For some investors, a focus on high-quality companies never goes out of style. Yet, as a result of the pandemic, assessing which companies to include in that category may take more legwork than usual.
“We’re trying to find high-quality companies with sustainable business models for reasonable valuation,” said Natalie Taylor, a portfolio manager at CIBC Asset Management, in an April 23 interview. “However, given the dynamic environment, this comes with a few extra steps.”
First, Taylor stressed the importance of balance sheets, debt covenants and liquidity.
“We want to make sure that companies are able to survive the disruption to their business without significant dilution to shareholders,” she said.
To that end, measures implemented by central banks and governments in response to the pandemic, such as asset purchases and lending programs, have helped provide the financial system with ample liquidity.
Second, investors should be aware of paradigm shifts in response to market disruptions.
“All previous assumptions for the future need to be re-tested, and new trends need to be identified,” Taylor said.
For example, more people could work from home permanently, affecting office space. Other potential shifts include a backlash against density that leads to suburbanization, supply chains that become more local and consumer spending that reverts to goods, away from experiences.
“These shifts in behaviour could have meaningful impact on a business’s prospects and earnings outlook, rendering traditional evaluation metrics unreliable,” Taylor said.
Lastly, scenario analysis and stress-testing are useful tools for investors, given the range of possible outcomes resulting from this period of economic uncertainty. “The future is unknowable, and it’s more productive to work in terms of probabilities,” Taylor said.
Ready to recover?
While economists have debated the shape and pace of the recovery, it’ll likely look different depending on the sector or business. Factors to consider include the re-opening schedule mandated by governments and the ability to maintain social distancing.
For example, while manufacturing may check the box on social distancing, “the ability to stop and start production can be incredibly costly and complex in the event of a second wave of the virus,” Taylor said. As such, restarts in the sector must be carefully considered.
Taylor expects industries that rely on traffic will rebound sooner, as commuters favour driving over transit, particularly when gas prices are at record lows and congestion isn’t an issue.
“Road trips will replace air travel in the near term for essential business travel and leisure travel,” she said.
Her outlook is positive for Laval, Que.–based Couche-Tard Inc., the multinational operator of convenience stores. The company will “benefit from a pickup in traffic and fuel volumes,” she said.
Winnipeg-based Boyd Group Services Inc., an owner of collision repair shops in North America, could also benefit. While demand for the company’s services declined significantly in March, the name remains “well positioned to grow through industry consolidation given its size and strong balance sheet,” Taylor said.
For some companies, the market is overestimating the negative impact of Covid-19. Saskatoon, Sask.–based Nutrien, a multinational fertilizer company with retail businesses — and the world’s largest potash producer — is an example.
“The company has affirmed its guidance for the first half of 2020 as the outlook for acres planted appears set to rebound from a dismal 2019,” Taylor said.
The pandemic’s impact on other companies may have been underestimated.
“The strength in certain technology stocks seen as the beneficiaries in a Covid[-19] environment is overdone, and valuations appear full relative to the rest of the market,” Taylor said.
The same is likely true of consumer staples such as groceries. “The benefit of pantry loading is starting to fade and the higher costs of doing business are not reflected in the shares currently,” she said.
Sectors expected to take longer to recover include travel and leisure. “The sector is at the core of the crisis, with airlines, cruise lines and hotels down an eye-popping 60% to 80%,” Taylor said.
She expects travel demand will take time to recover even after borders reopen. In addition, businesses in the sector will face increased costs for disinfecting and implementing social distancing measures to help ease traveller anxiety.
Oil and gas is also expected to have a prolonged recovery, as global demand has declined sharply —particularly for jet fuel — and oversupply remains a challenge, Taylor said.
The sector’s future is also challenged because of trends unrelated to the pandemic.
“The longer-term prospects for oil in a world that has become hyper-focused on climate change are grim, as capital flees the sector and governments face political backlash to bailing out the industry,” Taylor said.
The retail sector is also expected to suffer, with the pandemic accelerating disruption from e-commerce. Bankruptcies in the sector have already started, Taylor said, including U.S. clothing retailer J. Crew earlier this week.
The poor outlook extends to REITs.
“Retail real estate investment trusts will face increased pressure as well, as traffic remains anemic and vacancies rise,” Taylor said.
This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.