The ‘old economy’ sectors that will fare better than their disruptive counterparts

As a new year approaches, you often hear the phrase ‘out with the old, in with the new’, but that does not necessarily apply to the stock market.

Some of the so-called ‘old economy’ companies, often perceived as slow and antiquated, still manage not only to survive in an ever-evolving environment, but to thrive.

James de Uphaugh, head of the Liontrust global fundamental team, even suggested that they are taking revenge.

“Most companies that are in the old economy, or are typecast as old economy businesses, have adopted technology incredibly fast in recent years, whereas new economy companies have struggled with supply chain issues and the rising cost of capital,” he said.

This is a consequence of the rise in interest rates, which provided headwinds in terms of valuation, source of finance, and flows of funds to companies in numerous sectors.

“Let's look at it through the lens of Tesco, for example. Twelve months ago, it was all about quick commerce, with companies such as Gorillas promising to deliver groceries within 10 minutes of ordering products through their app. Now, all that has changed, and these companies are still trying to ensure a root path to profitability,” he said.

“This had a positive impact on the incumbent, which is Tesco, because it no longer needs to worry about that as a particular issue. As the hype around quick commerce wanes, the value of the incumbency increases. Rather than old economy versus new economy, I would call it the revenge of the incumbent.”

Another company that de Uphaugh highlighted was Shell. As the cost of LNG cargoes has multiplied year-on-year and the amount of collateral needed to play in this field has increased enormously, a number of European governments have put in place extra facilities to allow trading organisations to post the collateral that's needed for an LNG cargo.

He said: “This is one of the many attributes that makes Shell such a strong business. It also has very strong engineering and research and development expertise, as well as credibility and good balance sheets. All these things are crucial in terms of the unique selling point that they bring.”

In his Edinburgh Investment trust, which he co-manages with Chris Field, Shell is the first holding, making up 8.2% of the whole portfolio. The second is Unilever (6%) and Tesco isn’t too far down the list (fifth, at 4.4%).

Performance of trust against sector and index over 5yrs
 
Source: FE Analytics

Ben Lofthouse, manager of the Henderson International Income trust, also shared the enthusiasm for the old economy. Technology broadening out into a wide range of sectors and coming together with challenges such as decarbonisation and climate change “fits really well for big, established companies”, as this trend comes with increased investment requirements.

“In the past few years, Zoom was the exciting place to be, but Zoom doesn't help you build a wind farm, automate production or make transport more efficient. We're in this really exciting phase at the moment where lots of big blue-chip companies have more exposure to growth in those areas than they've had across numerous others,” he said.

Lofthouse took big pharma as an example, which trades very cheaply for how big those companies are and makes up a 19.4% weighting in his portfolio.

Performance of trust against sector and index over 5yrs
 
Source: FE Analytics

“As we saw during Covid, big, established pharmaceuticals do have a place, and that place is mass production. It may be that the smaller companies will come up with the new ideas, but it's the larger companies that turn that into trials, phase three trials and safe manufacturing,” he said.

Another area where you can see this dynamic is the automobile industry, where three years ago, Volvo Trucks, Europe's biggest electric truck manufacturer, was making electric trucks that were not popular.

“Last year everyone thought Nikola Motors was the truck company to have. However, as Nestle and Amazon will be buying more electric trucks to decarbonize their transport networks, they are more likely to do so from Volvo, which, by the way, is on an almost 10x price-to-earnings ratio and has a 6% yield,” said Lofthouse.

“If you combine all this with China being on a slowdown for the past five years, you can see why this might be a genuinely interesting time to invest in these companies.”

In comparison, smaller companies in the automobile space face too many obstacles, according to Jacob Mitchell, lead portfolio manager at Antipodes Partners.

He mentioned the Chinese NIO and the US Rivian and Lucid as examples of companies that could suffer from the competition of the incumbent.

“These companies came in the automobile sectors with a fairly differentiated products but no scale or distribution. For some of those, it's going to be tough, especially as capital is no longer available to fund losses,” Mitchell said.

The only advocate for the new economy was Paul Markham, manager of the BNY Mellon Sustainable European Opportunities fund, but only in selected sectors.

Performance of fund against sector and index over 5yrs
 
Source: FE Analytics

“When you look at computing, software and technology, capital expenditure is not as relevant. You can be sitting in your bedroom on a computer for that. When it comes to innovating, innovation still does favour smaller companies. Bigger ones tend to be held up by decision-making processes, which often you don't have so many of in a smaller company,” he said.

“Of course, the biggest question mark is when a small company is bought by a big one, whether the small company maintains its culture, intellectual capital and dynamism. That's something which big acquirers of small companies have to think about.”