Value Investing in the Shadow of Covid-19

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John Goetz. I’m the co-chief investment officer at Pzena Investment Management in New York.

While the markets have been massively impacted by the coronavirus, [that] impact has been felt around the world. As you all know, it started in China in Wuhan. Ultimately the impact has been harder felt actually I would say in developed markets, particularly Europe and North America. So the impact of this virus has triggered government actions, specifically I’m referring to shutdown orders, stay at home orders, et cetera. And that impact on the economy is really unprecedented. If you look back at all the recessions we’ve had in the last 40, 50, 60 years, none of them have seen the impact on business that the shutdown orders have created. You can kind of see that in the stock markets’ volatility; kind of a fear gauge, we’ll call it. Volatility spiked to levels that we haven’t seen since the Great Depression, and obviously volatility really reflects the uncertainty of going into this unknown territory of the impact of these shutdowns.

I mean, we know because in our process, we identify companies that are interesting, significant and undervalued. One of the things that has shown up here, particularly in the month of March as these shutdowns really began to take hold in Europe and North America, is that companies were facing revenue fall-off and business fall-off that was just unprecedented; -70%, for example, in April. In this uncertainty, our job as deep value investors is to pick out good businesses selling at, I call it, ridiculously low prices now. Many things we’re seeing are down 50% to 70%, off their highs over the last three years. Our job is to go in and find the businesses that survive and maybe even thrive on the other side of this.

In emerging markets, China particularly, they came out of the shutdown ahead of us. They’re ahead of the developed world. What’s interesting about that is that didn’t stop companies that sell to the West, just think of all the export-driven firms in Asia, from getting hammered as a consequence of the shutdowns in Europe and North America. So really I would say today there are opportunities around the world. They have one thing in common, and that is that the business is viewed as sensitive to the global economy. Just think of it as sensitivity GDP, or a cyclical effect. So the common thread is not so much geography, but the companies exposed to a consumer meltdown, the likes of which we haven’t seen. So think about the impact of Covid[-19] and this shutdown. Clearly the biggest impacts are in the airline industry, hotels, other travel-related businesses. But beyond that, the impact is strongly felt in industries which are impacted by a consumer slowdown. So think of all of retail, think of anything that’s cyclical. Think of banks that make loans, or industrial that supply physical goods.

So really no geography has escaped, no company has escaped the impact of Covid[-19]. And what we see is rather than thinking of it as particular countries being hurt, it’s particular industries which are being heavily impacted and their stock prices have been really hammered. So right now, if you look around the world, I would say the most common themes that we see of stocks that are heavily impacted would be anything consumer-related. Think auto, industrials, travel, et cetera. I think the interesting part of finding these investments is as we’ve always been committed to on behalf of our clients, finding good businesses selling at low prices. What you have to do is figure out who are the winners and losers.

Trade was already impacted before the coronavirus, and then is impacted heavily by the decline of demand around the world. Things like shipping; just [to] mention one company there, Maersk, which is a leader in container shipping. That business is way off. What’s interesting, though, is that because they have so many competitors that are weaker than them, we suspect that during the course of this virus, it actually gives Maersk a chance to gain share as some weaker competitors go bankrupt. This is just one example of an industry where this kind of downturn will actually change industry structure and maybe longer-term improve the opportunity for Maersk.

Another industry that was hard hit by the coronavirus was the energy industry. We all know that people are staying at home, they’re not driving their car, planes are not flying. There’s been a tremendous drop in demand for energy, particularly oil-related products, and on top of that, as you probably read in the newspaper, there is this big power contest between Russia and Saudi Arabia on the supply side — specifically both of them increasing production, even as demand was declining. And then a record event were crude oil futures traded negative, which has never happened before in the history of the futures trading.

This tremendous event in energy and the tremendous drop in the oil price has created carnage throughout the oil industry, particularly the companies that are the capital spending of the oil companies, and here I’m referring to oil-service companies. Their revenue has been impacted by the decline of spending, as particularly the oil demand for shale in the United States has collapsed, and you know that supply and storage was overfilled in the month of April. So I would say energy is one of the hardest hit areas, and is an area of opportunity for us today as deep value investors.

One of the things that’s interesting in the energy patch today is the oil-service companies, including Halliburton, as one example — one of the holdings that we found to be exceptionally cheap during this period of time — that their ability to match their cash flow on the spending side to their revenue side is really quite amazing. And by that, I mean, they’re able to shrink the business to match the demand for their services. This enables them to retain cash flow positivity, even in one of the worst energy environments in the history of energy.