It would be disappointing to survive the crisis to discover fundamental value had turned to dust with a new normal. Following the shock of death and economic damage caused by COVID-19, we find it hard to imagine structural changes will not happen after the crisis. We anticipate regulators will wade in on perceived weaknesses or abuses, demand will shift with newly discovered efficiencies, and consolidation will be had behind failing companies. A few potential shifts to consider:
Benchmark’s buyback driver to weaken. A shortage of cash flow will likely lead to a sharp fall in buybacks—historically an important return driver. Last year, the yield from buybacks from S&P 500 was 3.2% on a market weighted basis. Companies that retain their strong cash flows will be in a position to buy back shares at considerably more attractive prices than last year.
Capitalization of business with strategic importance. US balance sheets are generally in decent shape. But bankruptcy risk of vital and naturally oligopolistic industries are prime targets for change. One example is airlines. Within days of the crisis gripping Europe and the US, the need for taxpayers’ support was clear. Raising capital requirements for airlines would bring stability along with less exciting returns through the strong end of the cycle. Looking wider, it is likely certain manufacturing industries will need to carry more inventory to avoid further unexpected disruptions. Carrying more working capital takes funds that could otherwise be invested in growth or paid out in dividends.
Control of the supply chain. In the US, around 80% of the active pharmaceutical ingredients used in drugs are imported, mainly from India and China. In March, India restricted the export of 26 ingredients and the drugs made from them. With globalization, companies and consumers have lost track of their supply chain. Most large corporations have insights into their first-tier suppliers. But suppliers to those suppliers (Tier 2 and beyond) remain little known. The risk of national hoarding during a crisis means a country could go short of vital products or components due to a reliance on imports. Tracking and securing supply chains could lead to on-shoring of ”strategically important” products—notably away from export facilities in Asia. The lack of supply chain tracking from field or mine to the shelf has become a glaring oversight.
Real estate—catalyst for change. Brands strong enough to drive direct-to-consumer sales have the potential to further stretch their share of profit pools. A sustained absence of shoppers from marginal shopping malls and chain stores could prove the final straw. This would signal a further step in retail’s structural shift from physical to cyber. Companies such as Nike, Microsoft, Apple, Starbucks, and LVMH are well-placed for this step of the consumption evolution.
Speed of recovery is key for minimizing damage, but the shock is going to lead to change. Some of it will be fundamental and long-lasting. Keep your eyes on the horizon.
Sudhir Roc-Sennett is head of ESG and Thought Leadership at Vontobel Quality Growth, a boutique of Vontobel Asset Management.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.
Tags: Benchmark, cash flow, Coronavirus, economics, Economy, Real Estate, structural change, United States