Staying the Course Amid the Coronavirus Epidemic

The recent outbreak and spreading of the coronavirus (COVID-19) and the resulting quarantine will affect business and economic activity in the near term, but conditions should normalize. We do not believe investors should be overly concerned, but we continue to monitor the situation. Our investment horizon is naturally long-term and this is likely a short-term issue. Thus, we continue to be diligent and will look to take advantage of any strong price dislocations that are not indicative of the long-term future earnings power of our quality growth investment universe.

Consumer facing companies may feel a negative impact, but strong consumer businesses can gain market share and benefit from long-term structural shifts. Consumption related businesses that sell mainly discretionary items, i.e. companies that sell luxury products or those related to travel and tourism (airlines, cruise ships) etc. will be most directly impacted. From a regional perspective to date, Chinese exposure in portfolios has been impacted more than other areas, but we will continue to monitor how the virus evolves. Within consumption exposure, consumer staples companies have historically been relatively immune to big shocks, although they will still feel an impact. Products that are used every day, such as packaged foods and beverages, cleaning products, toothpaste, soaps etc. should have greater immunity. However, upscale consumption products may feel some pressure. For example, since Chinese New Year is a time when people often celebrate with alcohol and drink more premium beverages, retailers, hotels, bars and restaurants buy in anticipation of large demand. Alcohol is not the type of product that consumers backfill if they do not consume – and they don’t go for that fancy bottle after the occasion ends. That demand is just gone. Thus, with weak demand, inventories will potentially be robust and not need replenishing. Manufacturers could therefore see weak orders for some time.  

Any unexpected event like this viral outbreak is a test to a business’s resiliency. However, strong businesses tend to survive and could even gain market share in such episodes. For example, Yum China (YUMC), operator of KFC and Pizza Hut chains in China, is taking a serious hit short term with more than 30% of its stores closed. However, its online business continues to expand, thanks to its investments in the delivery business in recent years. Moreover, YUM China will likely resume business faster than the mom-and-pop restaurants and small chains, due to its strong logistics capability. Thus, its earnings power should only be temporarily impaired and the company could be in a stronger position when the environment normalizes.

There are businesses that will stand to benefit. Longer term, this can be positive for e-commerce businesses, including leading players such as Alibaba. A certain percentage of consumers will increase ordering online across more categories than they normally would due to their less willingness to go out in public. This can result in a longer-term habit shift. It may also entice more merchants to shift to an online presence as well. Large-scale, long-term behavioral change is very difficult to predict. However, looking back at previous shocks – such as 9/11 in New York or the SARS epidemic in Asia nearly two decades ago – people avoided crowded spaces, ball games, concerts, subways, tall buildings – but eventually life went back to normal. Regarding the coronavirus, perhaps people will wash their hands more often for a short period, but after that, the normal pace of life will resume.

Outlook: focusing on long-term growth even as uncertainty increases

The epidemic clearly presents risks for equity investors. It will have a negative impact on economic growth in the near-term, and more cyclical, leveraged businesses could face greater pressure than those with earnings growth driven by structural forces.

Volatility resulting from exogenous events can create opportunities. Investors can take advantage of short-term price dislocations that may arise from the viral outbreak so long as they are not indicative of the long-term future earnings power of a quality growth company.

We have been through similar environments in the past and will probably experience such events again in the future. We stay the course with our quality growth approach, which is based on owning franchises that can withstand difficult environments and prosper over full economic cycles.