Companies that went into the coronavirus crisis are likely to emerge from it stronger than before, Royal London Asset Management’s Will Kenney believes, although these aren’t the only opportunities for investors.
In the midst of the current crisis, Kenney said that one way to figure out which are the winning companies is to think like the management, essentially “thinking like a CEO”.
Kenney, co-manager of the £226m Royal London Global Equity Select fund, noted that governments and central banks reacted quickly to the coronavirus crisis but added that “many CEOs haven’t outlined a coherent plan for emerging from the crisis”.
“While acknowledging that the near term is particularly unpredictable and leadership from governments has been mixed, some first-quarter results calls had a surprising ‘rabbit in the headlights’ feel,” he said.
“This was by no means true for all companies, however, with the most capable CEOs and management teams understanding how the pandemic has changed the world and reshaping their strategies accordingly.”
Looking at the long term and finding those companies that have adapted strategies to navigate the pandemic, Kenney said financial analysis and valuation requires a lot of information, some of which just isn’t available now.
“Investors are having to make a lot of assumptions,” the manager said.
“One tool that we’re finding particularly helpful is our proprietary Corporate Life Cycle model, which helps us to consider companies at different stages of evolution.”
RLAM’s Corporate Life Cycle model places companies along an economic timeline broken up into: Accelerating, Compounding, Slowing & Maturing, Mature and Turnaround stages.
In doing so, the team’s managers can ‘think like a CEO’, putting themselves in the role of management and seeing where capital would be deployed, what the returns are on that capital and how much longer a company has to generate high returns.
Source: Royal London Asset Management
“These [stages] help us to understand where companies are in their journey and how to analyse them to pick the real winners – and, perhaps more importantly, avoid the potential losers,” Kenney said.
The Royal London Global Equity Select co-manager believes that a good company can perform well across the economic cycle, as “what matters more is how the company is using its capital”.
“Depending on where businesses are in the Life Cycle, they should approach the crisis differently,” Kenney said. Ideally, an investor would want to identify companies in the ‘Accelerating’ stage and avoid those at the ‘Turnaround’ point as this is when businesses are most under threat.
These ‘Accelerating’ companies “have the opportunity to grow quickly and should take advantage of the opportunities presented”, the manager said.
“They are often innovators and are culturally more flexible and able to embrace change,” he explained. “This can be a huge advantage in uncertain times and that innovation can disrupt other markets, some of them large.”
A poster child for an ‘Accelerating’ company is Amazon, according to Kenney.
Both its at-home delivery shopping and its Amazon Web Services (AWS) cloud business have thrived during lockdown as people have turned more to online shopping and required cloud technology to work from home.
This has been well reflected in the company’s share price over the past six months.
Source: Google Finance
Netflix hosts its online streaming content on an AWS platform, despite Netflix being a direct competitor to Amazon Prime Video.
“In lockdown, many customers will have used both of these services more and Amazon has increased the competitive advantage that it enjoyed going into crisis,” Kenney said.
Another company in the ‘Acceleration’ phase and a lockdown ‘winner’ was UK food delivery company Ocado.
Year to date, Ocado’s shares have risen 65.75 per cent, outstripping the FTSE All Share index which is at a 15.82 per cent loss.
Source: FE Analytics
Kenney said: “Having spent almost 20 years developing its online grocery delivery platform, the company is a global leader and has licenced the technology to supermarket chains internationally. The current environment has favoured the business versus its competitors, accelerating its development and customer demand.
“Ocado has raised capital to take advantage of these additional opportunities.”
Going onto the remaining phases of the Corporate Life Cycle model companies in the ‘Slowing & Maturing’ phase have a mix of business operations or divisions. In the current crisis they have the opportunity to re-evaluate the company’s core abilities and what are the most advantageous elements.
As stated above the ‘Turnaround’ zone is where the potential losers can be found.
“[These] are some of the businesses that are under most threat from the crisis,” Kenney said.
He noted that these businesses have low capital returns and need to improve on this, but
“the lockdown makes this even more challenging”.
It’s not the case that any company placed into this phase is a loss, Kenney said, rather they have the most potential to be. But if they can revive the balance sheets and “take initiative”, then there will be opportunities as competitors struggle and potentially fall.
“Having an appropriate balance sheet will help some businesses prosper over others that have taken on too much leverage,” the manager said.
“Those that can survive should enjoy higher returns in the next cycle as capital will exit some industries. While this is a challenging area to invest in, it is also where valuations are most attractive. The data show that it is less well covered by analysts, so there are likely to be more opportunities.”
Kenney concluded: “Overall, we believe that the crisis will result in strong companies (high returns and strong balance sheets) getting stronger as they are better able to take advantage of opportunities, whether through new areas of demand or having better balance sheets to navigate through lower levels of cash generation in most industries.
“No single model or analysis is a magic bullet for investing, but seeing the world as a company’s management sees it helps to identify those that are actively responding to the crisis. Owning companies that merely survive the pandemic won’t deliver outperformance. We are looking for the ‘Accelerators’ that are increasing investment to take full advantage of the current environment, and ‘Slowing & Maturing’ or ‘Turnaround’ companies that are doubling down on restructuring.”