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(Runtime: 6 min, 05 sec; size: 66.9 MB)
Natalie Taylor, CIBC Asset Management, portfolio manager.
While we’re currently in a bear market, the process for investing is largely unchanged. At the end of the day, we’re trying to find high-quality companies with sustainable business models for reasonable valuation. However, given the dynamic environment, this comes with a few extra steps. First, balance sheets, debt covenants and liquidity become of utmost importance. We want to make sure that companies are able to survive the disruption to their business without significant dilution to shareholders. Investors keyed in to this need for liquidity in March, and for the most part governments and banks have ensured there’s ample liquidity in the system to help bridge the gap.
Second, with many market disruptions there are likely to be paradigm shifts underway. Essentially, all previous assumptions for the future need to be retested, and new trends need to be identified. For example, will a greater number of us work from home going forward? What are the implications for office space? Will there be a backlash against density that leads to suburbanization rather than urbanization? Will supply chains become more local in an effort to secure essential products? Will we see a reversal of spending on experiences, and more on things? These shifts in behaviour could have meaningful impact on a business’s prospects and earnings outlook, rendering traditional evaluation metrics unreliable, which brings me to my last point.
Given the uncertainty and range of outcomes, scenario analysis and stress tests become a very useful tool in this environment. It is important to recognize that the future is unknowable and more productive to work in terms of probabilities.
It’s impossible to know exactly how the recovery will unfold. There is much discussion amongst investors and economists on the pace and shape for the recovery from here, with paths such as V, U, L, W and even a backwards check mark considered. We’ll most certainly see differing degrees of recovery across different sectors and businesses based on phases of re-opening, need to earn income and the ability to maintain social distancing.
Surprisingly, restaurants, gyms and shops are being discussed as among the first businesses to re-open in the U.S., albeit with certain capacity restrictions and additional standards for cleanliness to ensure that customers can feel safe. While manufacturing businesses 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 and, as such, restarts must be carefully considered. It is likely office workers that are able to work from home productively will be among the last to go back to work. As of recording at the end of April, we are in the very early stages of certain economies reopening, and it will likely be two to three weeks after reopening before we can judge the success of various efforts.
When thinking about industries and companies that are likely to rebound sooner, we believe sectors that rely on auto traffic could be among the first to rebound as the economy reopens and commuters favour driving over transit, particularly with gas prices at decade lows and light traffic. We believe that road trips will replace air travel in the near term for essential business travel and leisure travel.
As such, we have a positive outlook for Couche-Tard, an owner and operator of global convenience stores and fuel stations. We believe they will benefit from a pick up in traffic and fuel volumes. We also like Boyd Group Services, an owner and operator of collision repair shops, which has seen demand decline meaningfully through the end of March, but remains well positioned to grow through industry consolidation given its size and strong balance sheet.
In addition, there are companies where we believe the market is overestimating the impact of Covid-19 and that those businesses offer a good value currently. For example, Nutrien, a fertilizer company with retail distribution, has affirmed its guidance for the first half of 2020 as the outlook for acres planted appears set to rebound from a dismal 2019. The agriculture cycle has limited overlap with the economic cycle, however the market’s taking the shares lower.
On the flip side, we think that the strength in certain technology stocks seen as the beneficiaries in a Covid environment is overdone, and valuations appear full relative to the rest of the market. Similarly, with certain consumer staples such as groceries, for example, we believe that the benefit of pantry loading is starting to fade and the higher costs of doing business are not reflected in the shares currently. We believe that there will be certain sectors that take longer to rebound. Perhaps the most obvious is the travel and leisure sector. The sector is at the core of the crisis with airlines, cruise lines and hotels down an eye-popping 60 to 80%. We believe that once borders are reopened demand will still take time to recover and that the industry will face additional costs for disinfecting and social distancing measures in order to make the general public comfortable with travel.
Other parts of the economy that are likely to see a prolonged recovery include the oil and gas sector. The decline in global demand, particularly in jet fuel, as well as the supply glut resulting from the recent price war is likely to impair prices for some time as the painful process of shutting in production and permanently reducing supply occurred. In addition, 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.
Lastly, we believe the retail sector is also likely to see more pain as the global pandemic has accelerated the disruption from e-commerce. We believe there will be an influx of bankruptcy announcements which have already started. In addition, we believe retail real estate investment trusts will face increased pressure as well, as traffic remains anemic and vacancies arise.