The risk of future regulation to your portfolio | Fin24
 
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The risk of future regulation to your portfolio

Jan 10 2020 14:23
Simon Brown

I have often written about the regulation risk in healthcare. Now I’d like to look at a few other sectors too. Healthcare costs have been rising faster than general inflation for a decade or more. 

This prompted governments the world over to push back against price increases from drug manufacturers and hospital groups. A part of the problem here is the increased life expectancy of people, which was brought about by, ironically, better healthcare. 

Despite this, governments remain concerned. 

That said, one area of healthcare that continues to escape regulation is medical equipment suppliers and data systems. This regulatory anomaly remains a long-term risk for the healthcare sector. 

Other sectors, however, may also run into trouble and subsequently see their future margins squeezed. The obvious sector is tobacco manufacturers, amid rising concerns about vaping from around the world. 

The US government has agreed to restrict certain flavoured vaping products as it is considered to be aimed squarely at kids as a gateway to smoking for life. Over December the US also raised the tobacco buying age to 21 years – this includes vaping products. 

This will immediately hurt sales, but also future ones as “catching them young” has long been part of the large tobacco companies’ strategy. We also saw the mobile telecom companies’ interconnect fees slashed by South Africa’s communications regulator, Icasa, over the last decade. 

That ended the business model based on the least-cost routing among industry players – this dented telecom profits.

In which other areas can we potentially expect increased, or new, regulation?

The easy target is big tech firms with several democratic presidential candidates talking about breaking up some of the larger constituents such as Amazon, Facebook and Google’s parent company, Alphabet. 

I, however, suspect the real regulatory risk here has more to do with data privacy. In short, right now we have little regulation on data privacy, and the large tech companies play fast and loose with our data, which makes us vulnerable. 

Potentially, US congress would promulgate a law that tightens control over data usage and privacy. This will hit the profit margins of tech companies, especially that of Alphabet and Facebook. It is early days, but certainly a risk to monitor.

Another regulatory risk has to do with climate change. Such regulation will eventually impact the large polluters, such as big oil companies and those generating power. This may be further off than data privacy regulation.

Power generation has an easy plan B in the form of green energy.  Big oil does not but will be safer due to the global economy running on oil, which is a long way from dying. 

Electric vehicles are the real threat to the oil industry and while the tech is exciting, it is still fairly early days, especially with the limits imposed by battery technology. But a planet where the most vehicles are electric is certainly on the radar. 

This will leave big oil companies very exposed. Hence, we saw Sasol* opting for producing more chemicals, as its ill-fated Lake Charles Chemical Project shows, and reducing its oil exposure. 

Their SA operations, however, remain large polluters. As investors we need to be aware of these potential long-term regulatory risks, even if they are on the horizon now. When they do eventually come the damage to profit margins will be marked. 

So, know which shares you hold. Know what the longer-term regulatory risks are and know what will trigger you to potentially exit a specific sector. That said, selling may not even be required. 

Companies such as Alphabet and Facebook are huge and make such insane margins that a slimming of these will still leave very robust profits. But if the regulatory issues prompt a crushing of margins that’ll be bad – really bad.

It is not just margins that will get hurt, but the details of any regulation and how deeply they will cut into those margins would need to be considered.

* The writer holds shares in Sasol.

portfolio  |  healthcare  |  governments  |  simon brown
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