Retail Trading has gone ballistic. In the US equities market, Retail Trading accounts for almost as much volume as Mutual Funds and Hedge Fund Trading volumes, combined. The ease (and gamification) of stock investing has opened up a new asset class to many ordinary people and has democratized the process of buying and selling stocks.
From 2015-2030, the share of the Chinese Population with ‘High Incomes’ (>$35k/pa) is expected to grow by 5x (from 3% to 15%). Those with incomes greater than ($11k/pa), the ‘Upper-Middle Class’, are expected to grow to 35% of China’s population compared to only 10% in 2015 (all numbers normalized for 2021 Prices).
This rapid rise in income per capita as people move into the middle class, is expected to open up Total Addressable (Retail) Wealth of ~$30tn by 2030, with over 500m Chinese Clients falling into this ‘Upper Middle Class’ Income bracket with money to invest.
One further catalyst is that Chinese households have a disproportionate amount of wealth tied up in Physical Property. As per capita wealth increases, this should start to favor Financial Investments as households diversify their holdings (to be more in line with other developed countries).
China’s Demographic Problem
Unfortunately, alongside greater wealth has come a greater willingness to buy unproductive assets (e.g. Louis Vuitton handbags, Tech gadgets and International Travel). Ten years ago, the average Chinese worker saved 39c on every dollar of income. Today, it is 33c and many young Chinese save nothing at all.
In this regard, Chinese Investing Platforms are not just in the business of democratizing finance like their US counterparts, but they are solving an underlying macroeconomic problem; they are creating the right incentives for households to invest.
To put things into perspective, the Shenzen and Shanghai Composite indices contain just 10% of the world’s equity by value (even though China contributes about 16% of Global GDP). Meanwhile in the US, the Nasdaq & NYSE have about 50% of the worlds equity value. Unlike in the US, Retail Holdings (as a % of market cap) inside of China have steadily been decreasing, speaking to a lack of incentives to invest in domestic markets. As a result, it is common for top tier Chinese companies to completely neglect domestic IPO’s in favor of Hong Kong or US listings.
Given the scale of the problem, I think the market is not just prone to disruption but if executed well, Chinese investment platforms can ride the tailwinds of (1) have the backing of the Chinese Government to solve a deepening macroeconomic crisis (2) exposure to a rapidly expanding middle class and (3) ride the broader growth trend in Retail Investing taking place in other countries.
China’s Robinhood’s: Futu & Tigr
The top two brokerage firms in China are ‘Tiger Brokers’ (Ticker: Tigr) and ‘Futu Holdings’ (Ticker: Futu). They surpass their competition by a wide margin due to their online only presence, reduced fees and established technology platforms. Both of these companies boast retention rates of approx. 98% and can be seen as the ‘Robinhood’s of China’.
Their three key revenue drivers are:
(1) Brokerage Commissions
(2) Interest Incomes from Margin Lending/Cash Sweeps
(3) IPO’s and Share plan services
Both companies generate over 60% of their revenues through (1) but this has been steadily decreasing this share through diversification into (2) and (3).
Futu has two main investment apps; Futubull and MooMoo.
Revenues from Brokerage Fees: Approx. 64%
1.4m Registered Clients, 516k Paying clients
Paying Clients Growth: 60%, 84%, 137%, 160%
Total Trading Volume: $150bn
User median age is 34, mostly affluent Chinese (40% work in technology)
To attract clients, Futu has a social networking element, ‘NiuNiu’ community. This allows investors to find new investment ideas (think Wallstreetbets but without the hype). The average user spends 38minutes per day on this in 2020 (versus 25mins in 2019)
Founded by an ex Tencent employee. Tencent owns a 30% stake in the company
Revenues from Brokerage Fees: Approx. 60%
975k Registered Clients, 215k Paying Clients
Paying Clients Growth: 29%, 53%, 76%, 110%
Total Trading Volume: $63bn
Initial focus is on US equities with international presence
72% of Tigr’s users are under 35 years old.
Acquired US baked broker in 2020 to build out in-house clearing functions
Interactive Brokers has 8% stake in the business (with Xiamo having 12% stake in the business)
Both Tigr and Futu deserve to be considered explosive high growth stocks, growing revenues at an average of 130-150% over the last few years (alongside paying clients – see above). Importantly, they are both also profitable and have sizeable Free Cash Flows.
On paper, Futu does look like the better business given that it has grown faster and has shown that it can monetize this growth better; with 76% Gross Profit Margins and Net Income Margins at 38% (in 2020). Tigr has Gross Profit margins in the 40% and Net Margins around 12%.
Using analyst expectations for 2021 Revenues, both businesses should grow revenues by over 120% y/y. Assuming a conservative growth rate assumption (Futu 40-55%) and (Tigr 25-40%) over the next five years, adjusting for a 15-20x P/E multiple in 2025 and assuming they can hold Profit Margins in line with where they are now (also conservative given that as businesses see more user growth, they should experience higher margins due to scale), I think both of these stocks are trading at very attractive entry points for new investors with over 100% upside in five years in the most optimistic scenario.
So we’ve all heard a lot about short squeezes in the stock market recently. In this post, I want to look at a different type of squeeze. I want to look at the supply squeeze occurring in the market for Rare Earth Metals and which stock I think has most the gain from it.
If you haven’t read my earlier post on Rare Earth Metals, here’s a refresher on what they are.
Rare Earth Metals (REM’s) are a series of metallic elements which have special properties; such as making great magnets or being heat resistant. They are not hard to mine (like Gold or Silver) but doing so profitably is very difficult because they are spread out along the earth’s crust.
The two most REM’s elements here are Nd and Pr. These are used to make magnets which power the batteries and motors used for Electric Vehicles (EV’s) and Climate Change Technologies (e.g. Wind Turbines). These also happen to be the two fastest growing end user markets.
Whats the big deal?
What makes Nd and Pr so important is that they are critical components of the products they produce. The technologies they are used in are very settled, especially the motors which are used in EV’s.
Above is an overview of the different EV technologies used by car manufacturers. What is apparent is that regardless of producer, the motorization technology is the same, and to produce these components, Nd, Pr are essential.
There is no known alternative to these elements existing in the world today so these are clearly very important components of our lives.
There are two fundamental problems here and in both cases investors have a chance to profit.
PROBLEM 1: THE SUPPLY SQUEEZE
The first problem is that demand is outpacing supply, at a considerable rate. You just need to look at EV policies across the globe to realise the scale of the problem. Nearly every major economy in the world has announced some form of EV push to combat climate change and EV vehicle penetration is going to continue to climb as we can see from the below.
If we overlay the demand forecasts for Nd Pr for the EV market, REM supply will not even meet 50% of the forecasted demand for this in the next 10-15 years. This is before demand for Nd Pr from other sectors like wind turbines or smartphones.
This is the hallmark sign of an impending supply squeeze.
PROBLEM 2: EAST VERSUS WEST
The Second problem is that whilst their demand is global, the supply of REM’s is not.
85% of the World’s supply of REM is in China as the Chinese government has made a concerted effort to increase production and relax regulation (through various means).
This is not supposed to be a politically charged article but I think we can all agree that having so much supply concentrated in another country is problematic. What happens if there’s a trade dispute? Or a military conflict? China can and has banned exports to countries like Japan before, and this can severely disrupt supply chains. Just see the price chart of the last squeeze below.
The solution is actually quite simple – we need more production and we need that to be in the western hemisphere. As of today, there is only one company operating in this space and that is MP Materials (ticker MP).
Why I like MP Materials Stock?
There are three things I like about MP Materials.
1) MP has a dedicated plan to shore up US manufacturing capabilities
MP has a three stage approach to shoring up US production.
The first stage of MP’s plan is to specialize in Rare Earth Concentrates production. This is the naturally produced concentrate of REM’s. MP has already completed this stage of their plan and they now produce around 15% of the world’s consumption of these REM’s. This is considerably more than what has been achieved at this mine in the past (particularly under previous management, Molycorp).
The second part of MP’s plan is to process this concentrate into refined metals. They are on track to create an onsite refining of REMs in 2022. This will allow MP to be integrated further down the value chain (and ultimately less dependent on China). This is the most important stage for me and I’m optimistic this will be completed on time, as it has the backing of the Department of Defense and is fully funded.
The final stage is to further integrate downstream and to produce the magnets used to make EV Power Trains; also expected to be the fastest downstream market. This would allow MP to sell directly to companies such as Tesla and transition from mining into manufacturing.
2) MP operates in a sector with extremely high barriers to entry
The second thing about this business is that MP’s competitors are significantly behind as they have high barriers to entry. As we can see below, as MP meets Stage II of expansion, it will be at least one year ahead of competition and far cheaper than new Greenfield Sites opening in the US (with uncertain timing).
3) Very strong Financial Position
Finally, I like this business because it has a very promising set of financials. MP forecasts strong growth in revenues as the company expands into refining/end user products. These products also come with higher gross margins of close to 60%. Meanwhile, the capex to fund this associated production will have already been put up by 2021, leaving sizeable Free Cash Flows for investors. Ultimately, this means more Revenues, Cash Flows and EBITDA (projections below).
MP is doing everything right for me. The REM market is due a serious supply squeeze in the western hemisphere and is vastly under exploited. The only way to publically invest in this space is via MP which is already targeting production growth and will remain ahead of its competitors in a market with huge barriers to entry. Despite very exciting future prospects, the company is still only trading at 13x forecasted 2023 Sales which I think is a good entry point for new investors.
China will overtake the US to become the world’s largest economy by 2028, five years earlier than previously forecast, according to the UK based CEBR (Centre for Economics and Business Research). This bodes well for the e-commerce sector which accounts for a whopping 36% of total Chinese GDP today, compared to only 15% in 2008 . In this post, I will look at the particularities of Chinese e-commerce and how and why retail investors should want a slice of this pie.
The global e-commerce market is expected to grow at 16% compounded over the next four years (having already grown at 17% compounded over the last seven years). For context, that’s 1.5x the expected growth rate of the global smartphone market, 2.5x expected growth rate of home ownership and about the same as the forecasted growth rate for the Electric Vehicle market over the same period…so it’s a pretty big number,,.
This is being driven by changing consumer preferences over how and where shopping takes place and improvements in mobile technology to facilitate this transition. 67% of millennials already prefer to shop online (and 56% of Gen X-ers), when compared to brick and mortar. Of these, about half make purchases whilst sitting in bed, 23% at work (and 20% from the bathroom or in the car!), representing how mobile technology has been able to make shopping more convenient and fulfill our endless desire to do things on our own terms. These structural trends are not expected to go away any time soon particularly as a result of COVID-19 which has spurred increased online sales in most industries.
China led growth
Whilst the current global e-commerce market is around $4tn (roughly 5% of Global GDP), the bulk of this market share is in China, which boasts an e-commerce market almost twice the size of the US equivalent. E-commerce accounts for almost 35% of Chinese total retail sales, compared to only 10% in the US. To put this into perspective, approx. 50% of global online transactions each day, happen inside of China and the largest online retailer in China, Ali Baba, has almost double the number of active users on its platform that Amazon has globally (600m vs 330m).
As the first major economy to post GDP growth in 2020, the Chinese e-commerce market is facing two very strong tailwinds; a global structural trend away from brick and mortar to online, and high sensitivity to a booming Chinese economy, which is set to continue to grow 5-8% per annum over the coming decade.
Chinese e-commerce market
The Chinese e-commerce market is not identical to other markets.
Mobile platforms generate 80% of retail ecommerce sales in the country (and 95% of total e-commerce activity) vs 64% globally. Put simply, this is because the average consumer in China spends more time on their smartphone (5 hours, compared with 3 hours globally). Given smartphone penetration is still far from reaching saturation (50% of the Chinese population), existing operators need to have a large-scale mobile retail presence to continue to expand.
2. Mobile Payments
This mobile technology has gone hand-in-hand with mobile payment platforms (such as Alipay, Wechat and Union Pay). In fact, 80% of smartphone users use mobile payments compared to only 27% in the US. The opportunities for newcomers in this space however are limited with Alipay (owned by Ali Baba) and Wechat (owned by Tencent) controlling 92% of the Chinese mobile payments market combined.
3. Omni-Channel Retail & Brand Awareness
The third distinction is that Chinese consumers are more discovery oriented than US consumers (i.e. they don’t always know what they want before they’re online), indicated by the former having more touchpoints with the brand before item purchase (8 touchpoints versus only 4 in the US). This has made omnichannel retail (selling across multiple platforms), international brands and interconnectivity with social networks, particularly important to drive retail sales in China.
Current State of Play
All three main players in the Chinese e-commerce market (Ali Baba, JD and Pinduoduo), cover some form of mobile retail, mobile payments and omni-channel retail but Ali Baba is miles ahead. This is because, whereas, JD and Pinduoduo both have secured strategic investments from Tencent to add additional services to their primary retail presence (e.g. mobile payments and social networking) Ali Baba has been able to integrate these functions across its existing businesses (such as Ali Pay and Lazada).
Resultingly, Ali Baba has the biggest slice of the pie with 60% market share, led by its Business-to-Consumer marketplace, Tmall. To put that into perspective, Amazon accounts for 40% of online retail sales in the US and is widely considered an e-commerce behemoth in the US.
List of Chinese e-commerce players
Tmall China (Ali Baba) – The third most visited site in the world and a brand driven B2C marketplace.
60% Market Share
JD.com (JD) – marketplace with in-house delivery and logistics.
20% Market Share
Pinduoduo – Group buying marketplace (like Groupon).
5% Market Share.
Others – (Wechat Store and Red/Xiahongshu)
~15% Market Share
Ali Baba as an E-Commerce Stock
Whilst Ali Baba is by no means a pure play Chinese e-commerce stock, 68% of FY 2019 revenues came from Ali Baba’s China based marketplaces (compared to 7% from international wholesale, 7% cloud computing, 6% entertainment and 4% logistics services). 85% of this in was via mobile sales. This illustrates that whilst Ali Baba touches many different industries, it is still very much a Chinese consumer focused, mobile e-commerce giant.
Ali baba strikes me as the most defendable business model within the Chinese e-commerce space. This is principally because it meets the threshold of having the strongest mobile retail penetration for the Chinese consumer (with higher gross margins), mobile payments integration and cross border retail presence to drive brand awareness.
Why Ali Baba is superior to competition
Strong Mobile Customer Penetration (and a more profitable business model)
Based on Chinese internet users of over 855 million, Ali Baba boasts an 83% penetration rate for its B2C and C2C platforms (Tmall and Taobao), which are the two largest online marketplaces in China. About half of the Chinese population are users of Ali Baba and over 85% of total yearly sales on Ali Baba’s platform, come from mobile (with total GMV larger than Amazon and Ebay’s yearly sales, combined). This deep penetration has allowed Ali Baba to leverage network effects across its platforms (the platforms drive traffic to each other thereby lowering acquisition costs) and as a result, Ali Baba is usually the first shopping experience for Chinese customers. This deep penetration has allowed the company to maximize revenue per user relative to its competitors (GMV per active user was CNY 730 versus CNY 143 for Pinduoduo and CNY 362 for JD).
Direct Customer fulfillment
Ali Baba is often described as the Amazon of China whereas in fact, it operates more as an ‘Ebay’ of China. Tmall, it’s B2C platform, gives businesses direct customer fulfillment so they manage the warehousing and shipping of goods to the end customer. This allows Ali Baba to charge servicing fees for marketing on its platform but it does not have to take inventory on its own balance sheet. This vastly improves the overall net income margin for Ali Baba which is 22% (vs 5% for Amazon, 1% for JD) and Gross Margin OF 44% (vs 40% for Amazon, 15% for JD).
Mobile Payments Technology
Ali Baba also owns a 33% stake in Ant Financial, a mobile payments and microlending platform. Ant has the largest share of the Chinese mobile payments market (54%) in an industry which is set to double in size by 2025. Wechat is second in size at only 38% market share. This dominant position has allowed Ali Baba a virtual monopoly on mobile payments as it can integrate this with it’s online e-commerce platforms.
Omni-Channel Retail via cross border e-commerce
Outside of China, Ali Baba is the furthest ahead in integrating its business with global brands and cross border e-commerce. This is primarily facilitated by Ali Baba’s controlling stake in Lazada, a South East Asia focused e-commerce business (with 200million active internet users across these regions). In these regions, e-commerce accounts for a meagre 3-5% of total sales reflecting lack of existing providers and strong runway of growth ahead. In 2009, Ali Baba also purchased Koala from rival Netease (integrated into Tmall) to build out its import strategy; allowing global merchants direct access to the Chinese consumer. This will allow Ali Baba to accelerate import/export services, have (exclusive) access to international brands selling into China, and drive brand awareness.
The biggest risks to backing this tech behemoth is regulatory uncertainty in China. The two specific risks to the price of Ali Baba stock (though these developments still have a corollary impact on the broader sector) are:
Ali Baba has a 33% stake in Ant Financial, whose long awaited IPO came to a grounding halt as Chinese regulators suspended the offering and proposed last minute changes to Ant’s business model. Whilst founded as an online payments platform, Ant has grown beyond this and this has become the sticking point for the regulators. 63% of Ant’s revenues come from matching consumers to lenders via its platform (this was 44% of revenues in 2017 speaking to the spectacular growth this division has experienced). Ant uses its own proprietary technology to provide customers with credit scores (Zhima credit scoring system), compiles lending risks and then securitize debt via third parties or to pass this on to conventional banks.
Chinese regulators want to treat these type of platforms as financial institutions and not tech companies, and resultingly want Ant to put up its own capital against these loans (30% of capital for joint loans with banks versus current 2%). This resultingly limits Ant’s leverage and growth rate, particularly if Ant also has to apply for new banking licenses.
Whilst Ant is not Ali Baba’s core business, the elephant in the room here is the Microlending/P2P scandal in 2008. During this period, China saw a rise in scandals and mismanaged debt which the government is keen to avoid the second time around.
My take on this is that unlike in 2008, the tech giants are providing a service which conventional banks have been unable to provide. Credit cards are not pervasive in China and financial records are largely inadequate in rural areas. This has limited access to credit in remote areas and to date, the biggest four conventional banks give out 75% of their total loans only in the form of mortgages (in 1H 2020). This has left a gaping hole for new microlending entrants who have the digital footprint and know-how to provide this service (and pick good borrowers from bad ones). Whilst Ant may be hamstrung by new regulations, this will likely come at the expense of short-term growth as this service cannot feasibly be performed by existing conventional banks or other private businesses without the same scale and expertise. In other words, the overall business opportunity remains intact but Ant will have to wait longer to achieve the same outcomes or at least, until regulators are more comfortable.
The second major risk to Ali Baba is an overhaul of the existing competitive framework in China for e-commerce. As we established above, Ali Baba relies on its massive network to be as effective within the e-commerce space. However, in 2020, the Chinese government first applied a monopoly law to fine Ali Baba (alongside others).
The newly contested issue is platform integration or exclusivity arrangements that Ali Baba may have for that prevent users from going on other platforms. This is a big blow to the company and so far, it is unclear how this will play out, particularly as there are so many avenues that they could pursue this with Ali Baba. For me, this is the single biggest risk to the stock as Ali Baba relies heavily on its expansive network to be effective.
I am bullish China and Chinese e-commerce. Ali Baba is the natural choice for investment, as it’s the biggest, most exposed and the most defendable business operating in the sector. Ironically, the biggest risk to this position is that regulators see these strengths and force Ali Baba to concede market share to allow new entrants in the market. Despite this, Ali Baba is sizably ahead of the competition and has cemented a strong position with the Chinese consumer. This should make policies short of actively breaking up Ali Baba, to be nothing but a slow burn; as what pieces of business Ali Baba may eventually lose to competitors will likely be more than offset by its levered position (and natural monopolies) in this fast growing industry.
Verdict: Cautiously Bullish (pending impact of regulatory investigation)
This week, I want to look at Rare Earth Metals (REM). It’s a nice segway from my previous post on Electric Vehicles, as these metals are a crucial building block of not just electrification technology, but most technologies we rely on today (Consumer Electronics, Medical Research, Defense…).