Businesses enter the second half of 2020 with great uncertainty around the outlook for economic recovery and COVID-19. Analysts across our global equity research team are gaining insights from their ongoing discussions with company management teams, their stress-test analyses of earnings and balance sheets, and collaboration with our fixed-income colleagues.
Tapping the bond markets for liquidity
In periods of severe volatility and stress, businesses are faced with short-term liquidity risk and in some cases solvency risk. Many equity investors may not realize just how key a role the corporate bond market plays in determining how some businesses will manage the impact of the COVID-19 crisis. Working closely with our fixed-income colleagues, our equity analysts have spent a considerable amount of time conducting liquidity analyses. We have stress-tested earnings and balance sheets, projecting various cash flow scenarios over the next few years. For example, how long would an airline’s cash supply last if travel remains down significantly for the remainder of 2020? And still down meaningfully throughout 2021?
“Some of the companies hardest hit by shutdowns have been able to access the debt markets for liquidity.”
Interestingly, some of the companies hardest hit by the pandemic-related shutdowns have been able to access the debt markets for liquidity. After the chaotic dislocation in March, we saw record primary issuance in the corporate asset class. We believe this is because of the market’s view of the durability of these businesses over the longer term, despite the recent massive decline in revenues and earnings.
Of course, the debt market is also discerning, and not all companies will have access to liquidity. Those less likely to get funding are companies that were challenged even before the pandemic, such as a number of retailers and distressed hospitality providers. If the long-term viability of a business was a concern prior to February 2020, the credit markets are less likely to support it. As a result, we expect the pandemic to accelerate market consolidation, allowing the strong to take share and potentially exit in even stronger positions.
Shifts in manufacturing
Another trend we are watching is the potential for more manufacturing facilities to move to the United States. As the COVID-19 crisis resulted in equipment shortages and supply chain delays and disruptions, more businesses began to consider the benefits of moving manufacturing plants to the United States. This may not necessarily bring an abundance of new jobs, since so much of manufacturing is automated, and it would likely be limited to critical industries. However, a notable development was the announcement in May that one of the world’s largest producers of silicon chips plans to build a manufacturing facility in Arizona, bringing 1,600 jobs. Di Yao, Portfolio Manager of Putnam Global Technology strategy, notes, “It’s quite a breakthrough to see a major Asian-based technology company make such a large investment in the United States after decades of moving in the opposite direction.”
Retail sector recovery: Sifting through the nuances
The retail sector has highlighted the benefits of our fundamental research in the current environment. Megan Craigen, our retail analyst, has had ongoing conversations with members of company management teams, and she understands the nuances and details of issues affecting the businesses. This is especially important as recovery prospects, plans for reopening, and consumer sentiment vary widely from state to state.
The retail sector has been a study in contrasts during the COVID-19 crisis. We have seen a considerable disparity between staples and discretionary. Staples retailers such as warehouse clubs, discount chains, and home improvement stores have done tremendously well.
On the other hand, retailers selling non-essential products such as clothing have seen dramatic declines in revenues. For retail chains, suburban locations are generally faring better than urban locations, and demand for do-it-yourself products has surged. Also, beginning in March, as people felt the need to stock up in preparation for quarantines, demand surged for many essential items. We expected this trend would be short-lived, but demand continues to be strong on a year-over-year basis in areas such as packaged food and home and personal care.
Even as non-essential retailers have begun to reopen brick and mortar locations, concerns related to COVID-19 and the need for social distancing are likely to continue throughout 2020. For this reason, we believe companies with strong online businesses and high penetration of online sales will be best positioned. In addition, the closures have caused considerable disruption across retail, which will result in a highly promotional environment as companies work through excess inventory. As the dust settles in 2021 and beyond, we believe the stronger players will take considerable share as weaker retailers are forced to permanently close stores or cease to exist.
“As the dust settles in 2021 and beyond, we believe the stronger retail players will take considerable share.”
Coke and Pepsi: The impact of COVID-19 may differ
Deep fundamental research is key to understanding the implications of COVID-19 on businesses. As Josh Fillman, one of our consumer sector analysts, observes, even if two companies appear to be similar, the impact of the crisis may differ significantly.
Consider Coca-Cola and Pepsi. Only 50% of Coke’s revenues are from at-home consumption, versus 80% for Pepsi. This was obviously an advantage for Pepsi during the height of the crisis. While both brands sell their products off-premise, each has almost no competition at a given stadium, restaurant, or theater. In the grocery aisle, however, they compete for market share against one another and other brands.
Even as we emerge from pandemic-related shutdowns, we expect different volume trends for the two companies. Capacity in dining facilities will still be reduced, especially outside the United States, where drive-through options are less prevalent. We expect fewer consumers will dine out due to ongoing virus concerns and a desire to cut costs. We believe Pepsi will continue to benefit from higher levels of at-home consumption and a prolonged shift to at-home consumption of packaged foods, which make up 56% of Pepsi’s earnings.
Source: Putnam Research. Data as of 4/30/20.
Coca-Cola and Pepsi are the two largest companies in the carbonated soft drink industry. The companies are presented as examples in order to represent the impact of COVID-19 and its effects on consumer activity, including distribution and consumption. The effects of COVID-19 (which may be short-term or last for an extended period of time) have adversely affected, and may continue to adversely affect, the global economy, the economies of certain nations, and individual issuers. Company examples were selected without regard to whether such industries, or relevant securities, were profitable and are intended to help illustrate our fundamental research process. The inclusion of company information should not be interpreted as a recommendation to buy or sell or hold any security. It should not be assumed that investment in the securities mentioned was or will be profitable.
