Markets:

Another two weeks have gone by and markets have turned in a great result. The US markets from an Aussie perspective returned 3.2% (S&P500) and 4.1% (Nasdaq), while the local bourse returned 3.0% (ASX200). Tech has led globally after a pull back in September. Coming into election season and Q3 results we expect further buoyancy in the sector. At home, the Federal Budget was released with infrastructure, builders, and the Australian taxpayer coming out as winners.

Framework Series: Payments – Buy Now, Pay Later

Our piece two weeks ago on AI was a hit, and the feedback from our clients was that they want to hear more stories from our investment framework. This is encouraging for us to hear, because we love talking about our investment framework with clients and frankly anyone that will listen.

One of the most interesting segments of our framework is payments. Cash usage is on the decline globally, and the world is moving to cashless. By 2023 it is expected that cash will move from 30% of our transactions to 19%. In the equity market if you are not growing you are dying, and cash is going the way of the dodo bird. Now the question is what will take cash's place in the global hierarchy and how will we transact moving forward?

It is an interesting question and will depend on which region of the world you live in and where you are buying. If you plan on performing an in-person transaction, you will be more likely to use a credit/debit card or a digital wallet in the future. These may be physical or installed on your mobile phone. All these methods exist today but are becoming more and more accepted.

Now what about where you live, and how things will be transacted. We brought this up, because having a bank account is a common thing here in Australia. Most of us were signed up as children and have kept that banking relationship throughout our lives. I still vividly remember the first $5 deposit I made in Canada, at the bank that I still bank with to this day. This experience is not universal outside of the western democracies. The world has over 1.7billion unbanked citizens. In a cashless world, the unbanked need a solution.

Interestingly 2/3rds of the unbanked population has access to a mobile phone. The rise of the digital wallet in Asia has evolved beside the rise in disposable income of that region's population. The growing middle class of 350million people are expected to have their disposable income rise to $300bn by 2022. In a country like Indonesia 25% of e-commerce transactions are carried out by digital wallet with the wallets accounting for 6% of in person transactions. Cash is king still at the till in the country, but that will change with digitization. The same people that pay a vendor cash to load onto a digital wallet for an e-commerce transaction will soon perform the same procedure for an in-person transaction. In the next decade Indonesia will have a cash usage rate like the 16% we enjoy in Australia.

Interestingly Australia finds itself at the forefront of a new sector in cashless. Our beautiful island is father, mother, and nurturer of the buy now, pay later (BNPL) movement. Industry titans Afterpay, ZipPay, OpenPay and Sezzle were dreamt up a stone throw away from the white sand beaches and turquoise waters of our coasts. This Aussie export is now penetrating lucrative markets in Europe and North America, but at home there is still a lot of confusion about exactly what the product is and how it works.

Most in Australia have now heard of Afterpay and are familiar that the product takes a transaction and spits it up into four equal payments, the first paid on the spot and the other three every two weeks. Beyond those facts APT:ASX is a bit of a mystery. The best way to describe the product is to contrast it with a traditional credit card. A traditional credit card you make a purchase at a retailer, that retailer will then pay a fee. That fee is split up between the folks that own the systems, the issuer of the card, and the banks that acquired the transaction, so your bank and the merchant's bank. It is called a 4-party payment system. Without getting into the detail every credit card transaction in Australia costs a merchant roughly 0.5%, with American Express more expensive and EFTPOS cheaper.

Merchant fees are the first way credit cards make money, the second is off interest payments and late charges. Anyone that has ever forgotten to pay their credit card is aware of these two payment forms. Credit cards typically charge interest rates more than 15% and have late payment penalties. Even new interest free products have subscription costs that work out to similar "interest' rates of traditional cards, the banks are simply re-branding the name of the fee. Now how is Afterpay and BNPL different?

It is a great question, first Afterpay does not rely on late fees or customer interest as revenue, they do everything in their power to keep customers paying. Initial limits are kept small, and the company derives only 20% of revenue from late fees. Traditional credit cards rely on you not paying off your bill on time by charging interest and fees. Miss a payment on APT's system and you are charged $10, never pay them back and the service is cut. Over time non-paying customers are purged from the platform and Afterpay is left with only credit worthy customers.

The bulk of APT's revenue comes from the merchant side of a transaction. Instead of the 0.5% fee the credit card companies charge, a merchant can pay up to 4% of the transaction value. Why are merchants willing to do this? Well because Afterpay users end up spending 20-30% more at a store when they use Afterpay. The merchant wins even if they are paying a higher fee. Merchants paying the fees is how Afterpay can offer their product for zero cost to a customer that pays on time. Why are credit card company's unlikely to interfere, well because most Afterpay accounts are linked to the credit/debit cards and credit card company's still get their 0.5%.

Buy now pay later is 8% (2019) of online transactions in Australia, and 1% of transactions in the US. The retail e-commerce market in Australia is $29bn (2019), and the US market is $343bn (2019). There is significant market share for BNPL to gain globally and a reason we love the sector.

Updating our checklist:

• Valuation: ASX & S&P500 levels : Valuations on the ASX and S&P remain elevated as fwd P/E is now 21.3x and 25.9x, respectively.
• Global PMIs: The detail of global PMIs remains on the upswing. Consumer confidence in Australia has hit a 12month high for October. We do expect some headwinds in the macro economic data from Europe as the virus spread increases lockdown concerns in that region, but nothing that will derail a global recovery.
• Downgrades on guidance: Next week several companies with August year ends will report, which will give us a preview of where Q3 figures could take US companies. Guidance and reinstitution of dividends/distributions is key for holdings in the REIT and large cap space. An example of the effect reinstituting a dividend can have on a holding can be seen from BPF.UN listed on the Canadian Index (TSX). Boston Pizza Royalties Income Fund is a company setup to distribute the profits from pizzeria pubs located around Canada (casual dining) - the deluxe pizza is a secret favourite of mine. The company pays a monthly payment to investors and trades at a 6-8% yield. During the height of lockdowns BPF.UN suspended payments to unit holders, tanking the share price. Upon resumption of the distribution on Oct 1st, the share price rocketed up 58%+ during the subsequent week. While this is an extreme example, similarities can be drawn in the Australian market where dividends and distributions have been halted across sectors. We expect positive guidance and resumption of payments from these sectors in Q3/Q4 as the virus outlook becomes better known.
• Infection rates to slow globally: Domestically in Australia there are state by state restrictions still in place on travel and gatherings. Victoria is still considered a hotspot but has had restrictions lifted since the end of September when the state moved from stage 4 to stage 3 restrictions. Internationally Europe is going through a revival of virus cases. France and Italy are more prepared than they were for the first wave, but curfews are being debated. We expect anywhere with rampant infection to have the traditional economy effected until case numbers retreat.
• Monetary and Fiscal stimulus announcements globally: US stimulus talks remain stalled and are unlikely to be settled before the election Nov 3rd. Markets have priced in a Biden presidency recently as his poll lead has grown to double digits, time is not the current President's friend, as there are a little less than 3 weeks to reverse the large lead. We are aware that 2016 saw a similar trend with Clinton leading into the final weeks, however, Mr. Biden's unfavorability numbers are superior to Clinton's and Clinton was hurt by the reopening of an FBI investigation into her private email server a week before the election. China remains quiet on the stimulus front and is likely holding off till after the US election.
• Australian Federal Budget: The federal budget was released last week and there were a few key winners, as the Feds try to stimulate the economy. Infrastructure spending will be accelerated, with a boost of $10bn in spending asap ($14bn total for 2020), and a pipeline increase of $10bn to $110bn overall. An emphasis will be on shovel ready projects, with a spend it or lose it approach, M1 part deux here we come here in QLD. Other highlights were expansion of the first home buyers' scheme and tax write offs for small business investment. Overall an excellent recovery budget to get Australia back on the growth track.

With the release of the federal budget the share market has gained back losses from late August and September. Events like this are something that we consider months in advance when we design our strategies and implement our framework. Your advisor has set out a financial plan to meet your long-term goals and avoid sequencing risk, where you are forced to sell down assets at the bottom to meet short term needs. This plan is essential during turbulent times to keep our focus. If you have any extra investment capital, there is no better time to speak to one of our advisors than today. We will touch base with everyone again in a few weeks.