When markets correct, it’s always for a different reason, but its almost always follows a market high when optimism is pervasive. Anton Tagliaferro, founder and Investment Director of Investors Mutual, said in a recent webinar that while you can’t predict the timing of a correction, preparation is key. He has four simple rules for situations like this:
- Always understand the companies you own and why you own them. Do you have an idea where they might be in three years’ time?
- Keep your leverage low. Swings can be violent, and leverage just amplifies them
- Try to stay calm and understand what’s happening. Don’t panic-sell.
- Look for potential opportunities in good quality companies.
While he acknowledges that “there is some value appearing” in markets now, he warns that this crisis is complex, even for someone with 30 years of experience in markets.
Three simultaneous crises
While most investors are viewing this as a single crisis, Anton says there are actually three major crises occurring right now:
- The health crisis, resulting in travel bans and lockdowns. He believes this will fade over the coming three to six months.
- The financial crisis. Corporate bonds are selling off, inter-bank markets are freezing, it’s “not dissimilar to what we saw on the GFC,” says Anton.
- The economic crisis. While the short term will be severe, the longer-term outcomes depend on government action.
For some companies, the impact is obvious - airlines, travel companies, hotels, casinos. Others are either unaffected, or even positively affected, such as supermarkets. The third group is those that are being affected in strange and unexpected ways.
One such company is pathology company, Sonic Healthcare. It had been doing well until the end of February. Even in early March is was trading well as they won COVID-19 testing contacts from governments. But then people stopped going to their GPs and getting routine testing, which has had a large impact on their business.
He also warns of flow-on effects if the recession is lasting. If a significant percentage of the population remains unemployed or has discretionary income cut, it could have a big impact on consumer businesses.
He says the expectation of a sharp, quick recovery is “probably unrealistic.”
How IML are responding
Anton says to look beyond the headlines, and even suggests turning off the news altogether. If nothing else, it’ll probably do wonders for anxiety levels.
On a more practical front, IML are doing a “company by company review.” They’re looking at various scenarios to see how things might play out.
“Obviously most share prices have corrected, 30, 40, 50 percent, sometimes more. You have to say to yourself, ‘Well, is that factoring in now, a worst case? Will the company survive?’ If yes, it will, what would it look like if the world is not such a jolly place in six months’ time?”
They’re looking for long duration assets – companies with a licence, service, or product that’s durable over time. And of course they need to have strong balance sheets.
“The perception of what is deemed acceptable gearing and is not, will change quite significantly in the months ahead. Some companies were tempted to take on more debt, and extend their debt, because of cheap interest rates. Many boards will probably think twice about that level of gearing going forward.”
While many companies had a good first eight months of the financial year, the last four months will likely wipe that out altogether. He says you have to look past 2020 into 2021 and consider if it’s a company you want to own then.
Anton has talked consistently about the high valuations in the technology sector with companies like Wisetech and Afterpay. Despite the large falls that some of these companies have experienced already, he said he thinks “there’s probably more to go in some of those.”
Previously, IML had positioned the portfolio in what they saw as resilient sectors, such as utilities, healthcare, and gaming. Due to the essential nature of their businesses, utilities have held up ok. While their healthcare names such as Sonic Healthcare and Integrated Diagnostics had been doing well, in recent weeks they’ve begun to suffer as people cancel or avoid pathology tests.
While they believed the gaming sector would be resilient when they invested, nobody could have predicted the impact of the lockdown. With most casinos and hotels closed, and most sports cancelled, this is far from a typical downturn.
Looking directly at the companies
Despite the hit to the share price, IML continues to hold Crown. It’s the leading operator in Australia, and due to the sale of their Macau assets a couple of years ago they’ve got a low level of net debt on the balance sheet. They’ve already sold $650 million out of $800 million worth of luxury apartments and received a 20% deposit on those sales. So, while housing markets may soften, people may be hesitant to walk away from a 20% deposit on a luxury apartment. Once Barangaroo opens next year, Crown will have unique assets in Melbourne, Sydney, and Perth. The licenses on these three locations expire in 2050, 2113, and 2060 respectively.
Orica is a company that he says they’ve been “adding to gently.” It’s the world’s largest explosives manufacturer and holds long-term contracts with all the big miners. Many of those contracts have set pricing too, even if volumes may reduce. They also earn a lot of their income overseas, which should benefit Australian investors given the falling Aussie Dollar. He reckons at current prices, Orica looks like “fairly good value.”
Another company that could come out of this crisis looking healthy is Sonic Healthcare. It benefits from the long-term tailwind of the ageing population, and it may benefit from ongoing testing for COVID-19, which he says will probably become a standard test for anyone entering the country. Sonic’s competitors are also highly geared, sometimes with debt eight- or nine-times equity. Some of these companies may not survive, giving Sonic the opportunity to take market share and maybe even acquire whole companies.
One company that they don’t own yet, but which they’re looking at, is Aristocrat. He said it was too expensive previously, but after falling from over $30 to under $20, they’ve started to look at it more closely. The company has been impacted by the closure of casinos and hotels on a couple of fronts. Firstly, casinos are unlikely to be buying new machines while they’re closed. But additionally, Aristocrat is missing out on the annuity-like revenue they normally make by taking a share of machine takings. On the plus side though, their two major competitors in the US are massively indebted and could face challenges in this environment. This could allow them to take market share, talent, or make cheap acquisitions. He says they’re not buying at current prices, but they “have a price target in mind.”
Sydney Airport has unsurprisingly been on the chopping block. They’ve got a highly geared balance sheet, and no revenues for at least two to three months. Given that the recovery could be slow, those debts could cause problems sooner or later.
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