As the global bull market extends into its 11th year, the dreaded “R” word has been getting a bit more of a workout in some circles.

The timing of recessions is impossible to predict, but if and when they do occur sharp falls in asset prices often act as a catalyst.

Lately, there’s been a few indications that markets are bracing for turbulence — starting with this week’s stock selloff amid the coronavirus outbreak.

Prices for the safe-haven asset of gold have hit new record highs, even more so in Australian dollar terms.

(The Aussie dollar is often seen as a proxy for global risk appetite, given Australia’s broad trade exposure to the rest of the world).

Meanwhile, the yields on government bonds (also a safe-haven asset) continue to plumb new record lows amid strong demand.

For his part, legendary investor Warren Buffett is sitting on $US128bn ($194.2bn) in cash because he can’t find anything cheap enough to buy.

If a serious downturn does arrive, all investors will probably feel some pain of some kind. But where some sectors outperform in a bull-run (eg high-growth tech), others perform better when the going gets tough.

For example, private equity firm BGH Capital took control of ASX-listed education provider Navitas last year partly for that reason.

Other well-known “recession-proof” sectors include healthcare and infrastructure.

To get an investor’s view on the idea, Stockhead spoke to Steve Collette from advisory firm Merchant Group about what aspects of a company or sector perform well in a downturn.

Collette’s focus is on telecommunications and data infrastructure, and within that he said companies with a strong business-to-business (B2B) proposition offer an added buffer from economic shocks.

“Obviously a meaningful downturn will affect in some regard. But one framework I use is to look at companies providing products or services that are fundamental to business and corporate activity at a core level,” he said.

“That’s one of the most defensive endeavours a set of businesses can be involved in. And within that, you’re looking for companies that are servicing the most defensible clients.

“In particular, if you’re in the business of providing services to blue-chip corporate clients or government clients then that’s the type of thing that’s going to assist.”

More specifically, Collette said companies that found ways to scale a solution for the secure transfer and storage of data were likely to stay more resilient in a downturn.

“I think data is one of the most valuable resources – not only in terms of governing economic transactions but also having value by itself as a commodity,” he says.

“Going back to the business application, you’ve got B2B customers that are dependent on connectivity to conduct their affairs at a core level. And that connectivity is governed by different forms of infrastructure on which data packets flow.

“So I can’t imagine anything more critical and fundamental – and for which the demand is more inelastic – than the transmission of these data packets.”

Despite that, Collette stressed the inelastic demand for data infrastructure solutions wouldn’t be a rising tide that lifts all boats.

“It’s a crowded and competitive space – the thematics aren’t new,” he says.

“An industry that’s now as ubiquitous as data and telecoms transmission, it’s going to attract a lot of people trying to pick holes in it.

“In that environment, you’re looking for companies that have a demonstrated track record, and you also want to be able to eyeball management and feel good about their concise messaging.

“If they can’t simply explain what it is they’re proposing to do for you as an investor, then there’s a higher likelihood they’re struggling to get it right in house as well.”

 

Potential ‘recession proof’ prospects

In the context of those broader industry trends, Collette provided analysis on two ASX small caps that operate within the space.

5G Networks (ASX:5GN)

“What I like is the potential for them to develop an end-to-end solution in data infrastructure,” Collette said.

“We live in a world now where you’ve got physical infrastructure and data centre requirements that need to be appropriate to the nature of the business client.

“Then you’ve got the cloud and the cloud can take different forms – both public and private information.

“Then it’s about the actual nature of the business and any third party software apps that are critical for running their company – the way they interact with this connectivity.”

Collette said companies that could integrate that network for the client at as many of those points as possible were “uniquely positioned” to have a defensive profile of earnings.

“That’s an aspiration that 5GN has, and that’s why you see them growing their revenue towards the higher margin endeavours – managed services, owning the data centre infrastructure and being able to offer cloud services,” he said.

Collette highlighted the company’s recent efforts to integrate its product offering by focusing on data centre acquisitions in strategic locations. But he stressed that executing on such a strategy was easier said than done.

“To strike a deal on favourable terms in an optimal location, you need to have a sense of where the balance of capacity will be used,” he says.

“But there’s nuance in the dealmaking – ownership of data centres of and by themselves is not easily done. You’ve got security considerations, how the infrastructure is capitalised. And there’s sensitivities to data provisioning in general.

“It’s a very nuanced endeavour, but if you get the mix right it can be a very profitable one.”

Over the Wire (ASX:OTW)

“I think the model they established is somewhat unique in that they sell telecommunications, cloud and IT services to business customers. But they haven’t looked at residential involvement, it just has not been of interest,” Collette said.

“And generally speaking that’s been to their benefit, because residential has been a difficult space. A lot of other parties have tried and failed, owing to the type of business model required to service this style of client.

“I think typically acquisitions have been well timed and priced. It’s a great example of how to build a business in a considered way over time, and shareholders have reaped the benefits.”

Over the Wire shares climbed steadily from around $1 at the start of 2016 to a high above $5 in November 2018.

 

“They’ve been consistent performers over the course of five years, and whilst they’ve encountered some short-term selling on the back of the result they just reported, their metrics remain robust. I think the business is well capitalised for future growth,” Collette said.

At Stockhead, we tell it like it is. While 5GN is a Stockhead advertiser, it did not sponsor this article.

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