During the August reporting season, most companies were impacted by COVID-19 in some way; however, a range of companies have performed well ahead of pre-COVID expectations whereas others have experienced disastrous impacts. E-commerce and some retailers for example, have had extraordinary results given the various stages of lockdowns, reduced avenues to spend and government wage stimulus. Caution is warranted in capitalising this increase as the economy moves back to a more normal level. However, there is no doubt that some companies will be lasting beneficiaries of this economic shock with potential changes in consumer and business habits.
Preservation of cashflow was evident in tighter control of working capital, with many companies reducing inventories and extending payables. There were also many instances of discretionary capital expenditure being put on hold. Many companies have deferred, reduced, or cancelled their dividend.
The FY21 earnings outlook deteriorated with only 23% of companies upgrading, whereas 40% downgraded. Materials provided the highest number of upgrades due to resource based names which benefitted from a weaker US dollar and the prospects of a recovery in the global economy.
Weak results were not necessarily met with the typical sell-off as the market seemed to look through the near-term COVID-19 weakness. There were a large number and quantum of “one-offs” during the month, typically an asset write-down, and as such, they were non-cash in nature. This rebasing has the impact of enhancing future reported earnings and apparent forward earnings growth—with little influence on cash generation. We last saw such a large increase in one-offs in the GFC.
While the ongoing global COVID-19 situation and ensuing uncertainty makes forecasting difficult, we continue to reassess our earnings estimates. This includes reviewing short-term earnings and implications for dividends and balance sheet risk, as well as long-term earnings, which has implications for valuations. As well as assessing the risks associated with stocks in the portfolio currently, we are also actively assessing opportunities thrown up by any aggressive and, in some instances, indiscriminate sell-offs.
Economic shocks like we are currently experiencing typically result in social and economic adjustments. Ultimately the impact on long-term earnings estimates and valuations will be a function of the depth, duration and damage inflicted during this period of enforced subdued activity. Some of the more obvious potential transformations include: 1. employees working from home for all or part of the week; 2. office space required may be less, given the work from home theme; 3. reduction in the use of public transport and more car travel; 4. business travel may reduce given the improving technology and thus more use of virtual meetings; 5. e-commerce and omni-channel retail has had an accelerated shift in market share; and 6. low interest rates and government stimulus have been surprisingly positive for housing with early signs of increased interest in moving away from the inner CBD suburbs. It is still too early to be confident that these adjustments will be longstanding or perhaps just a one-off. As such, the Nikko AM team will invest significant time post the reporting season looking to identify and thus appropriately value any of the structural winners and losers.
The combination of extreme positioning and valuation differentials that are still evident always provides strong forces when the market reverses. Recessions are typically the catalyst for style leadership to change and our expectation is for history to repeat with value outperforming—particularly when the world becomes less sensitive to the COVID-19 situation via a vaccination or therapeutic solution. Like other large market corrections, it is always difficult to pick the bottom and thus rotating slowly into some of the beaten down value names funded by reducing and exiting the outperformers is an approach that we have found has worked well in these type of markets.
Source: Brad Potter – Head of Australian Equities – Nikko AM
