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Thematic investing

Security: Strong earnings growth from a fast-expanding industry

July 2017

Businesses that provide security solutions are proving an attractive investment with growth fuelled by innovation, urbanisation and regulation

The security industry has expanded to reach every aspect of our lives

Security permeates our lives, from dawn to dusk. While using electricity and water to heat our homes, shower and make breakfast, we rely on utilities whose operations are securely protected. We travel to work by car or public transport under the watchful eyes of video surveillance cameras.

At work, cyber-security functionalities are activated when working online, while the safety of our meals is ensured by tests and traceability records. We use electronic payment systems that authenticate our transactions and detect fraud when we shop. Technology makes our travels safe.

The security industry is everywhere, strongly anchored in our daily life, and this has fuelled stellar growth over the last few years. And what makes it an attractive investment is that three long-term drivers provide secular growth: innovation, urbanisation and regulation.

The security industry is everywhere, strongly anchored in our daily life

Technological innovation has created new security needs. While great strides have been made towards autonomous cars, security requirements have increased significantly for autos - not only seatbelts and airbags but features such as cameras, sensors, autonomic braking systems, radar, laser and night visions systems.

Internet security was barely a concern 25 years ago but now the internet connects billions through different devices. Data theft and hacking attacks are already grabbing headlines but it is still early days - only 50 per cent of the world’s population is online and connecting the rest will expose the IT infrastructure to new threats at a time when data breaches are increasing by 60 per cent a year1.

Meanwhile, urbanisation, the second long-term driver, means massive investment is required to secure infrastructure such as power plants, mass transit systems, airports and water utilities. More than half the world’s population now lives in urban areas and that proportion continues to rise.

In the emerging world, security spending is forecast to grow at around 9 per cent a year over the next five years – more than twice the rate in developed markets2. Dubai showed what can be achieved by building a new smart city whose infrastructure integrates security solutions.

The third driver is regulation, which imposes rules on public bodies, companies and individuals. Even in sectors such as financial services which have compliance departments, testing, inspection and certification has become big business. New rules come thick and fast, such as mandatory side-airbags for every new car in Brazil recently.

In a near future, all new vehicles in Europe will have an eCall terminal automatically contact emergency services in case of a crash – a rule already in force in Russia. Meanwhile, the EU’s General Data Protection Regulation due in 2018 will require European companies to disclose data breaches, the financial and reputational impact and remedial action. Being in breach of this new regulation will expose companies to being sued, with fines of up to 4 per cent of turnover or EUR20 million3.

Given this sharp growth in the security industry, Pictet Asset Management has identified a universe of 330 companies with relevant activities representing a total market capitalisation of USD3.3 trillion. Excluding companies that generate less than 20 per cent of sales from security and those with more than 5 per cent of sales related to defence or military equipment results in an investable universe of around 210 companies with a total market cap of USD1.1 trillion.

Scoring companies’ business franchises and management quality and adjusting for share price volatility and liquidity results in a portfolio of 60 to 75 names solely made up of the strongest convictions, without any reference to a benchmark.

The resulting portfolio is well-diversified. Breaking down the demand for security products, North America accounts for 48 per cent of sales, Europe is the second largest source of sales with 24 per cent, followed by emerging markets (14 per cent) and Japan and Developed Asia-Pacific (10 per cent).

Since January 2007, sales growth of the security universe has averaged just under 7 per cent, compared with 3.7 per cent for global GDP. The future looks bright for security.

Security sales will continue to grow much faster than GDP*...   
Security universe total sales, GDP real rebased, Jan 2007
security sales
*GDP OECD data G20 GDP – Constant prices, growth rate same period previous year seasonality adjusted % – World
...which will drive further margin upside
Security universe EBIT margin (%)
Margins
Source: Pictet Asset Management, May 2017
We estimate that with the large restructurings during the last crisis and better cost discipline, a large majority of companies in the universe  can expand margin above prior peaks