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Brave new world for US equities

American companies and the US economy face an uncertain future under Donald Trump
Brave new world for US equities

Donald Trump’s victory in the US presidential election could be a boon for American companies. The real estate tycoon has pledged to spend billions on infrastructure, stem the outflow of manufacturing jobs overseas, cut the corporate tax rate, curtail financial and environmental regulations, and protect domestic industries by scrapping international trade deals. Lower taxes and higher government spending could galvanise economic growth and prompt companies such as Apple (US:AAPL) and Alphabet (US:GOOG) to repatriate and invest the cash they've stashed overseas. However, there's no guarantee the incoming president will actually pursue those policies or that Congress will approve them.

Investors are understandably sanguine about the US economy: it grew at an annualised rate of 3.2 per cent in the third quarter of 2016, its fastest rate in two years. It added 161,000 jobs in October, and the unemployment rate ticked downward to 4.9 per cent. Moreover, the US dollar has appreciated to levels not seen since April 2003. And just before Thanksgiving, all four major US stock market indices – the Dow Jones Industrial Average, S&P 500, Nasdaq and Russell 2000 – closed at record highs for the first time since 1999. Key drivers have been low interest rates, a recovery in oil and commodity prices, and the release of pent-up demand following the conclusion of the American election. In line with last year, we highlight six US-listed companies that provide insights into trends, industries and the economy as a whole.

Coca-Cola (US:KO) boasts an iconic brand, dominant market position and a global network of bottlers and distributors. But the soft drinks giant faces major challenges: fierce competition from PepsiCo (US:PEP) and Dr Pepper Snapple (US:DPS); weak trading in China, Argentina, Venezuela and other developing territories; and flagging consumption of sugary carbonated drinks in developed markets, due to growing awareness of the health risks of sugar and regulations such as taxes. Management has had to spend heavily on advertising and developing new products – such as Coca-Cola Zero Sugar in the UK – to maintain market share. It’s also selling bottling operations and other facilities to franchisees, in a bid to boost profitability, lower capital costs and focus on the Coca-Cola brand. Analysts at DBRS think the group’s refranchising and productivity efforts could widen its cash profit margin from 28 per cent to around 35 per cent by 2019.

UK investors can stick a straw in Coke’s can via London-listed Coca-Cola HBC (CCH),

a licensed bottler with a market capitalisation of nearly £6bn. They will hope the cola king can successfully offset weakening sales by reformulating its drinks, rolling out new brands, acquiring healthy-drinks businesses and streamlining its operations. Failure will leave a bad taste in their mouths.

Barack Obama’s bailout of the US auto industry during the financial crisis was heralded as one of the triumphs of his presidency, but all good things come to an end. A record 17.5m vehicles were sold in the US in 2015, meaning it could be downhill from here for General Motors (US:GM). The carmaker behind Buick, Chevrolet and GMC has benefited from strong retail growth and selling a greater proportion of larger, more lucrative vehicles. Full-size pick-up trucks and SUVs made up over 37 per cent of its sales in October – up from 34 per cent a year before – which pushed its average transaction price above $36,000, a significant premium to peers.

Bigger incentives for dealers and expanding inventories have fuelled fears that the US car market has reached ‘peak auto’. But JPMorgan analysts predict that dealer stocks will shrink due to production stoppages over the holidays, and expect fewer incentives now carmakers have got their latest vehicles into lots. Moreover, GM’s big bets on the future of the car industry should help to insulate it from a downturn: it invested $500m in ride-hailing service Lyft at the start of 2016, and recently launched the fully electric Chevrolet Bolt. A bigger worry for GM and its peers may be their plants in Mexico, given President Trump’s threats of tariffs and other barriers against America’s southern neighbour.

The advent of ‘biosimilars’ – pharmaceuticals that are nearly identical to existing, licensed drugs – poses a significant threat to Johnson & Johnson (US:JNJ). The maker of medical devices, consumer products such as Listerine and Neutrogena, and pharmaceuticals may soon contend with Pfizer's (US:PFE) biosimilar copy of Remicade – an arthritis drug that generated more than a fifth of J&J’s pharmaceutical sales in 2015. The pharma division accounts for about 47 per cent of turnover and underpins J&J’s growth, while the other two divisions have flatlined in recent years.

J&J boasts several popular drugs – Imbruvica, Xarelto and Stelara are expected to generate more than $6bn in sales in 2016 – and hopes to seek approval for more than two dozen more over the next eight years. It’s also building its pipeline through acquisitions: it has offered north of $26bn for Actelion – a Swiss biotech focused on the less competitive rare disease space that has developed two potential blockbuster drugs. Management is also cutting costs and restructuring the devices unit, and the $40bn cash pile provides ample scope for more deals. Overall, J&J looks capable of holding its own for years to come.

Satya Nadella, who took over as Microsoft (US:MSFT)

chief three years ago, has tried to offset declines in the PC market by investing heavily in cloud and mobile. He’s also slashed the computing behemoth’s sales and marketing and administrative expenses, in favour of ramping up research spending. And he’s made bold bets such as agreeing to buy LinkedIn for over $26bn this summer. Investors have cheered his approach: in October, Microsoft’s shares reached their highest level in nearly 17 years.

Microsoft benefits from a huge captive market of Windows and Office users to whom it can sell new products and services. Perhaps its most exciting offering is Azure: constant-currency sales of the cloud platform, which offers remote computing power, data storage and applications to clients, surged 121 per cent in the first quarter of this financial year. Annualised commercial cloud revenue now exceeds $13bn, and management expects this to reach $20bn by FY2018. However, the costs of running data centres, together with falling sales of PC-based products, have narrowed Microsoft’s gross margin from 80 per cent six years ago to 62 per cent last financial year. The group has also struggled to gain traction in areas such as search and smartphones, and faces mounting competition in the enterprise market. Microsoft will have its work cut out to topple Amazon, Salesforce, Oracle and other giants in its target markets.

Another corporation reinventing itself is Verizon (US:VZ). Faced with sluggish growth in mobile subscriptions and handset sales, the telecoms giant is branching out into new areas: it agreed to acquire Yahoo (US:YHOO) for $4.8bn this summer, a year after it acquired AOL for $4bn. Moreover, it has agreed to acquire Telogis, Fleetmatics and Sensity Systems in recent months, strengthening its positions in connected vehicles, mobile workforce management and smart cities. Those deals should augment its ‘internet of things’ division, which grew comparable sales by 24 per cent to over $200m in the group’s latest quarter.

Verizon's purchase of Yahoo puts it on a collision course with Google and Facebook (US:FB). It already faces stiff competition from AT&T (US:T), T-Mobile (US:TMUS) and others in the wireless market. However, there's a clear rationale for combining the two businesses: Verizon can charge advertisers to access data from its more than 100m mobile subscribers, easily integrate digital content and adverts into its mobile services, and offer marketers access to an enormous audience and use of AOL's advertising and data analysis tools.

The rise of Amazon (US:AMZN) and the shift to online shopping has been a perennial headache for Wal-Mart (US:WMT). The retail giant, which rakes in over $500bn a year from more than 11,000 stores across 28 countries, suffered its first sales decline in at least 45 years last financial year. The stumble has served as a wake-up call: Wal-Mart has acquired Jet.com for $3.3bn and almost doubled its stake in JD.com – both e-commerce groups – in recent months. Management has also emulated Amazon boss Jeff Bezos, informing investors that the group will focus on boosting sales and online shopping and likely not increase profits until 2019.

Wal-Mart’s strategy, which includes using its stores as click-and-collect and distribution depots, drove its global e-commerce sales up 21 per cent in the third quarter of 2016. However, management plans to raise wages, lower prices and ramp up digital spending, which is likely to weigh on margins. Another concern is Asda, which has been hit hard by UK discounters such as Aldi and Lidl due to its emphasis on low prices. Along with food deflation and feeble growth in the grocery space, a growth surge doesn’t appear likely.