9 undervalued companies with 'exponential' growth potential: pt 1

Part 1: Big Data and Analytics; Nanotechnology; Networks and Computer Systems

Look around. See how much the world and the way we live in it have changed in such a short time. Tasks that we deem dull, repetitive and dangerous have been relegated to robots. Paying by cheque is akin to using a Roman tablet to record our thoughts. Printers were once used solely for the written word.

Now a new kind is being used to make everything from aircraft parts to houses. Analytics, nanotechnology, robots, ultra-fast computers: these are just some of the areas that are primed for strong growth because of their competitive advantage in developing and using transformative technologies that will improve our lives.

The Morningstar Exponential Technologies Index tracks companies across sectors in the early stages of creating or advancing these technologies. The index features 200 names—some of which are trading at discounts of up to 35 per cent—identified by Morningstar’s equity research team, companies that are positioned to experience meaningful economic benefits as a user or producer of promising technologies.

Morningstar has identified nine technology themes:

• Big Data & Analytics
• Network & Computer Systems
• Nanotechnology
• Energy & Environmental Systems
• Medicine & Neuroscience
• Robotics
• 3D Printing
• Bioinformatics
• Financial Services Innovation

Leaders in the respective themes are often beneficiaries of the network effect, boast cost advantages, and maintain powerful brands that block competition. They’re gatekeepers with extraordinary influence because of the way they can define processes and/or control resources.

Leaders are expected to have significantly more exposure to a given theme, and, as a result, should capture disproportionate economic benefits compared to other firms. Companies can be leaders in more than one theme. In this three-part series, we examine each theme and identify the most undervalued leader in the field. In part one, we look at Big Data & Analytics; Network & Computer Systems; and Nanotechnology.

Big Data and Analytics

Big Data has become a catch-all term for vast volumes of information that can’t be stored or processed in traditional ways. Imagine trying to fit the names and addresses contained in several phone books, across several towns, into an envelope.

That’s the challenge of big data: compiling mountains of information across disparate sources into a distilled, intelligible form allowing business to improve its services and sell its wares. “Through real-time analysis and interpretation of data, companies can derive actionable insights,” says Morningstar analyst Ali Mogharabi. “They can learn more about their customers, manage risks, streamline operations, increase return on investment for projects and much more.”

More data creates more insights, which creates more data. As Mogharabi notes, faster and more powerful computers have enabled the task of analysing big data much easier. The result is artificial intelligence—machine learning or deep learning—where computers are now teaching themselves to filter the data and recognise new and crucial information.

The upshot is gains for business, across virtually every sphere of society. In financial services for instance, banks are using big data to minimise fraud risk, thwart attacks on accounts, and attract profitable clients.

In healthcare, the analysis of big data allows companies to identify the most effective and less risky treatments. “Data is sourced not only from patients’ medical charts, but also their activities, possibly generated by sensors in consumer devices,” says Mogharabi.

Retail too is benefiting. Data from operations, inventory, and sales, allows for insights into customer behaviour, which in turn can help improve customer service and retention—and ultimately expand margins.

Government agencies are using big analysis to prevent waste, fraud, abuse and terrorist activity, while in manufacturing it is used to streamline design and derive probabilities of risks to which a business’s supply chain might be exposed.

Among the companies associated with big data and analytics, Google, owned by Alphabet, is king. It has become synonymous with fast and accurate analysis and retrieval of virtually any content and data online. Alphabet has eight different products with over one billion users: Search, Gmail, YouTube, Android, Chrome, Google Play, Google Drive, and Maps.

These platforms produce vast amounts of data and improve the more people use them. By feeding it search data, Google’s algorithms are better able to refine results. “This has resulted in the company attaining and maintaining its No 1 position within the online search business,” says Mogharabi. Another key—and undervalued—name in big data and analytics is Alphabet’s Chinese equivalent Baidu.

Most undervalued leader:

Baidu Inc (XNAS: BIDU) – 4-star

Industry: Internet content and information

Baidu has been evolving from a mobile-first to an artificial-intelligence-first company and now has a revenue market share of 80%. Excluding overlaps, monthly active users of Baidu’s family of apps reached 990 million in September 2018, a 28% increase year over year. Year-over-year net revenue growth at Baidu in 4Q18 was 22%, beating our expectations of 15% and the top end of guidance of 20%.

Our 2019 Baidu core revenue growth assumption is 3.3% and 36% for iQiyi, Baidu’s online video platform. Growth will come from expanding of advertising products such as optimised cost per impression and optimised cost per video view, mini programs, and healthcare ads.

We are maintaining our fair value estimate at US$262 per share. (Chelsey Tam)

Nanotechnology

Nanotechnology is all about making objects superior by manipulating the atoms and molecules that comprise them. The ability to do this at such at minute scale is known as nanotechnology—a mix of physics, chemistry and biology—and it is allowing scientists to make advances in technology, medicine and materials that have the potential to disrupt any industry, says Morningstar analyst Abhinav Davuluri. From faster computers and longer-lasting batteries, the potential of nanotechnology is still largely undetermined.

“The ongoing pursuit of faster and cheaper has democratised computing and will usher society from the smartphone world into the age of artificial intelligence and ubiquitous connectivity,” says Davuluri. In technology, smaller and smaller microprocessors are improving energy efficiency of electronics.

In medicine, common applications of nanotechnology include gene therapy or DNA to treat diseases, and DNA-based nanoscale robots to imitate biological processes or target cancer cells. At the materials levels, the manipulation of atoms at such an infinitesimal level allows for stronger, lighter components (in aircraft, for instance), and more fuel-efficient batteries and fuel cells.

Equipment vendors supply the tools for such precision, and include names such as Applied Materials, ASML, Lam Research, KLA-Tencor, and Tokyo Electron. Meanwhile, manufacturers use these tools to make cutting-edge chips found in Apple iPhones or servers at cloud vendors such as Amazon, Microsoft, and Google. Key names include Intel, Taiwan Semiconductor Manufacturing and Samsung.

Most undervalued leader:

Applied Materials Inc (XNAS: AMAT) 4-star

Industry: Semiconductor equipment and materials

Applied Materials (AMAT) is a leading vendor of semiconductor fabrication tools and competes in almost every key equipment segment with the exception of photolithography. As a result, all major chipmakers develop strong relationships with AMAT that span multiple process steps of their chip production. Despite a fall in first-quarter sales our positive thesis on the rise in capital intensity for semiconductor fabrication is intact.

Applied Materials, Inc. headquarters in Santa Clara, California

Beyond 2019, we anticipate memory-related investments to resume growth as chipmakers pursue advanced 3D NAND and DRAM technologies that require more tools from the likes of AMAT. The company’s scale and resources allow a research and development budget in excess of US$2bn to serve cutting-edge technologies and thus benefit from inflections such as fin field-effect transistors (FinFET) and 3D NAND.

Our fair value estimate is US$49 per share, which implies a forward price/earnings multiple of 13. (Abhinav Davuluri)

Networks and Computer Systems

Once upon a time internet users dutifully accepted the long wait as a song or videoclip downloaded. Nowadays, as more people connect to the net, the thought of longer “buffering” times—and that infuriating blinking circle—has gone from being a first-world problem to one that affects more than half the world’s population.

Data is rising exponentially and in turn the ability to communicate it to and the from the internet—or via the “cloud”—is becoming increasingly important. “Connectivity continues to be in a constant race to catch up with consumer demand,” says Morningstar research director, technology, Brian Colello.

In the next decade, the 4G wireless network will be superseded by 5G. This advance means faster speeds but also lower latency—the almost instantaneous connection between devices. “Low latency is a key consideration in the ‘Internet of Things’ and connecting a variety of machines to one another,” says Colello.

The tech titans—Apple, Alphabet and Microsoft—are at the core of networks and connectivity as they control the three chief computer operating systems in the world—iOS, Android and Windows, respectively—and thus create the rules for developers and users. Another pioneer in connectivity—particularly its dominance in wireless chipsets—is Qualcomm, while Intel is the leader in the integrated design and manufacturing of microprocessors found in PCs and servers.

Most undervalued leader:

Qualcomm Inc (XNAS: QCOM) 4-star

Industry: Semiconductors

Qualcomm’s (QCOM) narrow-moat rating stems from intangible assets and the company’s ability to collect royalties on smartphones over the next decade. With a near-monopoly on CDMA technology patents, QCOM charges a royalty fee as a predetermined percentage (3%–5%) of the price of each 3G device sold.

Code Division Multiple Access (CDMA), allows several transmitters to send information simultaneously over a single communication channel. With all 3G wireless networks based on CDMA technology, as well as most 4G phones having backward compatibility with 3G, we expect QCOM to earn significant royalty fees over the next decade and likely beyond.

The Qualcomm stand at the 2016 Mobile World Congress (MWC) in Shanghai, China, 2016

This revenue stream is earned at 85%-plus operating margins. QCOM reported first-quarter results that fell slightly below our expectations, owing to a challenging smartphone environment. Despite the near-term headwinds plaguing major OEMs due to weak smartphone demand in China, QCOM’s forward guidance was quite reasonable thanks to its latest Snapdragon processors set to be featured in upcoming flagship devices.

Our fair value estimate is US$72 per share, which implies a 2019 price/earnings multiple of 14. (Abhinav Davuluri)