Two interesting trends have emerged from the pandemic. Australians are having more babies and they are swapping out their city lifestyle for the beach and bush. In contrast to short term phenomena such as the hoarding of toilet paper, these shifts have potential long lasting implications for the economy and listed companies. In this article we discuss these two trends and the opportunities they have created for companies in the Firetrail Australian Small Companies Fund.

COVID baby bump or boom?

When large mortality events occur including diseases, earthquakes and wars, birth rates decline and on average, reach a trough some nine months later. As shown in Figure 1 below, this pattern holds for events such as both World Wars and the influenza outbreaks of 1918. Following an initial drop, fertility tends to rebound. Birth rates begin to recover ~11 months after an epidemic and then increase in the subsequent 1-5 years.

The end of World War II sparked one of the biggest baby booms of the 20th century. Could we be at the start of a post-COVID generation? Estimates by academics regarding the post-COVID birth recovery vary widely. The Institute for Family Studies notes that COVID has the potential to boost births over the next four years by anywhere from 0.3% to 40%. We admit this is a wide range to draw a conclusion from just yet. However, recent trends in birth rates and anecdotal evidence provide reason for optimism:

• The number of babies born in NSW public hospitals during the June quarter was the largest on record. A total of 19,113 births were reported, an increase of 9% on the prior year. This is a significant upswing compared with the declining fertility rate over the last 10 years.
• Prior to the pandemic IVF volumes had been increasing gradually over time. But in FY21, 98,290 IVF cycles were recorded, up 29.3% compared to FY20 and the highest figure on record.

The increase in IVF volumes has benefited portfolio holding Monash IVF. During FY21, Monash recorded a 40% increase in new patient stimulated cycles and there are no signs of a slowdown. New patient registrations in 2H21 were up 8% compared to 1H21, and up 35% on 2H20. ~70% of patient registrations are converted into patient treatments within ~3-6 months.

COVID-19 has sparked a behavioural shift amongst Australians. Restrictions on travel and a greater focus on family, health and wellbeing is resulting in a re-direction of priorities. While it is still early days to call it a baby boom, recent birth rates and trends IVF trends indicate we are at the onset of a baby bump. 

Looking beyond the headline impacts of escaping the city

For decades the lack of job opportunities in regional areas has seen many Australians relocate to capital cities. Then the pandemic hit. The sudden shift to working from home has made a tree change or sea change possible and more attractive for many Australians. ABS data shows net migration to regional Australia is the highest since records began two decades ago. In the 12 months to March 2021, net migration to regional areas increased 87.1% year-on-year. The impact of demand for housing on prices in regional towns has been widely publicised. Digging beneath the headlines, second order impacts are more interesting and perhaps even more important.

Demand for products and services across some industries increase as more people move to regional areas. Regional houses are larger and hence require more bricks to build and more lights to illuminate. For listed companies with strong brands, regionalisation has created an avenue to expand store footprints, increase sales, and grow market share. Portfolio holding Beacon Lighting is capitalising on this opportunity. It plans to open three additional regional stores this year including Ellenbrook (WA), Butler (WA) and Melton (VIC). The City of Melton, where Beacon Lighting is expected to open a new store in FY22, is one of the fastest growing areas of Australia. 11 new suburbs have been proposed to be added to it! In 2020, the city recorded a population increase of 4.6%, more than double the increase for Greater Melbourne which grew at 1.6%.

Increased sales in regional areas often come hand-in hand with supercharged margins. This is a direct result of limited competition and lower costs of doing business. A key cost line for many retail companies is rental expense. Bendigo is over 150km away from Melbourne CBD. Looking at recent advertised rents, it is ~50% cheaper to rent a large retail space in Bendigo than it is in areas close to the Melbourne CBD like Southbank. Going regional also comes with less competition from smaller niche retailers that often compete on price. Regionalisation has created an opportunity for companies like Beacon Lighting to increase sales, grow market share and generate better returns on a per store basis.

Conclusion

There are many interesting phenomena that have emerged from the pandemic, many with direct and lasting implications for listed companies. Restrictions on travel and a refocus on family has contributed to a spike in birth rates and IVF volumes. The sudden shift to working from home has driven many Australians away from the cities to regional areas. The baby bump (or potential boom?) and regionalisation trends have created an opportunity for many companies in the Firetrail Australian Small Companies Fund.

Disclaimer

This article is prepared by Firetrail Investments Pty Limited ('Firetrail') ABN 98 622 377 913 AFSL 516821 as the investment manager of the Firetrail Australian Small Companies Fund ARSN 638 792 113 ('the Fund'). This communication is for general information only. It is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. It has been prepared without taking account of any person's objectives, financial situation or needs. Any persons relying on this information should obtain professional advice before doing so. Past performance is for illustrative purposes only and is not indicative of future performance.

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Three key issues - inflation, the power crunch, and China's economy - reverberated during the third quarter of 2021 and continue to present a complex backdrop for global equity investors.

As we move into 2022, we think it will be critical that global equity portfolios are appropriately positioned to provide exposure to the potential opportunities while providing protection against risks that may emerge such as an economic growth shock (perhaps from a hard landing in China), or an inflation shock.

There's also the possibility of a combination of both - the stagflation scenario.

Inflation

Antipodes has been saying for some time that we think inflation is going to be more sticky than transient, while central banks have taken the view that near-term inflation will fade.

Recently we've seen more and more evidence of inflationary pressures building around wages, rent and now energy prices, and in the last couple of weeks we've started to see a break amongst Fed members on just how transient or persistent inflation is.

It's almost a certainty that tapering will begin before the end of the year and rate hikes may start from late 2022 as opposed to 2023.

The risk is that the Fed is tightening as economic growth is slowing, which may compound the problem.

A power crunch?

Europe's gas price is at a record high, the US gas price has more than doubled over the year, and oil is back above $80 per barrel, the highest level since 2014.

Energy is becoming another pressure point.

Europe is facing a shortage of gas due to a strong rebound in economic activity, coupled with supply issues and an underinvestment in power infrastructure.

In recent days Russia declined to pump extra gas into continental Europe which compounded fears. Moscow's position may change in the coming months, but even if Russia does decide to supply some additional gas, Europe is unlikely to find enough volume from traditional suppliers to fill the deficit.

With LNG and European gas prices equivalent to $150 per barrel of oil we're seeing a shift to burning oil in Asia. This shows how the gas rally is also fuelling an oil rally.

Consumers are going to start to feel this. The cost of filling the tank will rise, as will the cost to power and heat homes in the northern hemisphere's peak winter demand season. 

At the same time, power shortages have hit China.

China's power demand has been strong due to domestic and global activity, but hydropower output - which is almost 20% of total power in China - has been hit due to low rainfall, and coal production has also been subdued due to capacity controls and tightening policies around mine safety and emissions. We've started to see shutdowns in high energy intensive industries, and if this accelerates through the broader industrial sector there will be implications for domestic and global economic growth.

So, we have a very real risk of a power crunch across major economies and higher power prices through winter months. As well as the impact to economic activity, this could have meaningful implications for inflation. Meanwhile, we think there are some US gas producers that look like particularly attractive opportunities.

The Chinese economy

China has been tightening property policies on and off over the last five years. Growth had become unsustainably high again in the first half of this year, so policy was tightened again to curb speculation and house price inflation.

Housing starts began contracting in August, which quickly exposed the weaker property developers.

We all know the Evergrande story - but the Chinese banking system can handle an Evergrande default, if it comes to that.

If you combine Evergrande's debt with that of other risky property developers, it still only accounts for around 2% of system loans. Under an extreme stress test, banks' Tier 1 capital would remain well above the minimum 7.5%, meaning there's still plenty of capital in the banking system to continue lending.

The bigger question is whether an Evergrande default seizes up financing for other developers, which spills over into weaker housing prices and a broader economic slowdown. Residential development accounts for around 10% of GDP, so it's a material contributor to China's economic activity.

There would also be implications for commodity prices, particularly commodities where China is a major consumer but an immaterial producer. Copper and iron ore look the most vulnerable here.

However, with Government debt less than 70% of GDP, China has the firepower to re-stimulate - and we think it's a question of when rather than if.

This time around we think stimulus will focus on consumption, reinforcing the social safety net and decarbonisation. China wants to accelerate its transition to a consumption and services driven economy. To do this, household spending needs to grow at a faster pace than incomes via running down China's extraordinarily high savings rate.

With changes in the regulatory backdrop now well-progressed, investors are going to start to re-focus on long-term opportunities, particularly around consumption trends.