BARON
INSIGHT
FOURTH QUARTER 2014
Global Retail: Expanding Markets, Expanding Opportunities
Research Analysts: Ashim Mehra, VP; Kyuhey August, VP; Aaron Wasserman, Anuj Aggarwal, Catherine Chen
Baron has a long-standing history of investing in the retail space. Today,
retail stocks continue to comprise a key component of many of our
Funds, including our three Funds with an investment focus outside the
United States: Baron International Growth Fund, Baron Emerging Markets
Fund, and Baron Global Advantage Fund.
When we analyze potential global retail investments for these Funds, we
use the same research-intensive, long-term approach that we apply to
our U.S.-focused Funds. We look for what we believe are strong
management, sustainable competitive advantages, long-term growth
opportunities, and an attractive price.
In the Baron International and Baron Emerging Markets Funds, we also
employ compelling investable themes to help us identify long-term
growth opportunities in specific regions, sectors and/or sub-industries.
Within global retail, many of our investments are plays on long-term
trends driven by shifting demographics, such as the rise of the middle and
upper classes in emerging markets. Other retail investments are focused
on opportunities associated with the increasingly interconnected global
economy. Other themes range from the impact of transformative
technology to the competitive advantages of local businesses.
In Baron Global Advantage Fund, we simply look for the best
opportunities we can find across the globe that meet our investment
criteria. Historically, we have capitalized on market inefficiencies by
investing in companies we believe are underappreciated due to various
factors, including the short-term horizon of market participants,
conventional valuation bias, erroneous sell-side analyst coverage, lack of
easily-understood “comparables,” or relative lack of coverage. We look for
stocks whose purchase price is at least 20% below our estimate of
company’s intrinsic value.
like the virtual marketplace business model because it leverages the
Internet’s ability to connect retailers and consumers to a degree that is
unparalleled in the physical world. The virtual marketplace also appeals to
retailers because it gives them the opportunity to market and sell to
consumers with minimal upfront expense. Finally, these platforms offer
consumers a compelling shopping experience: a wide selection with
competitive pricing, from the convenience of their home or pocket.
Online marketplaces we hold in our global, international and/or
emerging markets Funds include The Priceline Group, Inc., a
conglomerate of travel-related sites that operates in more than 200
countries, with the majority of its sales outside the U.S. Like Priceline,
Amazon.com, Inc. is a U.S.-based company with global operations. In
addition to serving as an online platform for third-party retailers,
Amazon generates revenue through its direct-to-consumer retail
operations, hardware products, and media and advertising services. In
Japan, Rakuten, Inc. is that country’s largest e-commerce site, offering
consumers more than 95 million products from about 40,000
merchants. In China, Qunar Cayman Islands Ltd. is a metasearch travel
platform much like Priceline and the most visited travel website in that
country. No discussion about global e-commerce leaders, however, is
complete without the mention of China’s Alibaba Group Holding Ltd.,
the largest e-commerce company in the world.
Growth of the Chinese E-Commerce Consumer
Base from 2010 to 2015
2010
2015E
China
140 Million
Online Shoppers
520 Million
Online Shoppers
Virtual Marketplaces
The Internet has fundamentally transformed how people communicate,
socialize, conduct business, entertain themselves, find and share information,
shop and get around. Within Internet, we believe that by far the largest and
most powerful secular investment theme, with a long runway for multi-year
growth, is the global e-commerce trend. Currently, just 6% of total retail
transactions take place online; over the next four years, this percentage is
projected to almost double, to roughly 11%.
Several of our e-commerce holdings operate as virtual marketplaces,
offering a one-stop-shop online platform for consumers and retailers. We
USA
2010
140 Million
Online Shoppers
Sources: Strangeloop, iResearch, Money Morning Staff Research
2015E
200 Million
Online Shoppers
On September 19, 2014, Alibaba completed its IPO on the NYSE, raising
$25 billion to claim the title of the biggest IPO in history. Previously,
Baron had been indirectly invested in Alibaba through Tokyo-based
SoftBank Corp., which has a post-IPO stake in Alibaba of roughly 31%.
Baron became direct shareholders in Alibaba through its participation in
its IPO. As of December 31, 2014, Alibaba’s shares were trading at
$103.94, up 53% since its IPO price of $68.
In China, Alibaba captures a stunning 80% market share of e-commerce
transactions, bringing together some 279 million buyers and 8.5 million
sellers. Founded in 1999 by Jack Ma, a former English teacher, Alibaba
achieved dominance through an ecosystem of three online retail
marketplaces, which generated $248 billion worth of transactions in
2013. As a dominant franchise that benefits from massive scale and
powerful network effects; a rapidly expanding e-commerce market with a
long runway for above-average growth; and an advertising-centric, assetlight business model that produces outsized profit margins, we believe
Alibaba makes a compelling long-term investment.
Leveraging Globalization
Increasing globalization is facilitating the ability of retail companies to
take advantage of divergent trends across regions to grow their businesses.
For example, China’s Man Wah Holdings Ltd. is benefiting from the
ongoing housing recovery in the U.S. Man Wah manufactures mid-to-high
end reclining sofas. About 55% of its sales are in the U.S. and Canada,
where Man Wah’s more competitive prices give it an advantage. Another
30% of its sales are in China, where it is benefiting from the growing
middle class and gaining market share from local furniture stores.
We learned about Steinhoff International Holdings Ltd. through our
investment in Man Wah. Steinhoff, which is a South Africa-based,
vertically integrated discount furniture manufacturer, sourcer, and
retailer, is one of Man Wah’s largest customers. While Man Wah is
profiting from the improving U.S. market, Steinhoff is benefiting from
slowed growth in Europe, where it is the second largest furniture retailer,
behind Ikea. Steinhoff has been expanding rapidly through gains in
market share as European households downgrade to value-based
furniture, and through the acquisition of distressed assets as smaller
European retailers are driven out of business due to weak consumer
demand in the down market.
Leveraging Local Presence
While many of our global retail investments are setting their sights
across borders, others are focused more closely at home. Local players
in emerging markets can leverage powerful competitive advantages
that companies new to the region may lack, such as an intimate
knowledge of the market, fluency in local business customs, an
established network, and a well-known brand. We could (and, in certain
cases, do) own multinational companies that are seeking to penetrate
local markets, but we believe that by owning local champions, in many
instances we can gain a
much greater impact from
the emerging middle class
in these regions.
In China, Alibaba
For instance, PT Matahari
Department Store Tbk is
capitalizing on Indonesia’s
growing middle class with
the
brick-and-mortar
equivalent of the virtual
marketplace
concept.
Matahari is the leading
department
store
in
Indonesia, serving its middle
class for more than 65 years.
It operates principally in
more remote areas where
good products at low prices are scarce. In 2010, new management
overhauled the company’s business model, providing a bazaar-style retail
environment to vendors who pay Matahari to transport their products to
the stores and sell them on a consignment basis. Matahari’s business
model is unique in its market, and its existing real estate footprint,
distribution network, relationships with vendors, strong brand and local
presence gives it, in our view, a strong competitive advantage. We believe
Matahari has the IT, logistics, and managerial talent in place to grow from
130 stores to over 300 within the next 10 years.
captures a stunning
80% market share
of e-commerce
transactions.
Smiles SA is another example of a regional business benefiting from the
growing middle class in emerging markets. Smiles runs the second largest
frequent flyer program in Brazil, selling miles on its partner airline GOL to
credit card companies, who give the miles to customers as incentives for
using credit cards. Customers accrue mileage points and later redeem the
miles for airline tickets or other items. Smiles enjoys multiple modes of
revenue generation including selling miles to credit card companies,
selling top up miles directly to consumers so they can redeem an award,
earning interest on cash before consumers accrue enough miles to
redeem (usually 6 months), and expired miles. Smiles is poised to benefit
from secular growth in both air travel and credit cards. Air travel in Latin
America is in a growth stage similar to that of the U.S. in the 1950s, with
flying representing a luxury for many consumers and business travel
becoming more commonplace. Further, we believe Smiles is likely to grow
faster than the market due to market share gains. While partner airline
GOL has 40% of the domestic market, Smiles has just 25% of its market,
and we believe Smiles will close this gap.
Global Logistics
With increasing globalization, the ability of retailers to keep in check or
reduce logistics-related expenses can provide a key competitive advantage.
We think retailers such as Amazon and Steinhoff are able to offer lower
prices than their rivals in significant part because of their superior handling
of the logistics of their supply and distribution chains. Outsourcing is
another way for retailers to manage the increasing costs associated with
today’s supply and distribution chains that can stretch across countries and
even continents. We discovered Australian company Brambles Ltd. when
we were researching unique businesses that allow their retail customers to
reduce expenses. The company, which operates in more than 50 countries,
leases pallets, crates and containers to retailers, manufacturers, and other
customers that transport physical goods. Because Brambles has a customer
base that numbers in the thousands, it is able to maximize the efficiency and
use of its asset base. By leasing instead of owning, its customers can avoid
the costs associated with purchasing transport items that are not used all
the time, and/or at their full capacity.
Deutsche Post AG is another logistics company that is taking advantage of
globalization-related opportunities. Originally a German mail and parcel
delivery service, with the buyout of overnight package delivery service DHL
in 2002, Deutsche Post started focusing more on growing emerging markets,
particularly Asia. The company targets customers with time-sensitive
delivery needs for high-value items, complemented by special industryspecific services, such as Collect and Return, in which critical high-tech goods
in need of repair are collected from the end user, taken in for repair, and
returned; and iMedical Express, a transport service for time and/or
temperature-sensitive medical products. With roughly 40% of the Asia
Pacific international express delivery market, DHL is benefiting from fast
growing consumer and manufacturing hubs throughout the continent.
management, and growing markets across the globe have helped drive
growth in the company. All of these factors have translated into strong
margins and high return on capital.
In recent months, uneven macroeconomic conditions, coupled with the
Chinese government’s anti-corruption crackdown, have affected sales of
Swiss watches and other luxury goods in China. While this has impacted
our near-term outlook, long term, we think demand for luxury goods will
return. Given the growth of the middle class in emerging markets and
their growing discretionary income, we believe European luxury brands,
including Richemont’s “maisons,” will continue to be brands of choice
among consumers.
Total Retail Sales Worldwide, 2013-2018
trillions and % change
$28.300
$25.366
$26.827
$23.927
$21.189
$22.492
Established Brands, New Markets
The rise of the middle and upper classes in emerging markets such as
China, India, and Latin America, offers appealing growth opportunities for
retailers, especially the luxury and aspirational brands esteemed by this
status-conscious group. The luxury retail industry is unique in that it is
dominated by Western brands, many of which have a long history in
Europe, giving them a level of brand panache that cannot be replicated by
local competition in emerging markets.A number of brands are tapping into
this lucrative market – brands such as Tiffany & Co. and Ralph Lauren
Corp. in the U.S. (both of which Baron owns in its Funds with a domestic
investment focus) and in Europe, Switzerland-based Compagnie
Financière Richemont SA.
Richemont is a luxury goods powerhouse, specializing in premium jewelry
and watches. Richemont’s impressive lineup of “maisons,” some of which are
hundreds of years old, include Cartier, Van Cleef & Arpels, Piaget, JaegerLeCoultre, Baume & Mercier, and Montblanc. The company has benefited
from a burgeoning market for luxury items in developing regions, driven by
wealth creation and pent-up demand for luxury goods. Roughly half of
Richemont’s sales come from emerging markets consumers, whether
purchased at home or while travelling. With the “Swiss Made” label tightly
controlled by the Swiss Watch Federation, Richemont has been insulated
from competitors, unlike other industries where local brands jockey with
multinationals for market share. The company’s dominant and powerful
brands give it immense pricing power. Its competitive advantages, excellent
6.4%
6.1%
6.4%
6.0%
5.8%
5.5%
2013
2014
2015E
2016E
2017E
2018E
Total retail sales
% change
Note: excludes travel and event tickets
Source: eMarketer, Dec 2014
Conclusion
Global retail comprises an important part of our global, international and
emerging markets portfolios. As with all of our investments, Baron takes a
bottom up approach to investing in global retail, looking for companies with,
in our view, long-term growth opportunities, significant competitive
advantages, strong management, and attractive valuations.With a projected
annual rate of growth of 5.8% over the next three years, we believe the
global retail sector represents a compelling opportunity for long-term
growth investors.
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You should consider the investment objectives, risks, charges, and expenses of the Funds carefully
before investing. The prospectus and summary prospectus contain this and other information about the
Funds and can be obtained from the Funds’ distributor, Baron Capital, Inc., by calling 1-800-99BARON
or visiting www.BaronFunds.com. Please read them carefully before investing.
The discussion of market trends and companies throughout this report are not intended as advice to
any person regarding the advisability of investing in any particular security. Some of our comments
are based on current management expectations and are considered “forward-looking statements.”
Actual future results, however, may prove to be different from our expectations. Our views are a
reflection of our best judgment at the time of the publication of this report and are subject to
change any time based on market and other conditions, and we have no obligation to update them.
Investing in the stock market is always risky. Baron may not achieve its objective. Portfolio holdings
may change over time.
Portfolio holdings as a percentage of net assets as of December 31, 2014 for securities mentioned are as follows: Amazon.com,
Inc. - Baron Opportunity Fund (1.1%*), Baron Fifth Avenue Growth Fund (7.1%), Baron Global Advantage Fund (5.1%); The
Priceline Group, Inc. - Baron Asset Fund (1.7%), Baron Opportunity Fund (2.0%*), Baron Fifth Avenue Growth Fund (4.0%), Baron
Global Advantage Fund (2.8%); Rakuten, Inc. - Baron International Growth Fund (1.4%); Qunar Cayman Islands Ltd. - Baron
Global Advantage Fund (1.5%); Alibaba Group Holding Ltd. - Baron Opportunity Fund (1.9%*), Baron Fifth Avenue Growth Fund
(4.1%), Baron International Growth Fund (1.4%), Baron Emerging Markets Fund (1.7%), Baron Global Advantage Fund (4.4%);
SoftBank Corp. - Baron Fifth Avenue Growth Fund (1.8%), Baron International Growth Fund (1.5%), Baron Global Advantage Fund
(2.0%); Man Wah Holdings Ltd. - Baron Emerging Markets Fund (0.8%); Steinhoff International Holdings Ltd. - Baron
International Growth Fund (1.4%), Baron Emerging Markets Fund (1.6%); PT Matahari Department Store Tbk - Baron
International Growth Fund (1.1%), Baron Emerging Markets Fund (1.2%); Smiles SA -Baron International Growth Fund (1.5%),
Baron Emerging Markets Fund (2.1%), Baron Global Advantage Fund (2.7%); Brambles Ltd. - Baron International Growth Fund
(1.2%); Deutsche Post AG - Baron International Growth Fund (1.8%); Tiffany & Co. - Baron Asset Fund (1.4%); Ralph Lauren
Corp. - Baron Asset Fund (1.6%), Baron Fifth Avenue Growth Fund (1.0%); Compagnie Financière Richemont SA - Baron
International Growth Fund (0.8%).
*% of Long Positions.
Portfolio holdings may change over time. At December 31, 2014, Baron Growth Fund, Baron Small Cap Fund, Baron Partners Fund, Baron
Focused Growth Fund, Baron Real Estate Fund, Baron Energy and Resources Fund and Baron Discovery Fund did not own any of the
securities listed above.
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