Valuations creating GFC like opportunities

The pace of the spread of COVID-19 globally has been faster than many of us had expected or could have feared. The first case in China can be traced back to November 2019 and the first reported case in Australia was the 25th of January 2020. China imposed unprecedented lockdowns on Wuhan and other cities in Hubei province on January 23rd and extended this out to the rest of the country. While it appeared to be contained in China, after a strong period of lockdown, sadly the virus has spread around the world. The Asian countries that got it first, quickly went into a shutdown period, telling people to stay at home and closing non-essential services. While this has had a significant short-term impact on these economies, countries like China, Korea, Singapore and Japan have managed to flatten the curve and the spread of the virus. 

The Chinese economy is slowly on the mend and at the same time as Apple announced the closure of its stores around the world, it announced the opening of its stores in China. We have seen the Chinese labour force return to work under a new normal where there are temperature checks when you enter buildings. This severe shutdown to quarantine the virus was crucial in order to save lives and keep the workforce employed. Only one family member was allowed to go to the supermarket and that was the extent of venturing outside in China. 

The good news is that life in China is slowly going back to normal.

Sadly I can not say the same about the Western World where the disease is spreading. We are also now seeing it spread into emerging markets like India. Some countries have pre-emptively taken swift and strong decisions to shut down all non-essential services and it is my guess that they will come out of this quickly like China. Those countries include the Asian countries I mentioned above as well as Norway, New Zealand and Israel. 

Unfortunately Europe, US and Australia have been too slow to shutdown borders and stop the spread of the disease. 

While Donald Trump and Scott Morrison seem to be taking a staged approach to stopping social interactions, I fear this will have a greater economic impact than a short sharp shutdown like China took and what Germany and the United Kingdom are doing. Germany and the UK have effectively stopped everything for a period of a month. The UK government is providing a UK wage subsidy, representing 80% of their previous wage capped at 2500 pounds a month, for all employees. Germany has launched a 750 billion stimulus package to support businesses and will increase government debt to GDP from 60% to 70%. Their efforts involve keeping businesses afloat. We recently spoke to a bank in the UK and they said they have seen businesses, which previously laid off workers, have started hiring them back. These steps support the banking system as it reduces bankruptcies as well as writing off bad loans.

The United States and Australia have taken a different approach to date. Their aim has been to keep the economy going and businesses operating. Unfortunately this has led to a significant escalation of COVID-19 cases, especially in New York City. Trump’s 2 trillion stimulus package has been taken positively by financial markets in recent days despite US jobless claims spiking in the past week. US jobless claims increased +3.28 million in the week ending March 21, which was over four times the previous record peak in January 1982 and 2009, both of which were among the worst recessions in the past 90 years. COVID-19 cases in the United States have now reached over 100,000, surpassing Italy and China. Fortunately many states have ignored Donald Trump and have moved to shutdown non-essential services. I am hopeful that the US can stop the growth of this pandemic within the next month, but they have let it get out of control. Europe has moved to a lockdown in most countries and what I read about Spain and Italy saddens me. Even France is now being forced to airlift patients out of the country to Germany and Luxembourg as the hospitals are full. Hopefully the peak in Europe will be reached by mid-April. Australia has been slow to move to a shutdown of non-essential services but I am hopeful that NSW and Victoria will make this decision on their own. The recently announced $130 billion wages subsidy by the Australian government is a good step towards keeping people employed and boosting consumer confidence.

How we are positioning ourselves

Over the past month, we have been deploying some of our cash holdings into existing positions as well as some new positions. We have reduced our cash holdings from 13% to about 8%. We have also taken the opportunity to hedge back some of our USD, Pound and Euro positions back into Australian dollars (AUD), increasing our AUD position to 18%.

Existing positions that we have added to include Nomad foods, Nasdaq, Fresenius Medical Care, Baidu, Lloyds bank, Merck Kga, Total, Pagseguro, Vivendi and RWE. Most of these businesses are not cyclical businesses and we expect them to do well in the current environment. We have increased our exposure to the healthcare sector by adding to Fresenius Medical Care, a leader in dialysis products and services, helping patients with chronic kidney failure, as well as to Merck kga. We have also increased our positions in consumer staples businesses like Nomad Foods, as more people shop in supermarkets, and RWE which is a leading utility provider and wind farm operator in Europe. The earnings of these businesses will not be that affected as they are providers of essential goods and services. In the technology space we have been adding to Baidu, as we expect China and Asia to come out of this pandemic quicker than the rest of the world. We have also added to Vivendi as at home entertainment, like listening to music will probably see an increase in demand, despite the valuation falling. We have also been adding to cyclical positions like banks and energy, increasing our positions to Lloyds and Total. 

The valuations of these businesses are at levels that we have not seen since the great financial crisis, over a decade ago. 

These businesses are leaders in their sectors and are of national importance and also provide essential services.

New positions that we have added also follow similar themes of buying into consumer staples, technology and essential services. We have been watching Unilever for a number of years now and have finally been given the opportunity to buy this high-quality consumer staples business at a discount to fair value. 

Unilever manufactures consumer goods in the nutrition, hygiene and personal care categories. Their iconic brands include Lipton, Bushells, Dove, Jif, Rexona and my favourite, Ben and Jerry’s! The company was founded in 1927 and now sells its products to 2.5 billion consumers in 190 countries around the world. 

While many consumer staples companies have struggled to grow recently, Unilever has managed to grow their earnings at a compounded annual growth rate of 9% over the past 5 years. This in part is due to their skew towards emerging markets with 60% of their sales in emerging markets. This is similar to our position in Mondelez and we are happy to be able to add another high-quality consumer staples company to our portfolio. We now have 13% of the portfolio in consumer staples.

We have also recently bought into Nutrien and Corteva. Both these companies are agricultural companies supplying products which feed into the food chain.

Corteva is one of the global leaders in seed and crop protection. Under the Pioneer and Mycogen brands, Corteva develops and supplies germplasm and traits that produce optimum yield for farms. In crop protection they provide products that protect against weeds, insects and other pests.

Nutrien is the world’s largest provider of crop inputs and services with operations in 14 countries. The business represents the merger of Potash corp, which is the world’s largest potash producer, with Agrium, a leading distributor and retailer of agricultural products. 

As a result, Nutrien produces and distributes 27 million tonnes of potash, nitrogen and phosphate and has an agriculture retail network that services over 500,000 grower networks worldwide. We have met management led by Chuck Magro, on numerous occasions and have been impressed by their market leading positions in the industry and expect continued synergies from the combination of these two agricultural leaders.

On the technology side, we are happy with the performance of our positions in Alibaba, Facebook and Oracle and have added to our position in the payments space by buying back into StoneCo. 

StoneCo is a highly innovative and entrepreneurial company, providing financial technology solutions in Brazil. They provide point of sale hardware and software that empower merchants to conduct electronic commerce across in-store, online and mobile channels. 

The company has been quickly winning market share from the incumbents, Rede and Cielo, in the SME space and has recently entered the micro merchant sector. This is one of the most entrepreneurial and dynamic companies we have come across, led by their Chairman, Andre street, and Chief Executive Officer, Thiago Piau. The company has been growing exponentially in recent years and while COVID-19 will be a hurdle they will have to navigate through, we expect the company to be much larger in a number of years.

Conclusion

2020 has started off in the most unexpected fashion. Economic fundamentals were picking up in January and were particularly strong and we added to some cyclical exposures for these reasons. However COVID-19 has sadly moved around the world swiftly and the key focus by governments needs to be the health of their citizens, even if this is at the expense of the economy. Fortunately we had some put options on the S&P 500 and a decent level of cash. We have taken the opportunity to add to quality companies that we previously thought were too expensive but are now at much more attractive valuations. You should feel confident in the businesses that we own and the valuations are now once again very attractive. I can’t tell you when the market bottoms because the extent and duration of this pandemic is uncertain. I have been recommending that savers start to accumulate into this sell off as bargains are afoot.

I am hoping that all governments globally take the smart decision to do a hard shutdown for a period of a month as I believe this will have less severe consequences than a piecemeal partial shutdown. I will leave you with how Bill Gates answered this question recently.

What do you think of the current approach the Netherlands is currently taking to combat this virus? They are not going to a full lockdown but rather try to spread it controllably in order to work towards “herd immunity”.

The only model that is known to work is a serious social distancing effort (“shut down”). If you don’t do this, then the disease will spread to a high percentage of the population and your hospitals will be overloaded with cases. So this should be avoided despite the problems caused by the “shut down”. If a country doesn't control its cases then other countries will prevent anyone going into or coming out of that country. I think the Netherlands will end up doing what other countries are doing.

I think the federal governments in the US and Australia are trying to take a similar approach to the Netherlands, while their states are being forced to enact a more serious shutdown. Hopefully Donald Trump and Scott Morrison realise that this is in our best interests for our health but also for consumer and business confidence and the state of the economy. Stay safe and healthy

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