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Talking About the Millennial Generation

19 November 2018 | by Sean Stannard-Stockton, CFA

People try to put us down
Just because we get around
Things they do look awful cold
I hope I die before I get old
-The Who (My Generation, 1965)

One of the narratives driving stock price behavior over the last decade has been the idea that Millennials are fundamentally different from past generations and that their different preferences will drive different consumer spending patterns. This is an important concept to wrestle with because consumer spending is 70% of the US economy and where exactly consumers focus their spending can radically change the fortunes of different industries and companies.

In general, the narrative about Millennials has been mostly negative. They live with their parents, they eat too much avocado toast, they aren’t interested in growing up and so they aren’t buying cars and houses and the other trappings of adulthood. But we believe that for the most part the negative narrative is partly just older people complaining about young people the way they always do (see The Who’s My Generation, a hit song over 50 years ago) and partly a function of Millennials’ reaction to the Financial Crisis.

Much as Depression Babies had fundamentally different spending behaviors due to coming of age in the Depression of the 1930s, it is perfectly reasonable to think that those young adults who came of age in the wake of the Financial Crisis might have distinct spending patterns. Importantly, these spending pattern deviations will be strongest in the short term after a crisis and fade over time, as new life experiences are laid over the memories of the Financial Crisis.

Let’s take home ownership trends amount Millennials as an example. The chart shows the home ownership rate for the prime first time home buyer age bracket of 30-34. The dark purple line is the home ownership rate while the pink line is the percentage of that age group that has a job. Importantly, the employment graph is lagged by 5-years. Basically the chart looks at the percentage of people in this age bracket who own a home vs the percentage of those same people who have had a job for the past five years.

What we see here is that basically all of the reduction in demand to buy homes for Millennials is due to the difficulty they faced in getting a job due to entering the work force in the middle of the worst economy in a hundred years. It is easy to paint a picture of Millennials wanting to live in apartments and take Uber everywhere and not have kids and refuse to grow up. But the data suggests that this generation is just paying the price of the economic disaster they were bequeathed with. Since we know that the percentage of people in this age bracket that have a job is up considerably from where it was five years ago, it is very likely that over the next five years this age bracket will be buying homes at much higher rates than they have in recent years.

What about cars? Aren’t Millennials all childless, city dwellers who ride around in Uber? Here’s a string of quotes from a report out of University of Pennsylvanian’s Wharton business school.

“Millennials, the boomers’ children, have seemed far less interested in cars than their parents… But it turned out that the concern was largely misplaced. According to an article in Wards Auto, the weak sales were less a reflection of the generation’s attitudes toward cars and more the result of the Great Recession and the younger generation’s lack of resources… too many have mistaken the presence of millennials in cities as an indication that they prefer urban living. According to the 2016 National Association of Realtors Home Buyer and Seller Generational Trends study, a growing share of homebuyers are millennials, and more of them are purchasing single-family homes in suburbia.”

Here’s NPR with a similar take in an article titled “As Millennials Get Older, Many Are Buying SUVs To Drive To Their Suburban Homes”:

“As millennials get older — and richer — more of them are buying SUVs to drive to their suburban homes… Generationally speaking, the stereotype of millennials as urbanites falls flat when it comes to homeownership… And how are millennials navigating the suburbs? With SUVs, according to several recent studies… Millennials just might be mainstream after all.”

But wait, aren’t Millennials blowing all their money on avocado toast and frivolous travel that they document on Instagram? Whatever happened to buying tons of branded stuff to show off how successful you are like the Baby Boomers did? Well, while it might be easy to poke fun at Millennial consumption patterns, it is just as accurate to say that they are the least materialistic generation of the post war period. Avocado toast, travel and social media use seems frivolous? How about eating healthy, prioritizing experiences over stuff and spending your time engaging with your peers as well as the wider community of which you are a part?

At least we know Millennials are wasting their time playing video games right? Isn’t that solid evidence that they aren’t maturing into adults and that us older people are justified in complaining about their lack of work ethic? Well… How does spending every waking moment preparing to live and work in a digital economy sound? You think the military drone operators would be as good if they hadn’t played video games? Studies show gaming is a critical training activity for the modern military. How about surgeons who will spend their career manipulating robotic surgery tools like those produced by Intuitive Surgical? Studies show surgeons who have a history of playing three or more hours a week of video games committed 37% fewer errors and completed surgery 27% faster.

My teenagers type incredibly fast. The difference between their typing speed and mine is most noticeable on touch screens. Today, we dismiss that because we don’t take texting as a serious communication system. But as we move into a world where keyboards fade in relevance, older generations are going to be at a significant disadvantage against the younger generation. Just as corporate employees in their 60s and older tend to type slowly on a keyboard compared to Gen Xers who learned to type in school, I’m certain that as computing interfaces shift away from keyboards and mouses towards touch screens, voice and even augmented reality, us “olds” are going to suddenly realize that the time young people were spending on their phones and playing video games was actually an advanced, intensive training regime preparing them for their future jobs.

None of this is to say that the Millennial Generation will end up being clones of past generations. They are the most educated generation, many went to grad school pushing off employment until later in life and then needing to pay back student loans. That forced them to (responsibly) delay the phase of life where you get married, have kids, and buy a house, ie what is considered “growing up”. But they do have unique preferences (as all generations do). We feel certain they will eat healthier, travel more, be less interested in materialistic consumption and more interested in experiences (which they may well keep documenting on Instagram as their own version of social status signaling). A whole range of other preferences will also emerge over time as well, some positive and some negative. Some will fade as they get older and others will strengthen into defining characteristics.

As we look at the last decade of New Normal weak growth and observe the increasing rate of growth being experienced today, the key question to answer is whether the last decade was a drawn out hangover from the great recession or if something fundamental has changed. In thinking about Millennials and how their economic decisions compare to past generations, we’re solidly in the camp that people are people, their hopes and dreams and fears may change, but at the end of the day, they are striving for the same core life outcomes that past generations pursued.

The Millennial cohort saw the first decade of their working lives sidetracked by the foolish decisions of their elders. As the economy gets back on track, we expect the economic engagement of this cohort to rise considerable, creating a material tailwind to the economy from their pent up demand.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Nintendo: Capitalizing on Nostalgia

14 July 2020 | by Todd Wenning, CFA

“Nostalgia – it’s delicate, but potent.” – Mad Men

Nintendo kindles warm childhood memories of playing Super Mario Bros. and Zelda with friends in the 1980s. Growing up, I was a certified Nintendo fanatic – I had the t-shirt, the cereal, the magazine, and even wrote to Nintendo suggesting games they might develop.

Despite my early passion for Nintendo, as an adult I never considered Nintendo investible because the business seemed too cyclical. Even when Nintendo landed a hit console, such as the Wii or DS, it would have a few good years and then the hardware would fade into obscurity. Developers would lose interest in the consoles and Nintendo would start over again.

Nintendo’s historical stock price chart reflects the boom-bust cycle.

Bloomberg as of July 6, 2020

Ultimately, Nintendo seemed unwilling or unable to steadily monetize its unique intellectual property. (We’ll get into the IP in just a moment.)

This opinion was challenged after reading Ryan O’Connor’s April 2019 Crossroads Capital investor letter. Over the course of nearly 70 pages, Ryan made the case for why this time is different at Nintendo. If nothing else, the letter led me to re-examine my assumptions and consider some new dynamics.

A key point to consider, for example, is that Nintendo owns some of the most valuable media – not just video game – franchises in the world. Pokémon (Nintendo owns the trademark and is part owner of The Pokémon Company) has generated more revenue (estimated $95 billion) between books, films, video games, merchandise, etc. than any other media franchise, including Mickey Mouse & Friends, Star Wars, and Winnie the Pooh.

Mario is also an elite franchise, with an estimated $38 billion in franchise sales. It also happens to be the best-selling video game franchise of all time.

Additionally, Nintendo’s Wii, Donkey Kong, and Zelda franchises have each generated more than $4 billion in revenue.

It’s clear that Nintendo has a lot of potential to leverage its valuable IP.

But as we’ve discussed in earlier posts, what’s important from an investment standpoint is product relevance, not just recognizability. It’s nice that Nintendo’s characters are globally recognizable, but unless Nintendo makes games that are relevant to today’s gamers, it won’t translate into profitable growth.

One reason we believe Nintendo will remain relevant for future generations is that its games are intrinsically family friendly and fun. PlayStation and Xbox – the two other major console makers – primarily feature intense, often violent, games with incredible graphics and audio. (If you’re a non-gamer, watch some gameplay of Grand Theft Auto or The Last of Us: Part II, and you’ll see what I mean.)

Think about how Pixar films thrive with family audiences. They aren’t winning Oscars for best picture every year – these are typically reserved for dramatic films created for adult audiences – but families adore Pixar films, which have had massive box office success. Both types of movies can thrive with different audiences.

Similarly, Nintendo doesn’t have to compete with PS and Xbox on graphics and audio – they just need to be technologically advanced enough to attract game developers and keep gamer interest. Instead, Nintendo is in a unique position to provide a fun gaming experience for families that is still fresh and enjoyable to play.

To illustrate, Nintendo’s 2017 release of Zelda: Breath of the Wild is considered one of the best video games of all time. It is visually stunning and has a dramatic narrative, but is also suitable for gamers aged 10 and up.

When I was a kid, adults thought video games were “rotting our brains,” and a general waste of time. This Far Side comic satire from 1990 captures this sentiment.

It turns out that the comic was just ahead of its time. Gamers are not only getting paid today, but parents are increasingly playing video games with their kids.

As the following chart shows, U.S. parents are increasingly playing games with their kids on a weekly basis – a trend that only began to accelerate in recent years.

Nintendo is in a prime position to own this trend.

Part of the reason for this trend is that the cohort that grew up with video games is now in prime household formation years and many of them are raising young children themselves.

Just like Boomers shared their favorite TV shows and movies with their children, Generation X and Millennial parents are sharing video games. It’s a trend we expect to get stronger with time. Mario and Zelda, like Mickey Mouse and Luke Skywalker before them, will get passed down through generations.

Nintendo had not been able to capitalize on its nostalgia advantages simply because not enough time had passed. In other words, it had passionate fans who were not old enough to pass down their love for Nintendo to the next generation.

The window of opportunity to capitalize on Nintendo’s nostalgia-driven IP is only just opening.

As the chart below illustrates, the peak of the Millennial generation turns 30 this year and since the cohort has deferred having children relative to past generations, the number of Millennial parents will rise significantly for years to come.

Source: Dowell Myers. “Peak Millennials: Three Reinforcing Cycles That Amplify the Rise and Fall of Urban Concentration by Millennials”.

Evidence of Nintendo’s potential for family gaming was seen during quarantine, when due to a combination of limited supply and a spike in demand, there was a run on Nintendo Switch consoles. Switch was considered an essential for families during quarantine and units were being sold in the aftermarket for more than a 50% premium to the list prices of $199 for Switch Lite and $299 for Switch.

Source: ECM employee

In addition, during quarantine educators used the hit game Animal Crossing: New Horizons to connect with young people around the world. Monterey Bay Aquarium in California and The Field Museum of Chicago, for example, put on virtual tours in Animal Crossing to teach viewers about science and natural history. This reinforced our belief that Switch is considered a “safe” video game platform through which families can engage in gaming and learning, and have wholesome interactions with others.

Here’s what The New York Times said in April about Animal Crossing:

“For children, being able to engage in adultlike chores, like building and decorating a house, gives them power often out of reach. For adults, especially millennials who have lived through the Great Recession and current coronavirus-induced economic stress, it offers the white picket fence often associated with the American dream that’s increasingly elusive.

Though the aesthetics of the game might lead some to believe it’s geared toward children, it’s found a dedicated audience with millennials, some of whom grew up with the franchise, and with younger audiences experiencing it for the first time.”

Importantly, Nintendo’s IP is supported by rich narratives that draw gamers back to each franchise iteration. This itself serves as a competitive advantage in an increasingly competitive video game space that includes not just consoles, but PC, and mobile games.

Thousands of games are published each year, but only a few are legitimate hits. Consider Amazon’s recent release of its first original game, Crucible. Despite the backing of one of the most valuable companies in the world with millions of Prime members, the game is by all accounts, a flop. At its launch peak, the game had just 10,600 participants.

By comparison, all Nintendo must do is release a Mario or Zelda-branded game and it instantly has millions of unit sales. The mobile game Mario Kart Tour, for instance, had 123.9 million downloads in the first month.

Put another way, Nintendo’s narrative advantage provides greater probability of success and gives its first-party developers more freedom to be creative without worrying about commercial disasters.

Source: Nintendo, as of June 2020

Further, Nintendo doesn’t have to aggressively market new first-party titles. Gamers know what to expect when they buy something made by Nintendo. In short: it will be fun and familiar.

On the hardware side, Switch has been a massive success. NPD Group’s Mat Piscatella recently noted that “with a time-aligned 39 months in market, the Switch unit installed base in the US trails only the Nintendo Wii and PlayStation 2.” It’s worth noting that Wii and PS2 were launched in 2006 and 2000, respectively – long before smartphones and mobile gaming were ubiquitous and competed with console gaming. This makes Switch’s success even more impressive.

Switch combines the best parts of Nintendo’s two most recent successful hardware products – Wii and DS – and allows users to enjoy video games in home, tabletop, or handheld mode.

Our take is that management does not view Switch as just another console product, but the ultimate Nintendo platform from which new iterations of hardware can be launched.

The 2019 launch of the Switch Lite suggests that this is the case. At a lower price point, Switch Lite is a handheld-only version of the Switch, and serves to bring more customers onto the platform who may have balked at the higher priced Switch.

We expect Nintendo to offer a “Pro” version of Switch next year to maintain third-party game developer interest after PlayStation and Xbox release their next generation products later this year.

Further, Nintendo is producing a single hardware platform for the first time since 1989 when it launched Game Boy alongside the NES. For almost 30 years, Nintendo was producing both handheld and home consoles simultaneously, which inevitably created some inefficiencies in marketing and development.

Iterating on the Switch hardware to higher and lower price points and maintaining a consistent software operating platform, much like Apple has done with the iPhone and iOS, strikes us as an intelligent break from the past boom-bust console cycle.

Of course, there’s a chicken and the egg issue with game consoles. Gamers go where there’s software and software developers go where there’s gamers. As such, Nintendo must feature compelling games to maintain an active user base to attract developers. Historically, Nintendo has relied on first-party franchises like Mario and Zelda to drive console sales, leaving third-party developers on the outside of the Nintendo ecosystem.

That has not been the case with Switch and is another sign to us that management is breaking from tradition and understanding the power of Switch as a platform rather than a product. Third-party developers are taking note of Switch’s massive installed base of gamers. Notably, in a recent conference call, game publisher Electronic Arts promised to “deliver more for Nintendo fans,” with more EA games slated for the Switch platform this year.

As the chart below shows, momentum for third-party developer sales on the Switch platform has been strong in recent years.

Source: Bloomberg

Thus far, we’ve provided a backdrop as to why we think Nintendo is set up for success. Here’s what we think that should look like.

First, despite progress on making Switch a platform rather than a product, Nintendo is still way behind other gaming platforms when it comes to multiplayer and the digital experience. For example, adding friends on Switch is clunky. We think the success of Animal Crossing during quarantine should prove to management the power of social gaming and encourage more development to this end.

Second, Nintendo has lagged other gaming platforms in digital game sales. Digital delivery of games carries much higher gross margins than physical game sales because Nintendo does not have to give the retailer a cut. The more software sales Nintendo can push through its Switch Online store, the greater the lift to gross margins.

Source: Bloomberg

The most recent quarter’s results showed the gross margin expansion potential. During quarantine, Nintendo saw a spike in digital downloads. For the quarter, 49% of software sales were digital and we estimate that it was between 70-80% during the last few weeks of March. Due in part to the shift toward digital, gross margins expanded from 41.7% in fiscal 2019 to 49% in fiscal 2020. A digital-only version of Switch – one that does not use physical cartridges – might also accelerate digital sales.

Third, Nintendo should offer access to all its legacy first-party titles through a more robust Switch Online offering. Currently, Switch Online costs $34.99 a year, or less than $3 per month, and offers a library of about 70 classic Super NES and NES games including Tecmo Bowl, Super Mario Kart, and The Legend of Zelda.

We think if Nintendo added access to all its legacy first-party games and made them online and multiplayer capable, they could easily charge Netflix-like subscription rates of $9-15 per month.

Nintendo is the only video game family where there’s massive demand for games that are 10, 20, or 30 years old and they should capitalize on this advantage. Few gamers want to play the original Call of Duty or Grand Theft Auto when the current generation is so much more technologically advanced, but gamers will fall over themselves playing the original 8-bit Super Mario Bros. The reason is nostalgia. Old Nintendo games are simple, but they bring back happy memories, whether they are realized consciously or unconsciously.

Fourth, Nintendo should continue to build on the surge of third party game demand to illustrate to game developers that there is a large, new addressable market in the form of parents and families – not just children and younger men, who have traditionally been the sole audience for video games.

A platform enables other things to be built on top of it. While Switch is an excellent platform for Nintendo to iterate on for years to come, they can unleash the full power of a platform business model through continuing to enable third party games to thrive on Switch, while ensuring that any and all games available on Switch are family friendly.

All four of these strategies are doable and, if successfully implemented, would improve Nintendo’s cash flow quality and reduce the view that Nintendo is a cyclical company. The result would not only be improved earnings growth, but also likely multiple expansion as investor confidence builds.

There remains, however, many skeptical investors who expect Nintendo to fall back into its ways of scrapping the old and starting something new. This remains a distinct possibility. Nintendo management has a track record of unforced errors and head-scratching decisions from a business model perspective, despite continuing to delight customers with its products.

As such, our investment in Nintendo is considered an “emerging moat” position, which is assigned a lower portfolio weight relative to our core holdings. We consider Nintendo’s IP to be a dormant moat and the “emerging” part is the business model and the potential for monetizing the IP. If we continue to see management making wise decisions, it could quickly become a core holding.

With a healthy net cash balance sheet, Nintendo can afford to be more aggressive with these strategies. There’s little downside and a lot of upside potential. Now’s the time for Nintendo to capitalize on its unique nostalgia-drenched IP.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Coronavirus: The Next Normal

26 May 2020 | by Sean Stannard-Stockton, CFA

“Change is the only constant in life.” -Heraclitus of Ephesus, 500 BCE

In the years after the financial crisis, the phrase “the New Normal” took hold as a way to describe the seemingly permanent shift in the US economy to one characterized by lower growth, lower inflation and lower interest rates compared to an Old Normal of higher growth, higher inflation and higher interest rates.

The Coronavirus has made this framing irrelevant. Today, neither the Old Normal nor the New Normal is what matters. All that matters is what the Next Normal looks like.

One of the phrases you hear people using a lot right now is when we might “return to normal” or predictions that “we’ll never return to normal.” But life never returns to “normal” because the only constant in life is change.

Of course, the future will not look like the past because it never does. But the future also never pivots completely away from the past because so many economic behaviors are driven by deeply ingrained human needs and desires that do not change all that much even when our environment changes radically.

So, we think it is a huge mistake to expect a quick return to pre-COVID norms and trends. But we also think that the widespread belief that Coronavirus “changes everything” is similarly a misreading of how humans operate.

In analyzing the companies we own in client portfolios, and those we might like to invest in, we have been carefully trying to think through the major Coronavirus-driven changes in trends that may impact them. It is not particularly difficult to understand the short-term impacts, but most of the value of a company is made up of the cash flow it will produce over the coming decades.

In this post, we will lay out some of the shifts we think may play out and that we think investors need to be acutely cognizant of tracking as we move forward.

It is important to note that everything we describe below describes changes in trends that at this point we believe are likely, but that is very different from thinking we know what the future holds for sure. This is an important reason why so far we have only added two new companies to our strategy since the crisis began and exited only one due to us losing conviction in the business.

For instance, we recently read the quarterly letter of another investment manager that we admire. In the letter, they explained that they had sold a stock in the midst of the Coronavirus market sell off due to their expectation that the number of miles driven by Americans would decline materially. Now they may be right about that, but over the past six weeks there has been a growing recognition that in a post Coronavirus world, people will be less likely to fly or take public transportation and thus miles driven may actually increase a lot. And there’s evidence building in favor of this counter intuitive outlook.

Here’s Chinese auto sales which last month were actually higher than they were a year ago as people came out of shelter in place and bought a car so they could travel safely without exposing themselves to crowds.

(Source: Evercore ISI)

And here is a chart of map requests to Apple Maps.

(Source: Apple Mobility Trends)

As you can see while public transit direction requests have plummeted, driving direction request have more than fully recovered all of the decline seen during shelter in place. And shelter in place hasn’t even ended yet.

In fact this weekend, the New York Times ran a story about the role of cars as a shelter from Coronavirus and the elevated importance of cars in American life.

“Once just a way of getting from one place to another, the car has been turned into a mini-shelter on wheels, safe from contamination, a cocoon that allows its occupants to be inside and outside at the same time.

It took a pandemic to give the automobile its new role. When people pack up their families and friends, they can still adhere to social distancing rules. They remain under a roof, within closed doors, sealed off and separated from the rest of their fellow human beings.

Mobile safe distancing has generated a new way of life — a society on wheels.”

Even if we knew exactly what trends were going to unfold, we still likely wouldn’t invest in a whole new portfolio of stocks because we went into the crisis with a portfolio of companies that we already believed were exposed to powerful long-term trends. While the Coronavirus will reverse some trends, it will also accelerate trends that were already in place. The new holdings we’ve added to our portfolio,  and those we will add in the future, will be businesses that we think are highly aligned either to the trends we describe below or to other trends that we come to understand over time are likely to drive economic behavior. Most importantly, we’ll focus on the trends that will play out over the next five years or more, rather than trends that might just impact this year.

Remote Life

As a company that embraced remote work years ago, we at Ensemble Capital feel certain that Coronavirus will cause a significant step change in the number of Americans working remotely. But this is self-evident to anyone who is paying attention and in investing you do not get paid for obvious insights.  The stocks of companies that will benefit directly from an accelerated trend towards remote work shot higher early in the crisis but that does not mean they are good investments going forward.

But we think “remote work” is thinking too small. What about “remote life?”

Obvious: More people will work remotely.

Less Obvious: Video conferencing and other remote work tools will enable a large expansion of “remote” experiences across many aspects of our work and personal lives.

Since shelter in place began, the school events I’ve attended for my two kids in high school, such as teacher meetings and school wide informational sessions, have all been Zoom meetings. Guess what? It’s better than driving to the school and sitting in the gym to hear the same content.

With my eldest being a junior in high school, we should be flying around the country visiting colleges. But now they all have virtual tours which means that rather than spending a week and thousands of dollars many college applicants may not have, we have been able to virtually visit four or five schools on a Sunday afternoon from our living room couch. While this does not preclude our continued interest in visiting some schools in person, I can certainly see how a family of college bound students may use virtual tours to visit more  schools than they used to pre-Zoom, while reserving in person visits for the small number of schools that are the students top picks.

As another example, my wife and I belong to a gym where we do high intensity interval training classes. For the last two months, we’ve been doing these classes via Zoom. There are aspects of the remote classes that I like better than going in person to the gym. I hope that as shelter in place comes to an end, that my gym will offer both remote and in person classes. I believe that if they do so, I’ll end up working out more frequently, even as I go to the gym in person less frequently.

Humans are social creatures and we feel confident that people will want to continue spending most of their time with other people in person. But that does not preclude a really significant shift in the frequency with which we utilize virtual or remote experiences rather than doing them in person. The ramifications of this shift may cascade through all sorts of industries and is something we think investors should be thinking about very critically.

Supply Chains

Obvious: Supply chains will diversify away from China with more domestic sourcing of supplies.

Less Obvious: The definition of an optimized supply chain may shift to include more robust measures of resilience. Adding more “slack” to supply chains may be negative for some businesses but will be a big positive for medium term economic growth, job creation, and businesses which can help enable more resiliency.

Every MBA student is taught that they need to “optimize” their business. While this can mean different things in different industries, at its core it means to create the most outputs with the least inputs. This is clearly a good goal. But we have long believed that too many business leaders and investors have focused on optimizing for “normal” conditions and not given enough thought to how this “optimization” will work out during periods of unexpected turbulence.

For instance, the concept of “just in time inventory” is designed to minimize the amount of inventory a company has on its balance sheet. Inventory represents cash that has been deployed but is just sitting there on a company’s balance sheet. The more you can reduce inventory levels, the more cash you can draw out of the business. But the “optimal” level of inventory is no longer optimal if you have a sudden stop to your ability to buy more or if demand suddenly goes parabolic.

Think about the shortages of personal protective equipment (PPE) during this crisis. Much of this equipment are very basic items. The issue with the shortage isn’t that PPE is so hard to make, but that the levels of inventory of PPE and the location of those inventories may have been optimal for most conditions, but it was very sub-optimal during a pandemic.

In addition, supply chains for many companies now stretch around the globe and involve a huge number of suppliers. As such, one multiyear trend that may play out is companies carrying higher inventories than they did in the past and re-evaluating their supply chains through the lens of understanding if they are indeed optimal even during times of crisis. We may well see companies shifting more of their supply chain to domestic suppliers and seeking to simplify and secure their supply chain rather than focusing on optimizing and reducing the costs of their supply chain.

This trend would be a real drag on many companies as cash flow that might otherwise accrue to investors will need to be deployed to secure their supply chain and make inventory management more resilient with more duplication of suppliers. Yet it would also be a big positive for companies who are selling products into those supply chains or companies that are part of the solution to a more robust and resilient supply chain solution.

One exemplar of this is Fastenal, whose business in safety equipment sales surged 120% y/y in the month of April after growing 31% y/y in March, and more than offset declines in its other reported business segments due to shutdowns. In part, this was because Fastenal acted preemptively to source and stock safety supplies as the pandemic made its way around the world, but it also demonstrates the longer term higher levels of inventory that many companies may seek to maintain.

Source: Q1 2020 Company Earnings Presentation

Much of the debate in relation to the US trade war with China has centered around nationalistic advantages to manufacturing being done domestically or globally. Many of the difference of opinions on this topic were related to people’s political points of view. But with Coronavirus, we suddenly have examples of the US not having domestic production capabilities for essential items like vaccines, PPE, and other items that were outsourced long ago. Thus, there may well be a surge of global manufacturing capabilities that are brought back to the US as part of companies’ efforts to make their supply chain more resilient to global shocks.


Obvious: Ecommerce sales will increase rapidly

Less Obvious: Incumbent ecommerce companies may face a significant competitive setback due to Coronavirus.

With the web now being over a quarter century old, it feels late to suggest ecommerce may be the wave of the future. But every indication we are seeing is that every retailer without an online presence is now deploying one asap and so called omnichannel retailers are moving with unprecedented speed to prioritize their ecommerce platforms. Amazingly, Visa said recently that 13 million people in Latin America completed their first ever eCommerce purchase last quarter. Shopify reported that the number of new stores joining its online platform grew 62% between March 13 and April 24, 2020 compared to the prior six weeks. Traffic was growing so fast by mid-April, that Shopify’s CTO, Jean-Michel Lemieux, said that Shopify was now handling 2019 Black Friday traffic levels every day:

The credit card industry tracks transactions based on whether the card is present or not. “Card not present” transactions are when the card is not physically presented to the merchant and while this includes transactions such as when you read your credit card number to a merchant over the phone, most of these types of transactions are ecommerce.

In this chart Visa lays out the growth in payment volumes of both “card present” and “card not present” as well as “card not present excluding travel spending”.

(Source: Visa)

As you can see, “card present” spending was still down nearly 40% at the end of April, while “card not present” transactions were up over 10% and if you exclude travel spending, “card not present” payment volumes were up nearly 30% vs 2019.

And then there is this amazing chart showing the increase in ecommerce as a percentage of retail sales. The last eight weeks has seen the same amount of increased ecommerce penetration as had been achieved over the prior decade (although note that with online sales up and offline sales down due to physical stores being closed, it is very likely that some meaningful portion of this ecommerce market share increase will quickly reverse as physical stores reopen).

Ecommerce does not just mean ordering stuff online that is delivered to your front door a couple days later. We believe ecommerce, paired with the Remote Life trend we described above, will catalyze large shifts in many industries.

For instance, with virtual tours having fully replaced open houses during shelter in place and states doing things like suddenly authorizing digital notarizations as legally binding for real estate sales, it may be that the real estate purchasing experience becomes much more of an online transaction. And even traditional retailers selling things that don’t really work in a delivery context, may start quickly following the lead of digital innovators such as Starbucks to integrate apps, cell phones and other ecommerce tools into the business of selling even those things (like a cup of coffee) that are nearly irrelevant to a more traditional definition of ecommerce.

For instance, as restaurants re-open we could see diners being asked to use their phones to pull up the menu and even place orders via their phone while sitting inside the restaurant. This would reduce the need for diners to touch menus handled by other guests and could allow restaurants to recognize “regulars” and even offer specials or discounts to them.

But again, you cannot just think about the “obvious” beneficiaries. For instance, it seems self-evident that a shift towards ecommerce would be a benefit to ecommerce king Amazon. But new competitive efforts flooding an industry is never good for incumbents. And the massive surge in demand seen by Amazon is by no means unequivocally good as you can see with the company saying on their recent earnings call that all of the earnings from Coronavirus related increased sales would need to be spent addressing the critical issues that Coronavirus has created for the company.

One of those issues has been shipment delays which we believe is likely causing some long time Amazon customers to go look at other options, thus breaking their knee jerk habit of ordering everything from Amazon. As an example of this dynamic at work, the chart below shows a massive increase in Amazon customers reporting a significant delay in shipping times with Amazon customers experiencing worse delays than at other major ecommerce sites.

(Source: Bespoke Intel)

Despite the surge of business during shelter in place, Amazon is now working to recapture the market share they lost.

“As millions more Americans turned to online shopping during the pandemic, Amazon struggled to keep up with the demand, and its rivals pounced. Target’s online sales shot up 141 percent last quarter, while Walmart’s rose 74 percent. Etsy’s were up almost 80 percent in April.

While Amazon’s sales did boom, its competitors’ grew even more. Before Covid-19, orders to Amazon accounted for about 42 percent of online spending in the United States. By mid-April, that had fallen to 34 percent, according to data from Rakuten Intelligence, an analytics firm.”

Digital payments

Obvious: Digital payments will increase.

Less Obvious: Acceptance of cash may collapse at a rate far more than what the consensus is expecting.

Every year consumers use a bit less cash and spend a bit more on their credit and debit cards. This trend is firmly in place, yet cash, a “technology” that has barely evolved over the centuries, remains a meaningful share of how payments are made. A step function shift away from cash may be driven from two separate, self-reinforcing events during Coronavirus.

First, due to the virus being transmitted through human contact, there has been a big increase in people using contactless forms of payment, such as Apple Pay or Google Pay via a watch or phone. Mastercard said on their recent earnings call that contactless payments of this type had increased by 40% in recent weeks.

One thing we know is that contactless payment trends have tended to accelerate greatly in a metro area once the local public transportation system implements this type of payment method. It turns out that when commuters get used to waving their phone or watch to pay twice a day during their commute, contactless payments become a habit and consumers start using them in other venues as well. We expect that the forced “training” to use contactless payments during the outbreak may stick with consumers for good.

In addition, retailers, in an effort to protect their employees, may simply refuse to accept cash when they reopen. We believe that accepting cash actually costs retailers more than the fees they are charged to accept credit cards due to all the indirect costs associated with accepting cash (slower check outs, employee theft, security costs, etc.), yet only a small number of establishments, mostly targeting younger consumers in urban areas, have stopped accepting cash in recent years. So we noted with interest that Nordstrom says they won’t accept cash when they reopen and Whole Foods will limit cash acceptance.

(Source: @pjs77777)

Health Care

Obvious: In a health care crisis, health care companies will do well.

Less Obvious: Coronavirus may accelerate long term shifts in the US health care system in ways that is terrible for the profitability of many health care companies, while being hugely beneficial to a select few.

In early 2017, we laid out our overall framework for investing in health care companies. The main thrust is that we think the current level of very high health care spending per capita in the US paired with health outcomes that put us on par with some developing economies is unsustainable.

Thus, we have only invested in health care companies that we believe both lower the cost of health care and improve patient outcomes.

What Coronavirus is making clear is that the health of our neighbors is indeed very relevant to each of us. Unlike many products and services that are distributed via market forces, health care offers social benefits when it is broadly available. Consequently, we think this crisis will accelerate the shifts in the health care sector we have been expecting.

These changes will need to focus on more preventative care and more care that keep patients out of the hospital, since it is time in the hospital that drives a lot of costs. Health monitoring may be about to go mainstream as people around the globe are tracked to assess any potential Coronavirus exposure. And, we think that companies that can help both individual consumers and the overall health care system monitor health conditions so resources can be deployed efficiently will become hugely important.

While it is difficult to predict the political conditions in the years ahead and how they might impact health care, it seems clear to us that the once “fringe” arguments that we should move to Medicare for All or at least “Medicare for All that Want It” is now very solidly in the mainstream of American opinion.

Realize too that health care companies are at war with the Coronavirus in an effort to support the public good. Will this be profitable? It is not clear. Typically, companies that profit due to supporting war efforts have been called profiteers and faced widespread condemnation.

For instance, it would seem that discovering a vaccine for Coronavirus would be hugely profitable for the company that does it. But will that turn out to be true? Will instead the world demand that the vaccine be distributed at cost or even cheaper to basically everyone on the planet? It is hard to say, but we note that the World Health Organization is already organizing most of the countries in the world and most of the leading health organizations to ensure that that the vaccine once discovered is made available to everyone without regard for their ability to pay.

On the other hand, a company like Masimo, that we have owned for some time, was able to repurpose existing technology to provide remote monitoring of Coronavirus patients to ensure they could stay home if their symptoms are not severe, while making sure that their doctor is alerted if the oxygen levels in their bloodstream should those levels decline, which is a key indicator that the illness has taken a turn for the worse. What’s fascinating about this technology is that even if the company does not make a lot of money using it during the Coronavirus outbreak, it will have proven out the money saving, health outcome enhancing benefits of the health care system shifting towards more outpatient monitoring.


Obvious: Coronavirus will cause people to flee cities and move to the country.

Less Obvious: No, it won’t. The pandemic won’t last forever, and the urbanization of the world is a mega trend that shows no sign of slowing down.

Even Less Obvious: But wait a second. Maybe people won’t flee cities for health reasons, but maybe the rise of Remote Life opportunities and the huge increase in recent years of the cost of urban living will bring about a major shift in housing preferences as newly full-time remote employees no longer need to live and work in the same area. And thus, can move to lower cost of living areas even while maintaining access to urban job opportunities.

The last hundred years has been a story of urbanization, not just in the US but around the world. We believe that many of the reasons that people need to, or desire to, live in cities will persist. But recent decades have also seen the cost of living in urban areas skyrocket, while the incomes of people living in urban areas have also greatly outgrown the income of people living outside of cities. So, while we don’t think urban environments will see people truly fleeing to the countryside, the combination of Coronavirus, high urban cost of living (especially real estate) and the rise of remote work being more mainstream, may all conspire to drive a surge of demand to live in suburban or exurban locations.

This shift would be very good for the US economy. Suburbs, exurbs and rural environments have more room to build housing and far more affordable housing. Yet these cost savings typically require people to move to places where job opportunities are scarcer and compensation levels are lower. Despite home prices in urban areas, especially along the coasts, rising dramatically, most of these areas have greatly limited the construction of new housing units making the problem even worse. Meanwhile, in much of the country a few hundred thousand dollars will buy you a large, amazing house in a wonderful neighborhood, but with limited job prospects to go with it.

Over the last decade, while home prices nationally have fully recovered their financial crisis losses, the number of home sale transactions has remained stubbornly low. Going into the Coronavirus crisis, transactions were starting to heat up and now, amazingly, according to Redfin’s CEO, housing demand has already recovered to above pre-COVID levels.

(Source: Redfin)

If this trend plays out, it will be fascinating to watch how labor market economics change. Last week, Facebook announced their plans to accommodate permanently remote employees saying they think that within a decade as many as half of their employees would be full time remote. But interestingly, the company said they plan to track where remote employees are living and adjust their compensation downwards if they move to low cost areas.

This policy of setting pay based on regional cost of living is very prevalent today, of course. But prior to the Coronavirus crisis only about 4% of the US workforce worked remotely. If 50% of computer engineering jobs are full-time remote, the practice of adjusting pay based on the IP address from which an employee connects to the company’s servers becomes nonsensical. This is easy to see if you invert the question. Is it reasonable to expect that employees will be able to trigger a raise simply by moving to a higher cost area? If a 24 year old who went to the University of Austin is working for Facebook out of their home in Texas, does it make any sense that if they decide to move back in with their parents in San Francisco that they’ll get a raise? What if they move to Thailand? If labor mobility greatly increases, then the labor market will get more efficient, not less so.

Baby Boom

Obvious: Coronavirus is going to increase the global death rate.

Less Obvious: Coronavirus is going to increase the global birth rate.

Historically, baby booms occur for a combination of cultural and biologically programmed reasons. In the aftermath of a tragic experience such as this pandemic, it’s natural for people to reconsider their goals, priorities, and changing circumstances. One of the important things that come out of an event like this, where people are stuck at home or dealing with potentially grave illness, is the realization of the importance of family, companionship, or simply boredom avoidance. Combined with the ability to move further away from urban areas and increasing affordability in the suburbs, it may well be that we see baby booms around the world. In the US, that may stabilize or reverse the trends of lower than replacement procreation (2019 saw only a 1.7 fertility rate, below the 2.1 needed to sustain a population ex immigration).

There are already early indicators of this sort of response that can be observed from pet adoptions spiking and reports like this charming video of a Florida dog kennel where all of the dogs were adopted for the first time in the kennels history.

In 2018 we wrote about how Millennials, after delaying household and family formation, were beginning to enter the stage of life of buying homes and having kids. In the chart below you can see that the crest of the Millennial generation turns 30 this year and while in the past people had kids and bought homes earlier in their lives, today we have a wall of people sweeping into household formation years with a huge number of 25-29 year olds lined up behind them.

The Decade Ahead

The fact is, we are all still grappling with how the reality of human society and global business will change. Many aspects of life will be unchanged while many others will shift. Most importantly, we think that the time period during which people will change their behavior, specifically to protect their health, will be relatively short on the order of one to three years. But as we have described above, Coronavirus may still be a catalyst that accelerates or even reverses important mega trends. As we gain conviction in what trends will persist and which will prove to be short lived, we will continuously adopt these views into our portfolio management decisions. And, even before we have a high level of conviction in where these trends are headed, to the extent they would present a significant risk to a portfolio holding, we will incorporate that risk, as well as the probability of it playing out, into our analysis

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

We recently hosted our quarterly client conference call. You can read a full transcript HERE.

Below is an excerpt from the call discussing our investments in Netflix, NVR, and First Republic and why we expect them to survive and thrive on the other side of COVID-related economic and business impacts.


Arif Karim speaking:

As the leading streaming video provider around the world with over 160 million paying subscribers, Netflix has seen a huge increase in engagement as a result of global lockdowns. A recent estimate we saw indicated 4 billion people have been ordered to restrict their movement. And what do people do when they stay home? Well, one thing they have been doing is watching a lot more Netflix. In fact, so much so that it’s put a strain on regional internet networks that have also seen a surge in capacity utilization from work at home and school at home activities such as video conferencing.

As a result, in parts of the world including Europe, Netflix has voluntarily reduced video streaming quality to free up bandwidth for other productive uses. This indicates strong user engagement, which is always the first level proxy in value creation in a service that is about consumer attention at its core. And the more valuable a service, the less likely the consumer is to drop the service for any reason and the higher the pricing power the service builds up.

Source: Netflix

So, from our reading, the value of Netflix has gone up tremendously for its users as they stay in and socialize less. In the meantime, with economic pressures on consumers globally, we think it’s reasonable to expect that Pay TV subscriptions like cable and satellite, could see accelerating declines, especially here in the US where that trend has already been in place. This would free up five to 10 times more budget than cancelling a Netflix subscription of $13/month. Netflix is more likely to be near the bottom of costs to cut and near the top of services to add in our view.

Finally, Netflix announced it would spend $100 million to support out of work members of the creative community as a result of the impact of Coronavirus. This is a strong show of support for creative partners and potential partners on the production side of its business but also demonstrates the company’s financial strength and culture. It undoubtedly wins Netflix even stronger sway as the preferred partner for creators to help Netflix fill its growing global audience’s appetite for new content across categories.

Todd Wenning speaking:

We’ve previously discussed our interest in finding idiosyncratic businesses, or companies that aren’t easily compared to others. NVR is one such company. While it is a homebuilder and is impacted by macroeconomic trends in housing, it has a unique culture and business model that is primed to not only survive near-term shocks but thrive on the other side.

Most homebuilders started as land developers and later got into homebuilding. As such, land development is in most homebuilders’ DNA. Owning and developing land has its benefits, especially in boom times when land values are appreciating and property is scarce. This works both ways, however, and as we saw during the housing crisis in 2008/2009, land-heavy homebuilders are often forced to write-down land values and some go out of business. In fact, the largest homebuilders were more land-heavy going into the COVID downturn than they were in the years leading up to the housing crisis.

Source: Ryan Homes

Rather than owning land, NVR’s long-time strategy has been to option its land, providing it with more financial flexibility when times get tough. Further, NVR had over $500 million of net cash at year-end 2019. During the housing crisis, NVR expanded into new territories and in the coming quarters we expect management to once again capitalize on opportunities to both expand and consolidate share of key markets.

When the market gets concerned about homebuilding, NVR often gets thrown out with the bathwater and we believe this has been occurring again. Going into the economic pause, there were several strong tailwinds supporting new home builds including the largest cohorts of millennials moving into household formation and prime earning years, a lack of existing home inventory, low mortgage rates, and low unemployment. Indeed, in February, monthly new home sales hit their second-highest level in 12 years. Though unemployment is a big question mark over the next few quarters, the demographic, existing home inventory, and low interest rate tailwinds remain in place. In fact, the rise of remote work during COVID quarantine may be another tailwind for new home sales (which are typically in suburban and exurban areas) as more workers may find they do not have to live close to companies’ urban headquarters to do their job.

Sean Stannard-Stockton speaking:

First Republic is a bank that caters to high net worth families. They are widely seen as the most conservative bank in terms of underwriting loans and over the long term, including during the housing bust and financial crisis, they have seen a rate of losses on their loans at about 1/5th the level of losses reported by the big banks.

There is no doubt that First Republic will earn less this year than we would have expected them to earn prior to Coronavirus. The main reason for this is the rapid decline in interest rates and thus the rate of return they can earn on the home loans they offer their clients. Yet it is important to note that it is the spread between the amount they earn lending money vs the rate they pay on checking and savings account deposits that drive earnings. While this spread will narrow, part of the decline in mortgage rates will be offset by a decline in the interest the bank pays on deposit accounts. In addition, the drop in rates has triggered a boom in refinancing and as we saw during the refinancing surges in recent years, First Republic is typically a net winner as more people with loans at other banks refinance the loan over to First Republic rather than refinance their First Republic loan to another lender.

Source: First Republic

In making the decision to invest in First Republic years ago, we certainly did not forecast a viral outbreak occurring. But we did assume that there would be deep recessions and ever financial crises that may occur while we owned the stock. Their strong credit profile is important not just from a financial modeling perspective, but in attracting customers. For as long as we’ve been invested in First Republic, the bankers’ desks at the local branch near our office have displayed a one-page summary of the company’s credit ratings, illustrating how they are better capitalized than all the well-known big banks. It is the companies that recognize the importance of being safe and secure all of the time that are best positioned to retain their customers’ trust during a crisis. So when Americans started thinking about sheltering in place and wondering if their cash in the bank would still be there after the crisis, knowing that First Republic has always stood for risk avoidance and high levels of service provides their customers with the confidence they need to keep their assets with the company or even consolidate other loans or deposit accounts they might have elsewhere.

You can read the full transcript here.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Ensemble Capital Client Call Transcript: Tiffany & Co Update

21 October 2019 | by Ensemble Capital

We recently hosted our quarterly client conference call. You can read a full transcript HERE.

Below is an excerpt from the call discussing our investment in Tiffany & Co (TIF)

Excerpt (Todd Wenning speaking):

When we think about luxury goods, two things tend to come to mind. First, we tend to think of European brands like Louis Vuitton, Chanel, and Cartier. In fact, according to the consulting firm Deloitte, French, Italian, and Swiss companies together accounted for just under half of global luxury good sales in 2017. Second, we tend to recognize a luxury brand when we see one. A Ferrari, for example, is unmistakable, as are Louis Vuitton handbags with their ubiquitous LV insignias. That’s largely the point in purchasing a luxury item, of course – to communicate status to others.

Curiously, Tiffany does not fall into either of those buckets. It’s one of just a few global American luxury brands and the casual observer cannot tell a Tiffany diamond engagement ring from one purchased elsewhere. There’s no room on a diamond for logo placement, after all.

So how does Tiffany do it? Like its European luxury counterparts, Tiffany is draped in a wonderful narrative and history. You might be as surprised as I was to learn, for instance, that Tiffany has been around since 1837 and has been in the diamond business since 1848, when Charles Lewis Tiffany opportunistically purchased diamonds from fleeing French aristocrats in the French Revolution of 1848. His timing couldn’t have been better, as new American millionaires clamored for royal jewelry to show off their recently achieved status. That’s what got the ball rolling.

As a company, Tiffany is older than Cartier (founded in 1847), Louis Vuitton (founded in 1854), and Burberry (founded in 1856). This durability matters in luxury because it communicates a brand’s ability to endure all kinds of major socioeconomic changes and remain relevant over successive generations. It also communicates a certain timelessness of core products that remain in fashion despite intermittent fads and trends.

Tiffany is one of the few brands in the world that can be identified by a color alone. Its trademarked robin egg blue provides instant recognition, from near or far. And that color communicates elegance, exclusivity, and sophistication. To be sure, more than one would-be suitor has tried his hand at putting a non-Tiffany item in a Tiffany Blue Box to achieve the desired effect. It’s a risky move, of course, for if the ring doesn’t fit, you have some explaining to do when the recipient needs it to be resized. But that speaks to the power of the Tiffany brand – that the color of the box can multiply the value of what’s inside it. Assuming the item was properly acquired, a Tiffany ring in a Tiffany Blue Box communicates to the recipient that you’re worth the extra money.

Tiffany’s narrative has been carried forward into the modern era by popular media, such as the classic movie Breakfast at Tiffany’s starring Audrey Hepburn, and more recent movies like Sweet Home Alabama and The Great Gatsby. The most recent advertising campaigns feature millennial celebrities like Zoe Kravitz, Lady Gaga, and Elle Fanning.

To be sure, the Tiffany brand has been mismanaged at various points in its history. However, we think current CEO Alessandro Bogliolo, who joined the company at the end of 2017, has been a fantastic brand steward and is executing well in the areas the company can control. Notably, we are encouraged by his focus on “informal” luxury to better resonate with the Millennial generation. Last year, for instance, Tiffany opened a “style studio” in London’s Covent Garden, about a mile away from its ritzy high-end storefront on Old Bond Street. The “style studio” format is more informal than the main store, with barstool seating, fragrance dispensers, and opportunities to interact with and customize Tiffany-branded jewelry. We think this is a healthy way for Tiffany to reach out to new consumers without diluting the core brand value.

Like other luxury brands, Tiffany is seeing growth in emerging Asian economies, some of which are adopting Western-style engagement ring culture. In August, Tiffany announced a partnership with India-based luxury retailer Reliance Brands Limited to open new stores in Delhi and Mumbai. As the CEO of Reliance Brands put it in the press release announcing the deal, “Tiffany needs no introduction in India – it is iconic and timeless.”

That quote brings up an important point about Tiffany’s brand-driven moat. As I mentioned earlier, it’s extremely challenging to attach a brand (and command a related price markup) to a piece of jewelry that from a distance cannot be differentiated from a similar item. Given its rich heritage and place in popular culture, Tiffany, as the Reliance Brands CEO put it, “needs no introduction.” This is a huge advantage for Tiffany against any would-be upstart competitors.

In many other areas of the luxury goods market, we’ve seen direct-to-consumer brand startups leverage social media to take on incumbents. But it’s far more difficult to start and scale high-end jewelry, as the product doesn’t outwardly advertise the brand. It takes decades, if not generations, to be considered “iconic and timeless.” And this says nothing about the expensive input costs – gold, platinum, diamonds, skilled artisan wages – that would go into a high-end jewelry operation.

In summary, we’re confident in Tiffany’s moat and have growing confidence in Tiffany’s management. We think the company is set up well for continued relevance in future generations.

You can read the full transcript HERE.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.