Life After Covid, Part I

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There has been much speculation life will have changed inexorably once the pandemic has passed, but will it? Such predictions inform where we should invest from here. Researchers and analysts offer their views.

-Will there be an "after covid"
-Eating, shopping, working…what will change?
-Online or out of business
-A return to old norms

By Greg Peel

Before we can truly consider what life might look like after covid, there has to be an “after covid”. In order to avoid an economic impact of greater devastation than the virus itself, economies have been gradually reopening, deciding the balance of risk is worth it. But much hinges on an actual vaccine being developed.

The stock markets of Australia and the US have regained more than half their initial losses based on three key factors – massive fiscal, and unlimited monetary support, staggered lifting of lockdown restrictions earlier than first assumed, and the assumption that there will indeed be a vaccine by early next year, if not late this year.

Points to note:

US biotech giant Merck developed a vaccine for Ebola in 2014. It was approved by the US FDA six months ago;

While there is a vaccine for the flu, of which covid is a variation, the flu has never gone away, but rather has continually mutated, and there remains no cure for the common cold;

Covid-19 is also a variation on SARS, and to date a vaccine for SARS has never been found. Rather, SARS mysteriously disappeared on its own.

So, a vaccine might be found for covid-19, or the virus may be with us forever, or it might go away by itself. State governments in Australia and the US, and elsewhere, are taking it for granted that reopening the economy opens the door to a second wave. But unlike the situation when the gravity of this virus first became apparent, governments are now confident they have the testing capability, tracking capability, PPE and bed supply to quickly nip new outbreaks in the bud.

This is not 1918.

We might safely assume that were covid-19 not to be vanquished, then yes, our lives will be very different from now on – much more akin to the two months we’ve just been through than those hazy, crazy days before March. However, when it comes to speculating the near to medium term future, analysis from the investment community assumes there will literally be an “after covid”.

The entire global team of analysts at US-based Jeffries Equity Research has pondered the question of life after covid, and this is what they came up with:

“Three key themes emerge from our speculation. First, we will do more for ourselves: self-quarantine entails more self-reliance. Second, we care more about ourselves, our environment and our fellow citizens. The only thing we don’t care more about is money. Third, we slow down. We consume less, focusing on pursuits and experiences and loved ones. We work hard but our careers don’t define us anymore.”

Really? I’d say for about five minutes. Although that would be to play Grinch to Pollyanna.

Yes, more self-reliance is an obvious starting point. Many of us have learned to cook and bake for the first time, discovered hobbies we never knew we’d enjoy, learned how to entertain ourselves beyond Netflix binging, become confident in accessing online shopping and communication platforms, and finally mastered Year 6 maths.

Yes, we may now have a much greater appreciation of the expression “work-life balance”. As for the environment, Australians, at least, were already on to that one. As for fellow citizens, yes indeed in the case of health workers, but as for that lady with the trolley overflowing with toilet paper…

Sydney beaches had to be closed twice, because beach-goers ignored social distancing requests. This is one example of how care for our fellow citizens might be a stretch, particularly given a “better to die on your feet than to live on your knees” attitude from the masses.

While we may have come to appreciate from a wider perspective that money isn’t everything, and that money can’t necessarily buy happiness, or health, I’d wager that in the short term many of us are going to be a lot more worried about money once deferred mortgages, rents and bills will have to be caught up. Assuming you still have a job. This is the more likely reason we will consume less.

“Our careers don’t define us anymore” ties back into the work-life balance concept, while as for experiences, well maybe, as long as it doesn’t involve a cruise.

Jeffries’ key themes, however rose-tinted, nevertheless translate into a selection of winner and loser stock market sector and sub-sector recommendations, which rather brings us back down from the utopian heavens to investment realities, an irony not lost on the analysts.

Winners: grocery, video games, sportswear, semiconductors, payments, internet, software (SaaS), biotech & pharma, telcos and IT hardware.

Losers: airlines, luxury goods, fast fashion, beauty, travel and leisure, fitness, real estate, food service distributors and restaurants.

Much of the above relies on the virus having changed our world, not just disrupted it. For example, grocery as a winner implies many will have a newfound love for home cooking, which balances out against losers food delivery and restaurants, but for every new Margaret Fulton surely there will be those just dying to get out and have someone else prepare a meal, eaten anywhere other than at home?

Winners sportswear and IT hardware play to the work-from-home theme, but we already know casual-wear and home office equipment sales leapt during during the lockdown, so can these be sustained? Working from home has its pros, but also plenty of cons.

Beauty as a loser? As a former prime minister once said, never stand between a woman and a bucket of cosmetics.

Anything to do with online and cloud is a fair call as winners, and airlines and real estate as losers, but of course at this stage of the game, it all comes down to where the market is already pricing them.

We could break this down further, but many a researcher already has, and not all are as misty-eyed as Jeffries.

Retail

Morgan Stanley does not subscribe to the view the easing of lockdown measures represents the beginning of the end of virus impact on the retail industry. Social distancing of various degree and severity will continue, the analysts suggest, until a vaccine is found, which they hope is by mid-2021.

Changes to consumer lifestyles, and thus spending patterns, are likely to last much longer, Morgan Stanley believes. Retailers are likely to emerge with weaker balance sheets and ill-configured store portfolios. But at least for now, they are likely to face less competition.

Whether or not a retail stock is cheap or expensive will be determined primarily by the strength of the balance sheet, and then by to what extent ongoing social distancing measures will impact, how deep the recession is going to be, and how much consumer behaviour actually changes in the longer term, Morgan Stanley suggests.

A strong balance sheet is the determinant of how long a business can last through this cycle, but consumer behaviour is a structural issue.

Eating

Of all the life-after-covid considerations, eating is among those most often discussed.

Cooking at home has for some time been a rising trend anyway, and a generational shift has seen kids interested in food. Home vegetable gardens have been springing up as a result, and even backyard chooks, both of which a few decades ago would have been scorned as indicative of poverty.

Take-away/delivery has been with us for just about ever, particularly your pizza and Asian offerings, although Uber-Eats-style services have also come and gone over the years as well. Maccas and friends have been offering drive-thru for ages.

The lockdowns meant we had to cook and eat at home, or at the least eat delivered food at home, and to that end those restaurants never before offering take-away suddenly swung into action, some opting for drive-by pick-up. High-end restaurants even managed to overcome the issue of getting food to you still hot and moist by offering pre-prepared meals for which you did the last bit.

Those restaurants, and particularly fast food chains, stepped up their delivery services, and all learned very quickly if you’re not online you’re nowhere.

What will be sustainable at least, analysts agree, is online supermarket shopping. Many have now tried this out for the first time, successfully, and let’s face it, who actually enjoys the weekly trip to the supermarket? To that end UBS is forecasting online grocery shopping will account for 30% of total sales growth, which will provide Woolworths ((WOW)) and Coles ((COL)) the potential for market share gain over Aldi and Metcash ((MTS)), given the latter two don’t offer an online service.

As for online take-away/delivery, UBS has upgraded growth expectations to 27%. Presumably some restaurants now offering this service for the first time successfully will stick with it alongside dine-in when restrictions ease, and others will be glad to see the back of it. Those already ahead of the online service pack are Domino’s Pizza ((DMP)) and Collins Foods ((CKF)), which owns the local KFC business.

UBS does see an increase in home cooking and online meal sales, and figures every 0.1 times families decide to cook at home adds 1% to grocery sales. Restaurants will likely be forced into consolidation, but then restaurants were always a high-risk business.

In the “eating” sector, UBS sees the winners as Woolworths, Coles, a2 Milk ((A2M)), Domino’s and Collins Foods, and the losers as Coca-Cola Amatil ((CCL)) and Metcash.

Beyond Food

The online retail story extends far beyond food. There will always be bricks & mortar supermarkets, and dine-in restaurants, but the twenty-first century has already been a story of the growth of online shopping versus in-store shopping. Amazon, founded in 1994, is now America’s third biggest company (Apple, Microsoft, although the order is often subject to change). Iconic department store chain JC Penney was founded in 1902 and last month filed for bankruptcy.

In order to avoid liquidation JC Penney plans to increase its online offering.

The retail winners ahead of the virus crisis were new online-only businesses and those legacy retailers who swiftly developed an online service to complement in-store business. The losers were those failing to see the train coming down the track. Lockdowns have served to highlight the glaring difference between the two.

UBS expects Australian online retail (ex-food) to rise to 17% penetration by FY24, implying a 70% acceleration from pre-virus. This would bring penetration closer to global peers (19%). Online sales are forecast to grow at a compound annual rate of 14%, and in-store sales not to grow at all.

The analysts estimate every 1% per annum increase in online penetration drives a -2% per annum reduction in specialty stores.

The news is nevertheless not all bad for any retailer still relying on physical stores as well as online.

During the lockdowns, retail landlords have had no choice but to offer rent deferrals to longstanding, reliable tenants given there is no one ready to fill the void. Perhaps ever. “Deferrals” imply those rents must be caught up at a later date. However, some tenants have negotiated lower rents to get them through the crisis. Is there any going back?

The shift to online sales means lease terms will shorten, UBS believes, thus retailer bargaining power is increasing versus landlords – again, a trend that was already underway but now rushed ahead by the lockdowns. This suggests lower rents or an increase in turnover-based, rather than fixed-rate or inflation-adjusted rents.

This in itself would incrementally increase retailer earnings, but more impactful still would be reducing physical store numbers as online penetration increases.

Which retailers are best positioned? UBS cites JB Hi-Fi ((JBH)), Premier Investments ((PMV)), Adairs ((ADH)) and Kogan ((KGN)), and as flow-on beneficiary of the need for distribution centres for online sales, logistics REIT Goodman Group ((GMG)).

Worst positioned are Myer ((MYR)) and Wesfarmers ((WES)). We note Wesfarmers has now begun closing Target stores or rebranding them as Kmarts.

Across the wider consumer sectors, UBS notes stocks that screen positively, according to analyst modelling, in a post-covid world are Treasury Wine Estates ((TWE)), Adairs, Costa Group ((CGC)), Domino’s, a2 Milk and Super Retail Group ((SUL)). Screening negatively are Coca-Cola Amatil and Flight Centre ((FLT)).

The Bigger Picture

It is easy for the average Australian to postulate as to how the virus experience will alter their world for good in the close-to-home areas of food, work, exercise, entertainment and travel. But it’s a bigger world out there. The “work” element is not just about home or office, but about actually having a job, and that leads to the wider question of what will industry look like.

Global investment manager PGIM believes that even after the lockdowns are over, the crisis is likely to drive major structural and cyclical changes around the world. Economically, the global recession could reach a magnitude not seen since World War II.

Alongside the resulting fiscal and monetary responses, this will impact employment, inflation, savings, investments and macro-prudential stability for many quarters ahead, the analysts suggest.

Socially, with minorities and lower income households disproportionately affected, the coronavirus crisis will fuel the growing tensions from widening income and wealth inequality. Politically, the Great Lockdown will escalate the ongoing tussle between globalisation and sovereignty as the need for a multilateral response to a pathogen that doesn’t respect national borders is countered by the need to close borders to protect our own.

PGIM has posited four themes with regard how the world will change.

Global supply chains will become more resilient, diversified and multi-regional, with a “reshoring” push that will see those supply chains returning to their home markets, either because it makes economic sense or governments intervene.

The twenty-first century model of “just in time” inventories, aimed at keeping costs to the minimum, has been shown up as barrier rather than a benefit after factories shut down and borders were closed. There will now be a shift to “just in case” inventory management, especially of upstream components, on a balance of cost against supply uncertainty.

There will be an acceleration of the trend towards “weightless” companies, built on capital-light/tech-heavy models centred on investment in software, R&D, data and intellectual property.

Finally, a rethinking of the “live, work, play” urban community model, the co-working office spaces powering the gig economy, and the logistics and warehouse spaces required to support the next wave of e-commerce and online retail.

Canada’s CIBC agrees with the supply chain and inventory argument, and the question of whether the economy can change, or whether politics will intervene. One thing for sure is that governments will not be caught out again with insufficient pandemic-fighting supplies, such as PPE, testing equipment and medications, CIBC suggests, to which we can likely add ventilators and ICU beds.

But disruptions to global supply chains are not new, having previously resulted from strikes and natural or man-made disasters, although a combination with “just in time” inventory management can lead to cascading shutdowns. Nor has the trend to leaner inventories been ongoing. CIBC notes that trend has been quietly reversing since 2005, possibly reflecting the lower carrying cost of inventories in a low interest rate world. The virus will likely accelerate this shift.

This then raises the issue of whether it can be more cost effective to carry larger stockpiles of components from offshore supply chains than to set up local suppliers. In pondering this question, CIBC notes German automakers were shut down when Italy went into lockdown, because Italy supplies a lot of the parts. And before the virus, General Motors Canada had to shut down when US employees went on strike.

But while a shift in supply chains and inventory management practices may be a post-virus development most can agree on, CIBC has taken a more circumspect approach to a lot of the other changes in our lives that many are now assuming.

The analysts note World War I – the “war to end all wars” — didn’t, Russia did not become a friendly democracy after the fall of the Berlin Wall, and people returned quickly to air travel after 9/11.

Regression to the Norm

So is life really going to change that much?

What the virus has provided, CIBC notes, is a window into what economists call “revealed preferences”. Simply put, your choices among alternatives tell a lot about what you will do when those options are open again.

For one, when the virus is declared to be no longer a threat, we are not going to continue to stand 1.5 metres apart. Indeed, as lockdowns ease that’s already apparent. But some changes that were already gaining traction will likely be accelerated, given the virus pushed people into experimenting with what “early adopters” had already been doing.

Leisure travel will one day fully return, CIBC assures, albeit gradually given loss of income and wealth from the resultant recession, as opposed to just lingering anxiety. Cruises may be permanently dented, but the lure of ski fields and the lifelong dream of seeing Paris, for example, will not vanish, and despite the rise of online gambling, what happens in Vegas will return to Vegas.

9/11 and the concurrent recession of 2001 weighed on travel for one year, before it accelerated sharply.

It might surprise some to know that Zoom had been around for almost a decade, not making much of an impact, before the virus hit. Now it seems a household name. But will Zoom and peers signal the end of business travel? They didn’t ahead of the virus.

Video-conferencing for internal use had nevertheless been creeping up before covid, CIBC notes, and may now increase in usage, but a lack of pre-virus take-up of international video meetings as an alternative to face-to-face suggests a “revealed preference”, and thus international business travel not becoming a thing of the past.

(This writer used to, when possible, tack a holiday onto the end of a business trip overseas as part of annual leave, hence no flight cost. One way to see Paris cheaply.)

CIBC concurs with views outlined above regarding e-commerce, agreeing that while many will be happy to return to in-store shopping, those who were introduced to online shopping due to lockdown and enjoyed the experience will no doubt continue to so.

CIBC further notes that work-from-home trends were also evident pre-pandemic, and it is reasonable to expect a higher number of jobs will be WFH-based post-pandemic. More generally, occasional days working from home will be more acceptable. Many a CEO interviewed recently has agreed with this premise, while still endorsing the benefits of brain-storming between colleagues together in the workplace.

Notwithstanding that for many, being able to get out of the house is a part of the work-life balance required to maintain sanity, overriding aspects such as the drudgery of the daily commute and the obligation to dress appropriately for work. But were the virus to accelerate previous suggestions of staggering work hours and thus subsequent transport peaks, along with today’s more casualised workplace, together with occasional WFH days, one presumes the happiness scale could only head in one direction.

The technology to work from home has been in place for decades, but previously this wasn’t a general preference. Rumours of the death of office blocks may be greatly exaggerated.

As for the death of globalisation, this was also a trend very much in place pre-covid. Beyond the political, such as Trump’s “Make America Great Again” and the anti-EU groundswell in Europe, the rise of mechanisation in factories has driven a gradual move away from a need to base manufacturing in low labour cost countries for the sake of the bottom line.

China was no longer the go-to base for manufacturing pre-covid, given Chinese wages have been in catch-up since early this century when the trend to “offshore” costly processes began. China itself had begun to outsource, while developed markets sought other locations. The virus will nevertheless no doubt force a rethink of a reliance on China or any one country as a sole supply chain on the one hand and customer on the other.

Australia has had a wake-up call in this department.

Politics will still play its part, as the US-China trade war attests. Most at risk, CIBC suggests, would be items deemed sensitive from a national security or health perspective. Before the virus, telecom equipment, military equipment and health goods accounted for one fifth of all US imports from China.

To sum up, CIBC believes:

“Overall, then, by 2025, when this virus will have either run its course or been fended off by medical science, our lives, work and trade will share much more in common with how they looked in 2019 than the way they appear in 2020-21. Every major crisis, from the Great Depression, to World Wars, to the 2008 financial shock, left changes in their wake, and this one will too. But history and the concept of revealed preference suggest that these are more likely going to be in the direction of trends already underway, and perhaps not as earth shattering as those who want to write attention grabbing headlines are predicting.”

Fund manager Janus Henderson agrees:

“Predictions during crises are notoriously bad. Humans tend to fixate on how we will be forced to change the way we live and interact with one another. We surmise that travel will never be the same, we will not eat out as often, and half of us will forever work from home. But more often than not, humans seek a return to a comfort zone and strive to replace the things they enjoyed. If past crises are a guide, in 12 to 18 months, most of us will be doing many of the same things that we were doing six months ago.”

Part II of Life After Covid will deal with interest rates, debt and everything from G-zero to zombie companies.

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