Amid COVID-19 and the economic shutdown, the outlook for global companies has been uncertain, leaving many investors unsure which companies will emerge as the winners and losers in the long term.
Typically at this time of the year, investors have looked to first-quarter earnings announcements as a temperature gauge for the health of both the economy and individual companies. However, COVID-19 has changed the game.
The first quarter’s earnings season reflects the period from January to March, and much of the impact of coronavirus-related lockdowns and restrictions was only felt towards the end of the period. Therefore, investors have focused their attention mainly on trends since the end of March and future expectations.
Perhaps unsurprisingly, these trends showed that companies have been very weak during the lockdown period. Many have dropped their earnings guidance for 2020 as the significant uncertainty makes it near impossible to forecast for the next few months, never mind the rest of the year.
While all recessions all different, the coronavirus recession is unique. It has been caused by government-mandated social distancing measures which have had a significant impact on companies’ ability to do business – affecting even those that are normally stable or modestly cyclical in a recession.
For example, Coca-Cola’s bottler in Western Europe, Coca-Cola European Partners*, has experienced a 40-85% hit to its ‘away from home’ sales as restaurants, pubs, tourist sites and other immediate consumption venues have closed. Similarly, healthcare companies are often seen as ‘recession proof’, but medical devices company Medtronic* suffered a 40-60% drop in its revenues as elective procedures have been delayed during the lockdown.
It is clear that companies are now in crisis-management mode. The message we keep hearing during conversations with companies’ management teams is now is the time for hard hats and to focus on finding stability and looking after employees, suppliers and customers.
Amid this uncertainty, the question on everyone’s mind is: ‘what’s next?’ Companies will be turning their attention to how to navigate through the remainder of the year and beyond.
A key issue will be whether demand will recover to pre-crisis levels and, if so, when. We must be realistic about what kind of recovery we will see as rules continue to be relaxed. In China, where lockdown rules were lifted earlier than elsewhere, companies are beginning to report a normalisation of operations as plants and shops re-open and exports recover. However, demand has not yet recovered and is taking longer than many optimists may have hoped.
Therefore, companies are hoping for the best, but preparing for worst. This means it is likely they are preparing cost-reduction plans that can be quickly implemented when needed. We are also starting to hear that many companies are cancelling any discretionary projects as well as cutting their capital expenditure.
These early indicators make us less optimistic on the prospects for a V-shaped economic recovery, which means it is now more important than ever to focus on finding the right investment opportunities and identifying the companies that are likely not only to survive but thrive in the long term.
We are looking for companies that show the following characteristics:
1. Benefit from social distancing measures
We are interested in companies with businesses that are not impacted by social distancing, or are even beneficiaries. For example, Microsoft* offers a suite of individual and team productivity tools to support working from home, such as Microsoft Teams. However, valuations for many of these companies are currently high so we will only act on these when the price is attractive.
2. Take advantage of the disruptions within their sector
We believe a number of companies, such as Next* in UK retailing, have strong competitive advantages and will use the severe market disruption to increase their market share and leave the crisis in a stronger relative position thanks to superior business models and their lower costs and debt levels.
3. Have longer-duration cash flows
We expect interest rates to remain low for a long time, which makes companies with longer-duration cash flows more attractive from a valuation perspective – for example, those within renewable assets or consumer staples.
We believe that focusing on finding companies with these characteristics will help us find investments that will weather the current COVID-19 volatility and position our portfolios for the long term.
*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.
Past performance is not a guide to the future. The value of an investment and any income taken from it is not guaranteed and can go down as well as up; you may not get back the amount you originally invested.