A recent survey of 3,000 institutional investors showed a record 98% of them are now negative on retail. But when virtually the whole market is on one side of the trade, the other side is usually worth a look. Things only need to be ‘less bad’ than perceived for money to be on the table.

We sat down with Tim Hannon, Co-Chief Investment Officer at Lucerne Investment Partners who highlighted this skew and its implications. Tim also then expanded on two other structural themes that eCommerce’s growth is feeding into, with potential exposures that include one of the best performing ASX20 stocks over 12 months, a small-cap listed digital infrastructure fund, and a little-known tech microcap with big plans.  

So, while Amazon was meant to destroy retail, it seems that it has simply created new opportunities elsewhere instead.


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Transcript

We've been very negative on retail landlords, shopping centres, and retailers for many, many years now. This is not a novel idea. The structural threat from eCommerce continues to exist. eCommerce penetration is 10 to 20 to 25% in many developed countries. In urban China, it's up to 30%. So, it's still growing quite strongly. Retail landlords and retailers still will have some suffering to take, we think, as eCommerce market takes share.

But when you look at the positioning, which is critical, you start to have another think about it. There was a recent survey of 3000 fund managers, and only 2% thought that retail and retail landlords would out-perform. It's 2%. no one. So, on all the surveys that have been conducted before, there's never been more negativity towards the sector than retail landlords. That's interesting to us. We're not short the sector, and we think there's a possibility of a sentiment turn around. But the key question is, how does that sentiment turnaround occur? It's going to occur if there's a change in perception about the future of retailers and retail landlords, and that can occur from a variety of means.

Retail landlords, for example, are starting to create mixed-use developments, so there including office. They're including health and wellbeing. They're including dining pubs, gymnasiums and the like. They're combating eCommerce by offering services and offering goods and products that are experiential, more experiential in nature. I'll give you some examples. I mean, if you can just imagine going to an apparel retailer. They're using augmented reality in some cases to work out exactly what suits your complexion, your body shape in terms of clothes, and you might actually order the clothes online, but you go into the store for that experience and that customisation that only your physicality or proximity allows. That's one way that they're looking to combat.

Dining is a big one. That's obviously experiential. There's health, there's wellbeing. There's an array of experiences they're putting forth. No one knows what rents will do. These new formats don't necessarily pay the same level of rent. But if the market changes its perception, and starts to think maybe retailers and retail landlords can stop losing so much share to eCommerce and maybe even compliment eCommerce by having an omnichannel strategy, you could see sentiment turn around. That's something we're watching over the next 12 months. Will the market start to perceive retail landlords as not the worst in the world and maybe worthy of investment at some stage?

Logistics

One of the areas of great positive sentiment presently is in the logistics real estate sector. In Australia, we've got a company called Goodman Group. In the United States, there's one called Prologis. These companies are experiencing terrific share price appreciation. They're a key beneficiary of eCommerce. E-commerce uses about 25% of the space of the property space of these landlords. The rest is from manufacturers and distributors and the like, but eCommerce companies use two to three times as much space as these traditional tenants. It's a function of the robotics and automation that they bring along, these eCommerce companies. Right now there's a lack of supply for these eCommerce companies and it's driving up the rents of logistics companies.

In the most recent result with Goodman Group that bore out, they upgraded their numbers and you look at any survey, these companies and very, very well appreciated. We look at Goodman Group in Australia though, it's trading on 25 times earnings. Prologis in the United States, is on a 40 times earnings. So, despite Goodman Group having a terrific share price appreciation of recent, particularly after its result, we expect that it can continue to rerate over the next few years, and it should be a core holding.

Digital infrastructure

One of the early-stage asset classes, it's emerging currently, data centres, digital infrastructure. It's been a sector in the United States for many, many years now. Companies like Equinix and Digital Realty, we're starting to see it emerge in Australia now.

Data centres are basically large warehouses full of computers. For example, they think Amazon has a million computers in their data centres. They're big warehouses with computers that use a lot of energy and we're starting to see in Australia companies such as NEXTDC, 360 Capital with their digital infrastructure fund and data exchange, move into this data centre arena. Now, where does the data come from? Well, it comes from Netflix. It comes from Amazon, but it really comes from smartphones and the use of smartphones globally. It's interesting to note that smartphone usage and the requirements for data centres to store and process all of the information from smartphones might see electricity usage of 20 to 25% of total power production.

Data centres aren't exactly climate change friendly, but they are growing. It's growing wildly. There's a report from Goldman Sachs and another major investment bank that suggests that we need 1.1 gigawatts of capacity put in place in Australia to allow for the growth in the demand for data centre storage and processing and computing. It is a growing sector. It's an early-stage sector, but it's one we're going to hear a lot more about. It includes the data centres. It includes fibre optics. It includes towers. 5G, which is the next generation of phones. It's going to mean more and more data and therefore much more demand for data centres. So, that's an area to look out for as an alternative asset class.

One of the interesting and early stage investments for exposure is the 360 Digital Infrastructure Fund. They're targeting an internal rate of return of 10%. The initial yield's only 3 or 4% but there's good growth to come that should now enable that good equity internal rate of return of 10%. It's going to take time to grow. I think they began with $100 million but that will be a REIT that we think will grow pretty strongly over time. These are generally called data centres.

Another small cap company, it's a micro cap company is Data Exchange and they own data centres at the edge. The whole process is about pushing data out to the edge. Data takes time to move even through the NBN, and so these edge data centres, they're going to be in regional areas like Toowoomba and Hobart and Darwin and the like.

That will push data out to those locations to make it quick, so there's no slowness, there's no latency. But it also enables, along with 5G, the introduction of autonomous driving or augmented reality and internet of things, a whole host of other applications. These will come to bear over the next three to five years or so. They're fundamentally changing what we're doing. I mean, autonomous driving's a critical one. There's many, many groups experimenting with autonomous driving, including Uber and having data centres spread out is critical for latency. So. an Uber, a car that doesn't have a driver in it, if the rate of data exchange is 60 milliseconds or 30, that's the difference between five to six metres in stopping power. That's obviously critical when you're in traffic. 

So, that's only going to grow, the demand for data and the speed of data is also absolutely critical. They're going to be some big themes. Vodafone and TPG are involved in rolling at 5G. It is a heavy capital expenditure burden, but it is going to be a host of new industries that are spurred by the introduction of 5G and edge data centres.