• Since our initial coverage on the digital economy back in August 2020, the O'Shares Global Internet Giants ETF (NYSE:OGIG) has risen by close to 40%.
• COVID-19 will likely have a positive impact on the digital economy, as both businesses and consumers speed up the adoption of technology.
• With valuations becoming a little stretched in the near-term, we have decided to downgrade the digital economy from 3.0 Stars “Attractive” to 2.5 Stars “Neutral”.
• The long-term growth story of this sector remains intact, and we continue to remain positive on the digital economy for its superior earnings growth potential.
Since our initial coverage on the digital economy back in August 2020, the share price of the O'Shares Global Internet Giants ETF (NYSE:OGIG) has risen by close to 40%. In spite of the disruption brought about by COVID-19, the sector has managed to deliver returns of more than 100% in 2020, far outpacing the returns of broader equity indices such as the MSCI World Index (Figure 1).
Related Article: Why we think the digital economy deserves a 3.0 Stars “Attractive” rating
Figure 1: Despite the COVID-19 pandemic, OGIG has more than doubled in 2020.
Internet companies likely to benefit from COVID-19 in the long-term
The main reason why Internet companies have performed much better than its peers in other sectors is because COVID-19 has had a disproportionate impact on the global economy, with certain sectors more badly affected than others. In the case of the digital economy, however, we believe that COVID-19 was actually an unexpected catalyst that will accelerate technology adoption in the long-run.
The global health crisis has brought about structural changes to the way we live and work. With most countries implementing social distancing measures to stem the spread of the virus, physical, in-person activities have gradually shifted online, driving up demand for digital services, such as e-commerce, cloud computing, and digital payments.
Within the digital economy, the cloud services segment has been one of the biggest beneficiaries of the pandemic. The three largest cloud service providers – Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT), and Alphabet (NASDAQ:GOOG) – have all reported significant growth in cloud revenue as companies invest heavily in digital infrastructure so that their employees can continue to work remotely during this period (Figure 2).
The positive impact of the heightened demand for cloud services has also spilled over to the other segments of the tech sector, such as the semiconductor industry, where demand for data centre chips has been growing.
Figure 2: Despite the pandemic, the big 3 cloud service providers have continued to post strong double digit revenue growth across the first 9 months of 2020
Besides cloud services, e-commerce is another segment that has also benefitted from COVID-19. China, which endured one of the strictest lockdowns in the early days of the pandemic, has seen the sharpest rise in e-commerce activity since 2014, as online sales accounted for 25.2% of the total retail sales in China over the first half of the year, nearly five percentage points higher from what it was in 2019 (Figure 3).
Figure 3: E-commerce as a percentage of retail sales in China rose to a new high in 1H20
Besides e-commerce, online consumption of services in China also saw an uptick across 2020. In its latest quarterly update, Chinese food delivery giant Meituan (HKEX:3690) revealed that the transaction volume for its food delivery segment has surged to a record high of RMB 152 billion, approximately 35% higher than its previous record of RMB 112 set in 4Q19, before the pandemic hit.
This is mainly driven by the steady increase in the number of users and order volume as consumers began to appreciate the convenience of food delivery services. The growing popularity of food delivery services has also prompted more merchants to partner up with Meituan, with the company on-boarding nearly half a million new merchants over the first nine months of 2020 (Figure 4).
Figure 4: Meituan on boarded nearly half a million new merchants over the first nine months of 2020
These are just two of the many examples of how businesses have accelerated the adoption of digital technology in the wake of the pandemic. As we head into the post-pandemic years, we foresee that this trend will continue as businesses make preparations for the next crisis and also to remain competitive in a digitalised world.
Downgrade to 2.5 Stars “Neutral” on stretched valuations
Due to the spectacular run in the share prices of Internet companies in 2020, valuations have started to become a little stretched in the near-term. At the moment, the O'Shares Global Internet Giants ETF (NYSE:OGIG) is trading at 47X 2022 earnings, suggesting that it is more or less fairly valued based on the fair PE multiple of 45X we have assigned for this sector (Table 1).
Table 1: Valuations of OGIG have become stretched in the near-term
|
2020 |
2021 |
2022 |
2023 |
2024 |
2025 |
|
|
EPS |
195.00 |
292.50 |
438.75 |
570.38 |
712.97 |
855.56 |
|
Earnings Growth |
166.45% |
50% |
50% |
30% |
25% |
20% |
|
PE Ratio |
- |
70.9 |
47.3 |
26.4 |
29.1 |
24.2 |
|
Upside Potential* |
- |
-36.6% |
-4.9% |
23.6% |
54.4% |
85.4% |
|
Source: Bloomberg Finance L.P., iFAST Estimates *Based on the bull case PE multiple of 45X |
||||||
In line with our star rating methodology, we have decided to downgrade the digital economy from 3.0 Stars “Attractive” to 2.5 Stars “Neutral”. Having said that, we would like to reassure investors that this does not mean that the digital economy is out of favour. Even though valuations might not be as attractive as they were before, the long-term growth story of this sector remains intact.
COVID-19 has also provided a fresh impetus to the digital economy, driving businesses to accelerate the adoption of technology. Coupled with pre-existing megatrends, such as rising Internet adoption rates and the widespread digital disruption, we believe that this sector will be able to deliver superior earnings growth in the years ahead as the demand for digital products and services increases (Figure 5).
Figure 5: Internet companies are expected to deliver strong earnings growth, which would drive share prices higher
This is good news for investors as in the long-run, as share prices tend to be driven by earnings. For those with a longer investment horizon, the digital economy still is an attractive investment for their core portfolios.
What should investors do?
Investors who have held on to the O'Shares Global Internet Giants ETF (NYSE:OGIG) for the better part of 2020 would have likely made decent profits already, and we recommend that they consider taking some profits off the table but continue to retain some exposure to this sector.
It is our belief that asset allocation should always reflect economic reality, and the reality is this: the world that we live in is increasingly digitalised. Not only has digital technologies penetrated our everyday lives, they have also disrupted whole industries.
Going forward, we believe the digital economy is here to stay, and that Internet companies will make up a larger part of the global economy. It is for this reason we recommend investors to include the digital economy as part of their core allocation.
Investors who have yet to include the digital economy in their portfolios but wish to do so at this point in time may consider using a regular savings plan, before switching to a lump sum investment should the opportunity present itself. This will ensure that they buy more units when prices are low and less when prices are high, bringing the weighted average cost down.
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