following  the re-rating that many of these stocks have enjoyed in the last few years. Looking at the sector, many healthcare companies are currently trading at high price earnings(PE) ratios. However, a high multiple doesn’t necessarily mean a stock is overly priced, and so this is where, as an analyst, it is critical that I make an assessment of each company’s quality and long term prospects.

As an example, CSL is a global leader that invests over a third of its earnings back into R&D, so that it can continue to grow sustainably. This has allowed CSL to deliver earnings growth of 20 per cent per annum for over 20years. This means that it clearly deserves a premium to the Industrials market – the question is, how much of a premium?

Looking at the whole sector, the PE premium is now close to 100 per cent relative to the broader market, which is close to historical highs. And there are a number of companies with PE multiples at, or near, their own 10-15 year highs. These include Cochlear (40x), Fisher & Paykel Healthcare (37x) and ResMed(28x).

The premiums for these larger stocks makes us less optimistic about the sector’s returns in the near term but, as always, there are stocks that are offer value – it’s just that they are now much harder to find.

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What is your favourite Healthcare stock and why?

This would have to be CSL, which was originally a government entity (Commonwealth Serum Laboratory) that was listed in 1994, with a market cap of less than $500m.

Today CSL is the global leader in the plasma industry, having delivered compound earnings-per-share growth of 20 per cent per annum for over 20 years and now has  a market cap  of over $60bn.

CSL’s excellent management team has been a big driver of this success, with its strong science focus ensuring R&D is an ongoing strategic priority. CSL has also benefited from a number of well-timed large acquisitions, which have continued to improve its business. CSL has been very patient but also bold, with these acquisitions being made at ideal points in the cycle. In my view, CSL ranks with Westfield, Brambles and Amcor as one of Australia’s best international success stories.

The question now is, with the Healthcare sector’s ongoing focus on innovation, can CSL continue to stay ahead of its competitors and continue to perform well?

As a global leader, CSL’s scale means it has  relatively low-cost operation and the ability to run large R & D programmes relative to all of its competitors. We first invested in CSL in 2010 at $30, and with it now trading at well over $140, we have recently trimmed our holding.

While CSL is IML’s largest healthcare stock holding and has been for some time, Sonic Healthcare is currently my favourite investment. Sonic Healthcare is the largest pathology operator in Australia, Germany, Switzerland and the UK. It has a great reputation for quality and service, while its long-standing management team has a strong focus on innovation and developing new diagnostic tests.

Sonic also has a strong balance sheet, which has allowed it to make accretive bolt-on acquisitions as they arise – an area in which Sonic has an excellent track record. In addition, Sonic pays a very reasonable 3.8 per cent dividend yield.

Chart 1: CSL and Sonic – Daniel Moore’s favourite Healthcare stocks

 Source: Factset Date range: 03/01/13 – 04/01/18

Are there any Healthcare stocks IML holds that have disappointed recently?

Mayne Pharma has been a disappointing holding for our funds in the last 12 months. What attracted us to the company was its diverse revenue streams from its three divisions – generics, branded drugs and contract services, as well as the company’s extensive R&D pipeline.

What we didn’t foresee was that in 2017, a number of large US pharmaceutical buying groups merged and then re-tendered all their generic purchases. This led to significant price discounting within the generics industry of circa 7-10 per cent. Mayne Pharma had expanded in the US generic market through an acquisition of a significant generic portfolio from Teva in 2016. The acquisition from Teva looked like a good one as the multiple paid looked low, as it came from a forced sale from Teva after the FTC (the US competition commission) forced the divestment of certain drug categories from Teva following its merger with Allergan.

While the last 12 months performance has been disappointing, and we expect generic price deflation to impact Mayne Pharma’s FY18 earnings, we are encouraged by the outlook of Mayne’s branded drug business and contract services business, which are both growing at 10-20per cent per annum. We estimate that these divisions will make up over 50 per cent of the earnings of Mayne Pharma in FY19. We also believe that US generic prices will stabilise in the next 12 months, with some early signs of stabilisation in this market now appearing.

Mayne’s US generic earnings division should also do better from the second half of FY 18 onwards assisted by Mayne Pharma’s extensive R&D pipeline, which should see a number of new products launched in the US  market in 2H18, 2019 and 2020.

Mayne is clearly a stock that’s out of favour at the moment, however longer term we still believe that the company can do well thanks to its diversity of earnings streams and good balance sheet, and that the areas in which the company is involved are still witnessing good growth.

We continue to monitor the company’s progress closely and are looking to add to our holding once our indicators show a definite stabilisation in the prices of US generics.

Chart 2: Maybe Pharma has disappointed of late

Source: Factset Date range: 03/01/13 – 04/01/18

What are some of the Healthcare stocks that IML doesn’t currently hold and why?

Cochlear is one that has everything that we look for in a quality company – it is the market leader in cochlear implants, it has the best products protected by patents, it spends the most on R&D, it has a strong, recurring earnings base through its software upgrades, and very good management.

However, we don’t hold Cochlear due to its high valuation, as it is trading close to 40x earnings, which is well above its historic norms. At this valuation, we believe that there is a significant risk of capital loss, especially if the business has a minor hiccup.

Chart 3: Cochlear has generated strong returns for investors

Source: Factset Date range: 03/01/13 – 04/01/18

In contrast, Virtus Health has a reasonable valuation of 14-15x earnings but it does not meet our quality criteria.

Virtus is a provider of assisted reproductive services in Australia and Ireland, and we believe that it has very weak competitive advantage, as the value of its business lies predominately with fertility specialists who are on relatively short five-year employment contracts.

Virtus’ EBITDA margins also look unsustainably high (30 per cent in Australia), especially when one bears in mind that Government funding makes up around 50 per cent of total IVF revenues. Virtus was also listed as part of a private equity IPO in June 2013, which gives us extra reason to be cautious given the financial alchemy often used to make these companies attractive.

Ramsay Health Care is quite a well known healthcare stock that gets a lot of publicity – do you currently hold it?

We used to have a much larger holding in Ramsay Health Care, buying in at $12 many years ago. However we have significantly reduced our holding in the company as the stock price approached the $70 a share level as the company looks fairly fully valued now.

Ramsay is a global hospital group that operates over 200 hospitals and day surgeries in Australia, France, Indonesia, Malaysia and the United Kingdom.

We’re less optimistic about the growth prospects of its UK and France operations, given they are more reliant on government funding, which therefore makes the company’s outlook far more challenging.

That said, Ramsay’s earnings should still grow, but at a rate lower than they have historically. This, combined with its high valuation, is why we have trimmed back our position.

And finally, how do you see the years ahead unfolding for the Healthcare sector?

After 5-6years of very strong returns for the Healthcare sector (which has risen circa 400 per cent since November 2011), we are not expecting returns like these to be repeated going forward.

As I mentioned in Part 1 of this interview, the sector’s valuations are close to historical highs and governments are doing their best to rein in the growth of healthcare costs. We expect that some companies will perform better than others, particularly those with reasonable valuations that continue to invest and innovate.

At the current point in time, Sonic Healthcare and Ansell are appealing on both these measures from a long-term point of view, based on their quality and valuation and Mayne Pharma looks like a very good turnaround situation in our view.

While the information contained in this article has been prepared with all reasonable care, Investors Mutual Limited (AFSL 229988) accepts no responsibility or liability for any errors, omissions or misstatements however caused. This information is not personal advice. This advice is general in nature and has been prepared without taking account of your objectives, financial situation or needs. The fact that shares in a particular company may have been mentioned should not be interpreted as a recommendation to buy, sell or hold that stock.