Coronavirus: the strong get stronger

The coronavirus pandemic marks a turning point not just for society but also for many companies. It is dividing them into the winners and losers of the crisis. This is partly because of the way in which lockdown measures are being eased.

The differences could not be more pronounced. Microsoft reported excellent quarterly results in the midst of the crisis, primarily thanks to online services, whereas airlines like Lufthansa are fighting to survive. Coronavirus has turned our everyday lives upside down. But it is also dividing the world of business. Although contact restrictions are gradually being lifted, the pace and extent varies from country to country and area to area. Some sectors and companies will therefore see a much faster recovery than others. At the same time, the pandemic is shifting or strengthening existing economic trends. All this must be factored into investment decisions.

The pandemic is making daily life much more local and private. The large numbers of people working from home and the closure of shops and schools have provided further impetus for digitalisation in many areas of life. Trends that were facing criticism even before the crisis, such as globalisation, are likely to find themselves subject to even greater scrutiny in view of coronavirus-related disruptions to supply chains. Outsourced manufacturing activities, such as in the pharmaceutical industry, may be brought back inhouse. This would benefit certain engineering companies and automation specialists. However, it is unlikely that the wheel of globalisation will be turned back completely. Ultimately, the economic advantages of collaboration over isolation will have the upper hand in the cost/benefit calculations of many countries.

Overall, the crisis will alter the balance of power in the short and medium term, including in the capital markets. This is reflected in valuations and in the recent acceleration of the shift in the sector weightings in the US and Europe (see chart). The weighting of software and services has increased substantially, whereas energy companies and banks have lost a lot of ground.

Significant shift in weightings

Significant shift in weightings
Sources: MSCI, Bloomberg, Union Investment, as at April 2020

Software and healthcare flying high

Something else that particularly stands out in the US equity market (S&P 500 index) is the extreme concentration of market capitalisation among just five companies: Alphabet, Amazon, Apple, Facebook and Microsoft. Although all five have not been left unscathed by coronavirus, Facebook and Alphabet are likely to be disproportionately affected by falling advertising revenue. However, worldwide platform effects and their strong brand recognition mean they can leverage economies of scale and efficiencies that smaller companies cannot.

The recent reporting season showed that these five behemoths have weathered the crisis relatively well so far. Shares in these firms are currently trading with a valuation premium as they offer significant potential for growth in the medium and long term. Their healthy balance sheets also put them in a better position to continue investing in the expansion of their market share during lean spells. As at the end of March, the net cash held by Apple alone stood at around US$ 80 billion.

Contactless is king

One of the consequences of coronavirus is likely to be a permanent move to online transactions and business activities. In Europe and the US, online shopping still accounts for a far smaller share of retail than in China, where it will soon make up a third. The growth of e-commerce is set to continue, however. Alibaba and Chinese internet conglomerate Tencent, for example, are benefiting from this in Asia, while the winner in the west is Amazon. The trend for contactless payments is injecting momentum into the business of payment service providers such as Fiserv and Adyen. Companies that can easily sell goods online should also have good prospects. These include online grocery stores, food delivery companies, providers of streaming services and sellers of sports articles and online gaming.

Risk of a trade dispute in the tech sector

The winners of the coronavirus crisis also include cybersecurity firms and providers of surveillance technology. One of the growth drivers is the increasing use of applications in decentralised online server farms (cloud), such as data management and analysis solutions, and automation solutions. Semiconductor manufacturers that produce very high-performance graphic chips, and component suppliers such as ASML, are very well positioned to capitalise on this.

Renewed escalation of the trade dispute between the US and China poses a risk, especially for the tech sector. The relationship could deteriorate again following the temporary ceasefire that resulted from the phase-one deal. The US has already placed restrictions on the export of semiconductor high tech to China, Russia and Venezuela. Retaliatory measures could make it difficult for western companies to access the Chinese market.

Groceries and medication in demand

As well as IT providers, the coronavirus crisis has also given a boost to defensive sectors such as healthcare, food and communications. And these are also among the reliable sources of dividends. But there are both positives and negatives here too. Until now, pharmaceutical manufacturers have benefited from the effect of spending brought forward as a result of coronavirus, while medical technology firms have been adversely affected by the postponement of treatment in hospitals. These trends are likely to be reversed again. Companies such as Abbott Laboratories, Fuji Film, Chugai, Johnson & Johnson, Moderna and Roche have also enjoyed a tailwind because they offer coronavirus tests or are working on a coronavirus vaccine. However, demographic factors make healthcare one of the attractive sectors in the equity market in the long term too.

In the communications sector, it is noticeable that governments still have a strong influence on some telecommunications providers. One of the effects of this during the crisis has been cuts to dividends. Their business models are still intact, for the most part, and the rapid growth in demand for bandwidth for homeworking and online entertainment shows that this sector is meeting several basic needs. Companies are also likely to make greater use of flexible workplace solutions and online meetings for efficiency and cost reasons, not least because this enables them to save on travel costs. This indicates that there will be sustained demand for internet infrastructure and higher-quality communication services. Providers of data centres and network infrastructure will also benefit from this.

In the longer term, utility companies should profit from the growing demand for energy due to electric vehicles and internet computing power. However, the significant influence of governments means many companies are having to cut their dividend at the moment. Sectors with oligopolistic structures, such as fragrances and aromas or industrial gases, present interesting niche opportunities for investors at present.

Long road to recovery for tourism

The list of losers in the coronavirus crisis includes many companies in the aviation, tourism and leisure/entertainment industries. They are only likely to see a return to normality in the medium term. Social distancing requirements and ongoing travel restrictions will make it difficult for the aviation and tourism sectors to get going again. Many companies in these sectors already have high debt levels and are now being forced to borrow additional capital or take up government support. In the short term, other industries offer more potential during a recovery. The only interesting niches could be online booking platform operators, companies catering to people holidaying closer to home, such as motorhome manufacturers, and companies offering leisure and entertainment activities, for example online gaming and e-sports.

The energy sector is also currently under pressure because of the fall in the oil price on the back of the slump in demand. Royal Dutch Shell had to reduce its dividend for the first time since the Second World War and the US shale oil industry is at risk of collapse. Whereas the major oil companies probably have sufficiently stable balance sheets to survive the crisis, the US fracking sector faces a cull and is best avoided.

Companies in cyclical industries are also badly affected by the pandemic because consumers are postponing purchasing decisions and changing their buying behaviour. These include automotive manufacturers and, indirectly, industrial companies and banks. The share prices of many companies in these sectors have already recovered slightly. These companies would be hit disproportionately hard if there were to be a second wave of infection. Here too, a strong ability to sustain risk is required. Companies with healthy balance sheets and sufficient liquidity are likely to be at an advantage.

 

As at 6 May 2020