As a UK centric small and mid cap fund we have unfortunately been in the eye of the storm with respect to the recent coronavirus driven sell off. The extent of the short-term drawdown reflects a race to the bottom in share prices caused by the uncertainty as to the extent and length of the problem. We are one of the few European markets that has not banned short selling which as we have seen at previous crisis driven inflection points exaggerates share price falls, particularly in the larger more liquid mid caps, remember the Brexit baskets. Ultimately however this reverses.
Anecdotal evidence from companies with business in China suggests that things are rapidly returning to some sort of normality with manufacturing running at up to eighty five per cent of previous capacity. Whether or not this represents a useful timeline for recovery elsewhere around the globe remains to be seen and as ever expert views differ widely.
We have just come through a busy reporting period and it is helpful to remember that most numbers were in line, companies were profitable and generally growing and we had a pleasing number of dividend increases. Whilst the world has obviously changed dramatically since then it is worth highlighting a few points.
As an integral part of our investment process we insist on a good management team before investment and in a considerable number of our holdings we believe management to be excellent. This is important because the best management teams react swiftly to adversity.
Rank, Restaurant Group and Marston’s for example are delaying capital expenditure, improving working capital management, and looking for cost efficiencies as they continue at reduced levels. At the same time indebted companies will already be talking to their lenders to ensure they have enough flexibility to weather the storm. This is particularly the case with the latter two stocks who are arguably being priced as if they are going bust. The government has stepped up to help retailers and leisure stocks with a holiday from business rates as well, which is a significant help.
The government does seem geared to providing economic help which is both welcome, seems well targeted and underpins the consensus view that at the corporate level short term breaches of covenants will be tolerated by lending institutions.
Whilst profit forecasts are being suspended across a wide range of stocks market analysts, and ourselves, are systematically developing worst case scenarios for the next three months for the most exposed the companies. Ensuring company survival is paramount. Suffice to say in a risk off market where there are few marginal buyers earnings downgrades, where there are still estimates, are met with disproportionate price falls. The virus even seems to have scared off P/E for the moment.
It is our belief that the vast majority of our companies will come through this with little damage to the fundamental fabric of their business. There will be companies such as Marston’s that will have lost business where investors will look forward to a normalised year next year to provide a basis for valuation. Others such as DFS and the housebuilders should benefit from a release of pent up demand that had to be deferred during the crisis. Assuming a reduced but slowly improving macro growth rate all the ingredients will be in place for a recovery in share prices which ironically were not expensive on historic or relative grounds pre crisis anyway.
The sixty four million dollar question obviously remains when.
Wednesday 18th March 2020