The coronavirus crisis has changed our lives in many unique ways. Many short-term measures may have lasting impacts or even become permanent fixtures. In this article, we explore in detail the impact of the crisis on three industries, Retail, Financials and Media. In addition, we offer our predictions and discuss how to invest during this lockdown.
Before moving in to our analysis, here’s a pie-chart of my daily life before and after the lockdown. Drop us a comment if you’ve done a similar exercise. Sleep neutral and leisure down, that's about it.
Retail: The Future of Grocery Shopping is On(the)line
With news of empty shelves circulating in the media every day, it raises questions about the current supply chain model. As a result, it’s forcing many to turn to online groceries. The pandemic will serve as a catalyst to spur both supply and demand for online grocery shopping, accelerating the shift away from traditional shopping. Here's a chart showing online channel as a percentage of total grocery sales by country in 2018.
Nevertheless, the percentage of online sales remains pedestrian for most countries. UK registered only ~7% of total grocery spend despite being the European leader in this aspect.
Why have online grocery not picked up before this?
Firstly, scepticism on product quality. Traditional shoppers’ biggest concern is not being able to see the products before purchasing. To reinvigorate, supermarkets need to build trust, reassurance and create awareness around their commitment towards product quality purchased online.
Secondly, online infrastructure and logistics do not come cheap. Consequently, many retailers operate a subpar online proposition, leading to below average user experience, further weakening demand.
Prediction #1: Market share gain for mainstream retailers, margin pressure to persist
The transition to online doesn’t come without consequences. Driven by the lack of scale and infrastructure investment in the online channel, smaller size retailers may be economically challenged if we see a permanent shift away from traditional grocery shopping. As such, this implies mainstream retailers are able to wrestle back market share from those who have a weak online proposition, such as the discounters. Hence, the first part of our prediction. The table below supports our prediction.
The table above answers the question of how much retailers make for every £100 revenue, split by traditional and online channel. Unsurprisingly, traditional shopping is ~8x more profitable than online, driven by significantly lower IT, marketing and distribution cost.
This leads to the latter part of our prediction that the food retail sector will experience gradual margin erosion, should the online channel starts to pick up. In addition, cannibilsation, where traditional sales (higher margin) decreased as a result of increased online sales (lower margin), further aggravates the situation.
Retail: How to Invest During the Coronavirus Lockdown
In short, avoid and sell brick and mortar retailers who has limited online presence. We find it challenging to own any retailers for the long term. Further pressure on its wafer-thin margins, increased cost-base and cannabilisation is what make the retail industry unattractive. Consolidation anybody?
Financials: Dividend Hiatus and Business Interruptions
The challenges to the financial (banks, insurers, and asset managers) sector cannot be underestimated. Rising loan delinquencies, continued fund outflows and increased business interruptions are one of many impacts we see so far. Today, the sector is stuck between a rock and a hard place as it faces challenges from many fronts.
An area that has not been discussed a lot in the media is business interruption claims. While the direct impact on businesses is well-known, the spillover effect on insurance companies is less clear.
A business interruption policy covers you for loss of income during periods when you cannot carry out business as usual due to an unexpected event. In most cases, unexpected events includes flood and fire, until the recent pandemic. In fact, the definitions of damage and the extent to which the pandemic were specifically excluded in policies have attracted many legal opinions on the matter.
Hiscox (HSX), a Bermudan-based specialty insurer, recently updated the market and made clear that its core policy do not provide cover for business interruptions as a result of general measures taken by the UK government. As such, estimating the impact on single name insurers becomes more challenging as policy wordings vary. Regardless what the outcome may be, we expect providers to experience increased legal and defence costs at the very least.
Another key event within the sector is the dividend hiatus. With a realistic chance of a credit crunch, the European Central Bank (ECB) has ordered European banks to halt all capital return, dividends and share buybacks until at least October 2020. The freezing of capital distribution is aimed at boosting the sector’s capacity to absorb losses while supporting lending to households and SMEs.
Similarly, the EU’s insurance regulator also follows suit, urging insurers to withhold capital distribution, despite adopting a softer stance. This came at a surprise to many owing to its much stronger balance sheet relative to the banks.
Prediction #1: Insurers to continue outperforming banks
In times of crisis, a blanket measure halting capital return of banks/insurers can be view as the safest thing to do. However, this creates market dislocations, since it benefits companies with weaker balance sheets much more in the short term.
Financial companies are regulated entities which are govern by strict capital rules. For example, banks and insurers are require to hold capital for possible loan defaults and insurance claims, respectively. Because of this, capital ratio has been the responsible for companies’ capital return policy in recent years.
The reason for our prediction is two folds. Firstly, in a lower-for-longer interest rate environment, banks’ profitability is challenged, driven by pressure on net interest margins.
Secondly, insurers are generally economically stable relative to banks, as long-term liabilities are almost always closely matched with long-term assets. On the other hand, banks engage in maturity transformation, which means most banks’ asset have a longer duration than its liabilities.
For interested readers, we'll follow up later on the intricacies of financial companies in future posts.
Financials: How to Invest During the Coronavirus Lockdown
The crisis provides a good entry point into the high yielding insurance sector. Owing to its strong balance sheet, insurers are well insulated despite the current climate. In addition, the dividend hiatus for both banks and insurers is not a cancellation, but a postponement.
While we acknowledge that capital is not comparable across banks and insurers, for illustration purposes, the following chart does shed some light on the quality of capital.
At the time of writing, both banks and insurance capital ratio has decreased because of negative market movements.
All else being equal, the dividend postponement actually benefited the banks more capital-wise because dividends consist of a larger proportion of its capital ratio relative to insurers. In fact, one can argue that banks capital position look better than they actually are.
While we are downbeat on the sector, we still see value in sub-sectors. In short, buy insurance, while avoid and sell banks. Within insurance, we have a preference for short-term businesses, such as non-life insurance, due to its reliance more on insurance profit rather than investment income. If you’re dying for a stock idea in this space, you need to read our latest idea.
Media: Streaming wars - The Fight For Our Eyeballs, Time and Life
Finally, a topic that everyone can relate to. “Convenience, choice and control”, the three words that sums up the industry. The streaming war is a well-known phenomenon that we’re unconsciously participating in. In the current climate, the fight for our time has never been more competitive.
The lockdown has meant more time at home. This, together with a shift away from traditional TV and increased time spend watching TV, suggesting that we are glued to streaming services much more today than ever before. A recent study revealed that UK has caught up on this, with streaming subscriptions growing from nothing to almost half of all UK households in 2019, all in the space of seven years.
Interestingly, an average user spend ~2 hours on Netflix per day. This translates into ~1 full month on Netflix per year (just when I thought sleeping was a waste of time).
2020 set to be another year of fierce competition, with newcomers such as Disney+, Apple TV+, HBO Max and Quibi. The battle is often fought in content spending, a yardstick of competition. Hence, building a war chest of original content remains the ultimate goal of many to grow subscribers. This, however, requires substantial amount of investment.
With Disney leading the pack, the combined total spend on original content is at least $120.5 billion in 2019 alone. To put this in perspective, this is just shy of PayPal’s current market cap, at the time of writing. Importantly, content spending also acts as a barrier of entry, which explains the exponential growth in investment. For example, Netflix’s annual content spend increased 4.6x from 2014 to 2019 - equivalent to an increase of 35% per year!
Prediction #1: Netflix will be challenged in subscriber's growth
Netflix grew subscribers by 20% in 2019. Owing to increased competition, it’s not unreasonable for growth to moderate to a low-double digit. We hesitate in being more pessimistic due to its sticky user base and continuous commitment in original content.
Another angle to our prediction is that demand is not limitless. After all, there’s only 24 hours in a day. Spoilt with choices and increasing subscription costs are headwinds that can further limit demand. Interesting fact: a research concluded that it takes at least 4.5 months to watch the entire of content of Netflix in 2017. In short, the relationship between content spending and subscribers’ growth will start to grow less linear.
There are reasons to be optimistic about Apple TV+ and the value it brings to Apple Inc. A cheaper alternative to its key competitors, Netflix and Disney+ ($8.99 and $6.99 pm, respectively), Apple TV+ cost $4.99 per month.
Similar to Amazon’s Prime Video service, Apple TV+ could potentially be a “marketing tool” for the wider strategy of Apple. The idea to cross-sell higher margin Apple products, advertise and create stronger brand loyalty via Apple TV+ is genius. No pun intended.
Disney+ is the key reason why Netflix is forced to invest aggressively in its original content. The undisputed king of content, Disney owns Marvel, Pixar, ESPN, The Simpsons and Star Wars, just to name a few.
The latest subscriber data shows that Apple TV+ has ~33 million (as of 2019), Disney+ at 50 million (as of April 2020), and Netflix reported ~167 million in 2019.
Content is king and assuming Disney+ is able to catch up on subscribers’ growth relative to Netflix, it’s not hard to see that Disney+ alone would be much more than Netflix once it gains critical mass.
Read this if to learn more why we think Disney is more than just a bargain.
Media: How to Invest During the Coronavirus Lockdown
We have a neutral stance on the media sector. Although, we are excited about the longer term prospect for Disney+ (DIS) and to a certain extent Apple TV+ (AAPL) for the reasons discussed. We are more cautious Netflix (NFLX) stemming from its growth outlook.
It’s clear that the streaming services landscape will continue to thrive in this environment. However, stiff competition implies continued upward pressure on customer acquisition costs across the market. This raises two important questions. Firstly, how soon will content spend starts to plateau? And secondly, when that happens, how sticky is revenue? Finally, for the reasons discussed, the era of media consolidation may be sooner than we think!
Finally, the coronavirus crisis has caught the world off guard. We hope this ends sooner rather than later. Having said that, normality seems far-fetched today and we expect various industries to continue to adapt and innovate, because that’s what we do best. Tell us what you think.