COVID-19 equity market impact

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April 23, 2020
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MEDIA RELEASE: “There is still great uncertainty regarding how badly the global economy will be impacted by the COVID-19 pandemic and which companies can survive a prolonged period of being effectively idle.

The price volatility we have endured over recent weeks is likely to continue. At the same time, we have confidence that the current pandemic will also be resolved and that many businesses, currently impacted, will be able to return to normal operations later in 2020. Experience suggests investors will often over-react in uncertain times and this will bring opportunities for the disciplined investor focused on the long-term.

There are many businesses which, while impacted by the COVID-19 pandemic, are businesses that will thrive once more post this event, with Qantas one such example. Profitability for Qantas is concentrated on domestic travel, and notwithstanding an extended ban on international travel, there could be a scenario in which domestic travel ramps back up first (albeit under higher fees and charges). Qantas also has their freight and rewards businesses which will continue to operate while passenger volume is near zero. Retail property trusts are also being materially impacted, but ultimately, good quality assets (and locations) will attract good quality tenants and retail trade for the long-term. 

Many companies are already seeking additional capital from shareholders and we expect that this will continue in coming weeks. Experience indicates that participation in such transactions is often profitable, though investing more capital after share prices have fallen materially can often be “emotionally” difficult. For example, Cochlear, one of the first to approach shareholders in March raised capital at $140. Cochlear never traded down to this price on market and closed the quarter at $187.45 – a handsome profit for those that can look through the current challenges and take a longer-term view.  

Dividend income may also be compromised in the near term as companies focus on sustaining themselves through the lockdown period. The June quarter generally has a lower dividend yield relative to the March and September quarters (~0.9 per cent vs 1.3 per cent). However, the dividend income is concentrated in a few large banks this quarter as ANZ, NAB and Westpac would normally declare their interim dividend as they post their 31 March mid-year results. 

In many ways we are in uncharted territory in how to best forecast the economic impact of this pandemic and how this will further impact corporate profits and dividends. 

There can be little doubt corporate earnings will be materially impacted in 2020. Using standard valuation techniques and assuming earnings can revert to 2019 levels inside two years, we would estimate that the ASX200 (@5500) is currently trading at levels considered to be “fair value”. Using similar assumptions for Europe and the United States would indicate that Europe is similarly trading around “fair value” while the US market is still expensive by approximately 10-20 per cent. The key point is that a 50 per cent cut in earnings for one year does not imply a 50 per cent fall in value for a company where its profitability can be expected to return to normal in the medium term and it has the capital to sustain this temporary downturn. History shows us that markets often sell off to prices below fair value in a panic and that there are often short-term rallies of ten per cent or more within a larger market sell off. Retaining a focus on corporate balance sheet strength, cash flow generation and resilience will be critical in the near to medium-term.

Dividends are also highly likely to be cut in the near term as earnings contract. Looking back to 2008, we note that Australia’s major banks cut dividends by 20 per cent on average for a year before returning to normal levels. Our base case would be that dividends are cut in 2020 before returning to more normal levels in 2021/22. Unlike 2008 the cuts to dividends will likely pervade across a broader range of industries. Some industries, such as travel and hospitality, will be impacted more while others, such as supermarkets, will see unchanged conditions. As unsettling as this will be, we must recall another key lesson learned in the immediate aftermath of the GFC in early 2009: how quickly markets rebounded. The ASX200 rose 35.2 per cent in six months from April to September 2009 and the ASX100 Industrials rose by 37 per cent. Missing such reversals can be as damaging to long-term wealth as the share price falls that preceded them.

The domestic and global economies have endured slow-down in the past but really nothing like the hard stop of the current lockdown situation and health care crisis of COVID-19. The path back to normality remains unclear and the impact on corporate finances is similarly uncertain. Supporting this is the unprecedented fiscal stimulus being applied in Australia (as well as in other jurisdictions overseas) along with a continuation of extremely accommodative monetary policy settings.

This is a challenging time on many levels. It is difficult to forecast exactly when and how equity prices will rebound but history tells us that it won’t occur once we see the dawn of a new day. It will occur earlier than that moment: when the darkness of night becomes slightly lighter.”