Do not lose sight of the big picture

With so much noise coming in on a daily basis, it is sometimes hard for investors to keep a clear mind. Whether it’s distractions from President Trump, fears of the Fed, missiles launched from North Korea, the Brexit negotiations, the Qatar blockade or rumblings of a Chinese (and Australian) property bubble, investors could be forgiven for thinking there are few sensible investment opportunities left today.

Sometimes it is worth taking a step back and asking what the world might look like in 10, 15 or 20 years time. Identifying structural trends can be the first step to identifying which businesses might benefit from these trends. And businesses in industries that are growing naturally will typically find it much easier to grow revenues, expand profit margins and ultimately earn higher returns on capital investment.

One such global mega trend is the growth in the Asian middle-class associated spending. Based on analysis by Brookings[1], of the US$29 trillion increase in global middle class[2] spend between 2015 and 2030, more than 84 percent will stem from Asia Pacific. And of this, the vast majority stems from China and India.

Today, there are around 1.5 billion members of the Asian Pacific middle class. By 2030, this number will be closer to 3.5 billion. As middle-class wealth increases, the middle class population will travel even more than they do today. Airbus (Euronext: AIR), a high-quality aircraft manufacturer with few competitors, will produce many of the planes that will be required to satisfy the demand for flights out of Asia for the coming decades.

Similarly, TravelSky Technology (HKEx: 696), the Chinese global distribution system monopolist, will take a cut of nearly every aeroplane ticket that is booked in China. TravelSky owns an unrivalled ticket distribution network of more than 70,000 sales terminals in more than 8,000 travel agencies across China. This network connects travel agents to more than 129 commercial airlines around the world for ticket distribution.

Now, it is one thing to see a chart like the one displayed above and agree that the Asian Pacific middle-class is going to be an important source of growth over the coming 10-15+ years. It is another thing to translate this chart into tangible economic parameters.

The following is a simple example that illustrates how the above growth in middle-class spending can translate to earnings of well-positioned businesses. First, we note that the step-up from $35 trillion to $64 trillion equates to real growth of 4.1 percent per annum. Now, assuming average inflation of, say, 2.5 percent per annum, then this dynamic results in 6.6 percent per annum in nominal revenue growth for the collective businesses serving this demand.

As illustrated below, revenue growth of 6.6 percent per annum can result in significant earnings growth, depending on the split between fixed/variable costs. We show a Hypothetical Company with a 50/50 split between fixed/variable costs and currently earning a 10 percent pre-tax profit margin.

As can be observed, with these parameters, the 6.6 percent per annum top line growth translates into 12-25 percent per annum rates of earnings growth. These are big numbers that compound quickly. As you can see from the table above, in just 10 years, the earnings-power of this Hypothetical Company has increased by nearly 5x.

Mega trends like the growing Asian middle-class can be great anchors for your portfolio. In a world of continual distractions, sticking with multi-decade structural tailwinds can be a great way to cut through the noise.

Montaka owns shares in Airbus and TravelSky Technologies.

[1] (Brookings) The Unprecedented Expansion of the Global Middle Class (February 2017)

[2] The middle class has been defined by Brookings as comprising those households with per capita incomes between $10 and $100 per person per day (pppd) in 2005 PPP terms. This implies an annual income for a four-person middle-class household of $14,600 to $146,000.

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Andrew Macken is Chief Investment Officer with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.

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