In response to the global pandemic, we have altered our behaviour in innumerable ways. Enforced social distancing and isolation measures caused changes to our patterns of movement, our consumption habits, and our daily exercise and culinary routines. These adjustments have had a major detrimental impact on many businesses, while strongly benefiting others.
As investors, we need to not only assess the immediate consequences of changed consumer behaviour, but also ask the more important question – to what extent, if any, are we likely to see permanent alterations to the way people engage with the world, and how may that influence the business performance, and ultimately the stock prices, of our universe of potential investments?
There are now reams of data available that illustrate how consumers and businesses have responded to an environment of social distancing and lockdowns. As may be expected, discretionary spending on items such as clothing and motor vehicles collapsed, partially offset by large increases in spending on non-discretionary categories – i.e. canned food and toilet paper.
Fig. 1: Retail Discretionary vs. Non-Discretionary Spend
With offices closed and employees working from home, commuter traffic collapsed, impacting sales of everything from petrol and chocolate bars at petrol-station counters, to McDonald’s breakfasts and Starbucks’ coffees. Sales of business suits and other office attire have collapsed, along with purchases of party outfits and swimwear, partially offset by a spike in sales of loungewear as people seek to offset the discomfort of working at the kitchen table with more comfortable clothing. Meanwhile, purchasing related to the olfactory sense experienced a shift away from perfumes and toward scented candles, and Procter & Gamble’s shaving- related revenues fell as men (and women) focused less on personal grooming.
In purchases of apparel and other goods, we can observe an accelerated shift to e-commerce as stores were either closed or avoided.
This e-commerce shift can also be seen in food consumption, as the number of restaurants and consumers using food delivery platforms spiked with the closure of restaurants for dining in. Grocery e-commerce also exploded from a low base, even as physical supermarket stores themselves saw a jump in sales as people were forced to cook more at home.
Airlines, hotels, entertainment venues and tourist attractions experienced an evaporation of demand as international travel all but stopped and venues were required to close.
Meanwhile, video game console and software sales erupted and video streaming and social media services saw a spike in usage as people spent more time on their couches, and liquor stores saw an influx of customers who would otherwise have been drinking at a bar or pub in the absence of the pandemic. With physical betting shops and casinos closed, online betting providers gained, as increased spending on online poker and casino games more than offset the loss of sports betting revenues from the cancellation of live sport.
Where are the Opportunities to be Found?
While these immediate behavioural changes are interesting, our focus as investors should be skewed much more to the long term, rather than fixating on current trends as many commentators tend to do. Where stock prices have been hit due to pandemic-related business disruption, interesting investment opportunities can arise. An opportunity is interesting if we can be satisfied sales will recover and the company has the financial strength to survive the temporary demand interruption. Similarly, a temporary increase in sales generally does not significantly increase the long-term value of a company, so opportunities arise where the market is too focused on short-term sales outperformance and re-rates stock prices upward in situations where companies were only temporarily in the right place at the right time.
It is simply a matter of time until humans largely revert to previous patterns of behaviour. Hopefully, that is because an effective vaccine becomes widely distributed (a high probability in our view), but it could also be because we learn to live with the risks that come with COVID-19. The latter idea has precedents in societal attitudes toward the risks of influenza (12,000-61,000 deaths per year in the US), driving a car (~40,000 deaths), playing contact sport, skiing, skateboarding, or even drinking alcohol (88,000 deaths) and smoking (480,000 deaths).
Step-Change in Behaviour
While we will generally revert to previous patterns of behaviour, there are two areas where the pandemic has caused a step-change in previously observable trends, to the benefit or detriment of various businesses. These areas, the implications of which are discussed in detail below, can be categorised as:
- An acceleration of the shift to digital
- The increased casualisation of work
The consumer shift from the offline to the online world is a widely discussed and well-established trend. Consumers have increasingly turned to their smartphones, tablets, personal computers and internet-enabled smart TVs to facilitate their consumption of physical goods, services and media.
This trend would have continued to its ultimate endpoint with or without a global pandemic, but because of COVID-19 the journey is likely to be swifter.
COVID-19 has driven consumer adoption of digital tools by those who previously may have seen too many hurdles to using such tools. Whether that is the retiree who downloaded a betting app to his smartphone for the first time because his local TAB was closed, or the parent who signed up for online delivery of the weekly grocery shop in order to avoid visiting a crowded supermarket with a mouthing infant, much of this new behaviour is likely to persist in a post-COVID world. The pandemic was the impetus for overcoming the frictions to adopting these new channels, the time required to learn how to use an app and a likely fear of technology in the former case, and the effort of entering personal details and populating an online shopping list coupled with a likely fear of receiving lower-quality fresh products in the second case.
Fig. 2: Consumer Shopping Online for the First Time in COVID-19
These frictions are real, but once overcome, the new way of doing things demonstrates its inherent superiority – at least with respect to many use cases.
Yes, for a day of casual betting with friends, the TAB or sports-bar will still be the go-to option in a post-COVID world, but there is no longer the need to pop into a TAB to place a one-off bet on a sports team, or to act on a hot tip in race three. Likewise, once set up, the weekly shopping list requires only minor additions or deletions, and worries about over-ripe bananas may be assuaged with a quick dash to the local fruit and vegetable store. The saving in time and anguish is all too apparent to a parent familiar with the unfortunate appeal of the supermarket as a venue for infant tantrums.
With many having experienced the advantages of working from home and removed much of the friction through setting up a home workstation, an increasing number of employees are likely to choose to work from home into the future, at least for some of the workweek, as evidenced by Fig 3.
Fig. 3: Would You Prefer to Continue Working from Home After the Pandemic is Over?
Employers are likely to allow this, as they have most probably seen an improvement in productivity, and increased flexibility drives employee loyalty, which reduces costly attrition. Concerns around implications for organisational culture and cohesion are legitimate, but one day per week or maybe fortnight out of the office should be eminently workable.
Additionally, people have grown used to the sight of colleagues in casual clothing via video screen, so enforcing traditional business attire in the office becomes even less defensible, further accelerating the trend to casualisation of apparel that has been underway for decades. Indeed, Platinum, one of the last bastions of the compulsory neck-tie, has now freed the Adam’s Apple, leading to much rejoicing amongst male team members!
Within the framework outlined above, we can examine the observed changes in consumer spending patterns and infer where we are looking at a permanent behavioural shift that will have permanent implications for the sales and profits of affected businesses.
However, for the purposes of uncovering attractive investment opportunities, this is only part of the picture. Second-order thinking requires us to look past the apparent impact and examine the ultimate implications. For example, reduced store foot traffic and the shift to e-commerce is bad for department and mall specialty store sales and margins, but with many large chains permanently closing large numbers of stores, there is plenty of market share available for better-positioned brick and mortar survivors to take a cut alongside the e-commerce pure plays.
Starbucks and McDonald's are likely to experience permanent hits to revenues as a result of reduced commuter traffic, as well as a hit to margins as they pay UberEats for delivery orders. However, in the near term they could gain market share from the large number of less well-capitalised small cafés and restaurants that have gone out of business during the pandemic. In this case though, we will likely see a resurgence of competition in the medium term as new aspiring café and restaurant owners take over vacant space, most likely at reduced rental rates that should put the new independents in stronger competitive positions. This contrasts with the department store situation, where closures are likely permanent (they already had very low or no rents due to their status as anchor tenants).
Permanent vs. Temporary Beneficiaries?
So, which sectors and companies likely see a permanent increase or acceleration of demand as a result of the pandemic, and which are experiencing a temporary blip? While this is not the forum for a comprehensive analysis, we provide a few standout examples below to add to the cases discussed above.
The most obvious temporary impact has been in sales of household essentials such as toilet paper and canned soup. One can only use so much toilet paper (though we will likely use more at home than at work in the future), and the reasons for buying extra canned soup disappear in the absence of a pandemic. Sales of hand sanitiser, bleach and cleaning wipes may stay stronger for longer, but are likely to revert to normal levels soon after the end of the pandemic.
E-commerce pure-plays such as Amazon in general merchandise, or Zalando in European apparel, are currently the big winners as the rate of online adoption has permanently increased, and many stores will not reopen. Current elevated growth rates are unlikely to persist for long, but the spike in penetration will not reverse and indeed, we are yet to really see a slowdown in e-commerce, even as stores and restaurants reopen. US digital grocery sales, for example, continued to see an acceleration even as lockdown restrictions were eased through May as shown in Fig. 4.
Fig. 4: Online Grocery Delivery & Pickup
Large grocery retailers that have implemented compelling e-commerce options such as curbside pickup and home delivery have likely captured market share from smaller chains and independent grocery businesses during the pandemic.
These customers are unlikely to revert entirely to their old ways in a post-pandemic world, having discovered the convenience of the new offer.
While the economics of grocery home delivery are difficult, the ‘pickup from store’ option outsources the last-mile to the customer, so carries only the incremental cost of picking and packing the order and can be positive for overall profits, if enough orders are incremental to existing revenues rather than cannibalistic. Order profitability is assisted by the larger average basket size of online grocery orders when compared to instore purchases.
Retail landlords will see reduced incomes into the future due both to the acceleration toward digital purchases away from store purchases, as well as reduced traffic in central business district (CBD) locations, with more employees working from home making the economics of CBD stores (at current rents) less desirable for cafés, restaurants and clothing shops.
Where then, are the best buying opportunities for investors to be found at this time? We suspect that it will not be among the most obvious beneficiaries of the pandemic, which have already seen their favourable positioning expressed in strong share price action, but more likely among those businesses facing sizeable disruption to their operations, that are nevertheless likely to benefit longer term as weaker competitors exit the industry. The combination of weak short-term trends and uncertainty as to the duration of such trends, tends to lead to extreme negative market sentiment, creating attractive entry prices and implied returns for investors willing to look out over the horizon.
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Thanks James - thought provoking article. Found the ending a bit of a tease however. Do you have any hypotheses on these 'less obvious beneficiaries'?