Quality Growth Boutique

2Q 2020 European Equity Outlook: Balance sheets matter most now

Outlook

Income statements matter in good times, balance sheets matter most now

Donny Kranson talks about opportunities arising from indiscriminate sell-offs, how a company can survive the downturn, resilience in essential services, and acceleration of the shift to online retailing.

 

The virus induced sell-off and shutdown of large parts of the economy is unprecedented. Many investments that seemed safe at the beginning of the year, no longer do. Companies and industries that historically have been strong during recessions are at risk. It comes as no surprise that investors have panicked and sold indiscriminately. But panic breeds opportunities, especially for active investors. Great businesses are available at the best prices we have seen in a long time.

Investors should focus on two things: the long-term value and quality of a business, despite the short and painful period we are in now, and a company’s ability to survive through the downturn. While it hurts when a company revises its guidance or earnings are down substantially, investors should remember that once health risks recede, demand will resume. But to get to that point, companies need to be able to survive, which means they need to have enough cash to get through the trough.

Even in this lockdown period, people still need food, as well as soaps, disinfectants and other essentials. Over-the-counter medicines should be resilient, and video games, movies and books that can be downloaded at home will also be in demand. For example, Dutch-listed Prosus, whose value is largely tied to China’s Tencent, which in turn is big in gaming and social media, should be relatively immune to quarantines. Similarly, Wolters Kluwer, which sells services and software necessary for people to do their jobs, should also be resilient.

The crisis will accelerate the trend to online retail as more consumers use online grocery and other online stores. If they like the experience, it could become permanent. The shift affects not only retailers but also suppliers. Before the crisis, companies like Unilever already had the right packages for shipping, tailored ads for online consumers, the correct price points, and the right margins for the online offer. Companies that are behind the curve with their online business could be negatively impacted.

Central banks and governments are providing monetary and fiscal support to the economy, and those measures could be extended. Investors want to be in markets where strong support is being given. However, lockdowns will inevitably increase unemployment and lead to business failures. It is time to analyze each investment and make sure it can survive the turmoil. Indexes can not do that for investors, but active investors and active managers can.

 

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