Janus Henderson Investors: Examining the tech sector through the pandemic – and beyond

Key takeaways

• The timeline that we expected for e-commerce, remote work and social media platforms to gain a greater foothold in society has been pushed dramatically forward due to the coronavirus outbreak.
• Rather than an ephemeral spike, we believe many of these behaviours will last long after the virus subsides, complementing the already powerful tech themes of the cloud, Internet of Things and artificial intelligence.
• Near-term risks remain, especially in pockets of the semiconductor space that have exposure to economically-sensitive sectors.

The global economy has suffered a fierce blow as the COVID-19 pandemic has spared few – if any – regions and industries. Equity markets have followed suit as the hit to near-term earnings prospects and uncertainty about when and how the global economy will ramp up is factored into stock prices. But restart, the economy will. And integral to this process, in our view, is the technology sector. In fact, on display over the past couple of months are examples of how much individuals and companies have already come to rely upon technology in their daily lives.

An accelerated deployment

We believe the tech sector is a driving force of the secular themes that will redefine how we work, shop and socialise over a three-to-five-year time horizon. Many of the companies exemplifying the themes have been called into action – perhaps earlier than anticipated – to help businesses and societies navigate the COVID-19 crisis.

Businesses have been forced to deploy the capabilities required for remote work. People have increasingly relied upon social media platforms to communicate. Online grocery shopping has gone mainstream. Many cohorts, including older generations who have been hesitant to embrace the digital economy, have been compelled to do so. It is no longer optional.

With families sequestered at home, theatres closed, and sporting events cancelled, streaming entertainment and gaming have become go-to diversions. As with e-commerce and social media, the growth outlook for these services was already promising; what has changed is the pace at which they have been adopted by broader swathes of the population.

In this respect, the expected benefits of recent capital expenditures by these companies may likely have been pushed forward. As an example, Amazon has invested heavily to roll out one-day shipping. With shops shuttered, this initiative helped customers stay well supplied while they shelter in place. Furthermore, we have witnessed retailers across the spectrum rapidly ramp up their e-commerce capabilities to better meet the shifting demands of customers.

Something for enterprises

The cloud is another secular theme that has helped companies accelerate their digital transformation. Cloud-based front-office functions are helping businesses of all stripes keep doors open, and other functions are increasingly leveraging the cloud as staffs work remotely. Until now, business continuity plans had not been tested at this scale. Going forward, businesses will make sure they have the digital infrastructure necessary to maintain operations. Accordingly, we expect a reprioritisation of investment, with a much greater share of expenditure going toward strengthening digital capabilities.

Cyclical headwinds emerge

Other segments of the tech sector have found the past couple of months more challenging. Companies with more exposure to the economic cycle have suffered as global growth prospects have fallen. The semiconductor space has been hit hard by a convergence of factors as chipmakers were only beginning to climb out of an inventory overhang when the pandemic erupted. We believe that the longer-term prospects of semiconductors may be bright, given the critical role they play in the deployment of cloud data centres, the Internet of Things (IoT) and artificial intelligence (AI), but their exposure to global supply chains and the COVID-19-related demand destruction have weighed on the industry. Certain segments of semiconductors are more sensitive to the economic cycle than others, and some names are particularly exposed to industrials and automotive, which are areas that likely face acute near-term headwinds.

Maintaining a balance

We believe that the lenses through which we view the tech sector help us stay focused on the sector’s long-term drivers, as well as identify near-term challenges. We tend to view tech companies as either displaying more resilient characteristics or possessing optionality, meaning the possibility of rapid earnings growth.

The appeal of a company’s resilience is on display during periods of economic upheaval. Companies whose sticky products can generate steady cash flows across the economic cycle, along with those that do not rely upon a high degree of leverage to fund growth, are likely to come out of downturns largely intact. Changes in consumer preferences and opportunities presented by economic disruption, on the other hand, can increase the optionality profiles of younger, more nimble companies.

We also divide the sector between cyclical growth and secular names. While cyclical companies tend to contribute to the sector’s fortunes when the economy is on the upswing, we believe it is secular growers that will power the digitisation of the global economy in the years to come.

Economic growth welcome but not required

Should the economic slowdown last over the mid term, we believe investors will seek earnings and cash flow growth where they can find it. Propelled by the themes of cloud, IoT and AI, we believe that the tech sector should continue to offer long-term opportunities to investors. Should the crisis wear on, the relative strength of technology companies’ balance sheets should also prove desirable. If the health situation stabilises and policy stimulus ignites economic growth, more cyclical tech names may also see their prospects improve.