Coronavirus - Utilitarian approach
14 July 2020
Today nearly 400m people saw lockdown measures increased. Widespread lockdowns have demonstrated their effectiveness at bringing the virus under control, but they have also had an enormous impact on the global economy. With the UK economy already showing signs that the recovery may take longer than hoped, it is clear that other options must be considered in order to provide the greatest good for the greatest number.
• UK GDP grew by 1.8% mom in May 2020.
• Singapore’s economy falls 41% qoq.
• Thailand suspends all inbound flights.
• Three Indian states go back into lockdown
• Ashmore – “The global macroeconomic outlook remains uncertain, and the experience of individual countries will vary considerably, but it is increasingly apparent that the Emerging Markets in aggregate are less likely to suffer a recession as severe as that in the developed world. Meanwhile, current valuations are discounting a different scenario with Emerging Markets assets trading at significantly more attractive levels than the equivalent developed world bond and equity markets. Therefore, as investors continue to assess the impact of Covid-19 on their portfolios, there is a clear opportunity to enhance returns by increasing allocations to assets offering exposure to the superior domestic growth and yields that continue to be available across equity and fixed income markets in the Emerging world.”
• Mercia – “We now face the possibility of one of the largest global economic recessions since the 1930s, with domestic debt exceeding that of World War I. It is my strong belief that there will be a gradual recovery over a 12 to 24-month period and that experienced investors with liquidity and preserved capability will be well-placed.
Mercia's investment model was developed to counter the inevitability of cyclical markets, with many of the team at Mercia having invested through the cycles of 2000 and 2008. Mercia's model is to seek material influence (c20-40% stakes) in companies that have relatively modest capital needs – typically less than £10.0million – with realistic entry valuations. This, together with our strong liquidity, positions us well to support our investee companies and influence appropriate decision making at this time.
Sadly, in every correction there are both winners and losers. Businesses with near-term profitable business models and business-to-business ("B2B") operations with strong recurring revenue in favoured sectors such as software, digital entertainment, medtech, digital healthcare, diagnostics and biotech will likely benefit. Within our direct investment portfolio, Warwick Acoustics, Impression Technologies (both serving the automotive sector), Crowd Reactive (events management) and LM Technologies (Chinese supply chain) have inevitably suffered. However, others have benefitted; within the biotech sector, OXGENE and The Native Antigen Company; within digital home entertainment, nDreams and Soccer Manager, and Intechnica within online queue management and website defence. Reflecting structural changes and new emerging sectors, we have remodelled or pivoted certain portfolio companies and revised our investment approach to new prospects, to reflect this emerging paradigm.”
• Polar Capital# – “Our own outlook is broadly in-line with the current consensus which (we believe) assumes a limited lockdown period (2-3 months) that is followed by a recovery hampered by social distancing restrictions ahead of a vaccine in 2021 beyond which things 'normalise'. During this time, policymakers are likely to do whatever is required to preserve the financial system. Their efforts thus far have been nothing short of spectacular. Interest rates have been slashed to zero in nearly all developed economies, while central banks have already expanded their collective balance sheet by an estimated $4trn, led by $2.4tr from the Federal Reserve (Fed). By the end of 2021, the G4 plus China are expected to have increased their balance sheets by $13tr with the Fed and the ECB balance sheets exceeding 50% of GDP. Unlimited QE from the Fed, the world's lender of last resort, has effectively taken on private sector credit risk. Fiscal stimulus has also been "eye popping" with US efforts estimated at $2.6trn, close to double anything seen in over a century with its flagship Coronavirus Aid, Relief and Economic Security (CARES) Act worth c9% of GDP and double the size of the intervention following the financial crash in 2008. While different countries have adopted varied approaches, total worldwide stimulus has been estimated at $15tr to date, equivalent to c17% of the global economy last year.”
Food, Drinks & Household
• Fevertree – “The On-Trade is gradually re-opening across many of our regions, although the easing of restrictions and the extent to which outlets are re-opening has varied, with ongoing short-term uncertainty. While the Off- Trade continues to see good momentum in many regions, we expect some of the Off-Trade demand to switch to the On-Trade as it begins to re-open. However, the pace and quantum at which this will occur is likely to be gradual as the On-Trade still has to contend with cautious consumers, social distancing and therefore lower capacities.
As previously highlighted, the changes in channel and territory mix resulting from Covid-19 are expected to lead to gross margin headwinds during this financial year. However, we remain committed to our planned investments, particularly in marketing, and therefore intend to maintain our budgeted c£60m of operational costs for the full year, enabled by the Group's strong balance sheet and conviction in our ability to deliver long-term sustainable growth.”
McBride – “As indicated in our 19 May 2020 trading update, second half year trading was stronger than expected, due to increased demand for surface cleaning and dishwashing products in most of our Household markets, and due to encouraging sales of new hand sanitiser products developed by our Aerosols and Asia businesses. This was offset by a reduction in demand for laundry products over the same period. As the pandemic slows in Europe and countries ease restrictions, we have seen customer demand return to more normal levels.”
• Clinigen – “During the fourth quarter, the Group experienced more meaningful disruption to its activities from Covid-19, but continued to deliver good progress overall. Clinical Services was impacted by clinical trials being delayed or cancelled, whilst both Commercial Medicines and Unlicensed Medicines saw reduced volume demand as treatments in the hospital setting, particularly for oncology, slowed. However, the Group quickly pivoted activities to support efforts against the pandemic, resulting in material contract wins, whilst containing costs to lessen the impact from a lower top line performance.
Clinigen estimates that the impact of Covid-19 was at least £8m to EBITDA in FY20, with this primarily related to Proleukin. These headwinds are expected to continue into at least the first quarter of the current financial year, albeit the Group has already seen signs of recovery in territories that have begun to relax restrictions related to the pandemic.”
• Somero – “The uncertainty around the scale, duration and impact of the Covid-19 pandemic on Somero's end markets in the non-residential construction industry continues to make it difficult at this time to provide further guidance on the Company's financial performance in the rest of 2020 and beyond. While extended project backlogs reported by our customers prior to the Covid-19 pandemic, particularly in the US, indicate the non-residential construction market was active and healthy entering this period, financial performance for 2020 and beyond will depend on a number variables over which the Company has no control. The Company will provide updates as appropriate regarding the outlook for the business once greater clarity is attained.”
• Kenmare# – “The effects of Covid-19 are uncertain for the ilmenite market. Downstream demand for titanium pigment has been negatively impacted by lower global economic activity as a result of the pandemic. Some pigment producers reduced production in Q2 2020, which was driven by lower sales, and although downstream market conditions improved as the quarter progressed, pigment production is expected to remain below 2019 levels in H2 2020.
The domestic pigment market in China strengthened in Q2 as the country emerged from its lockdown, but pigment exports towards the end of the quarter were limited by restrictions relating to Covid-19 in other countries around the world.
Global ilmenite supply remained constrained in Q2 2020. This was exacerbated by reduced feedstock supply from India and South Africa, as a result of lockdowns, although this was more than offset by reduced demand. Therefore ilmenite market conditions are expected to become more subdued in H2 2020.
While the pricing outlook for 2021 is uncertain, Kenmare expects to be able to secure contracts for all of its increased production. The medium-term outlook for Kenmare’s ilmenite products remains solid, with demand expected to outstrip supply and additional sources of production required to balance the market in the coming years.
The oversupply in the zircon market continued into Q2 2020. This resulted in lower achieved zircon prices compared to Q1 2020, although prices began to stabilise in June. As with the ilmenite market, downstream demand for zircon has been hit by the Covid-19 outbreak, although this has been partly offset by the disruption to supply, particularly in South Africa.
Kenmare expects challenging zircon market conditions to persist in the short term but to improve in the medium term, with global supply deficits emerging due to depleting production from the major mines.”
• DFS# – “Order intake in our web channels increased significantly in the lockdown period benefitting from our well invested platforms and has remained strong since showrooms reopened, up 77% year-on-year from the start of the lockdown until 12 July.
We have also experienced very strong trading in stores since reopening with order intake up 69% year-on-year. We believe this performance materially benefited from latent demand from customers that would otherwise have completed purchases in late March, April or May and, given the wider economic uncertainty, we remain cautious on the outlook for demand.
Recent trading has been very strong, boosted by latent demand, which we have been able to capture as a result of our ongoing investment in our best-in-class online offering and a prompt resumption of our showroom operations. Despite the benefit of this exceptional recent trading performance and ongoing Government stimulus packages, we remain cautious on the outlook for the remainder of 2020 and into 2021, given likely lower consumer confidence and a potentially slower residential property market.
Whilst a weak trading environment would affect our short-term revenue and profits, we have historically prospered in economic downturns and gained market share. Furthermore, we believe that recent positive trading illustrates the resilience of the sofa replacement cycle over longer time frames and supports a view that the market can return to historical long-term growth rates in due course.”
• Motorpoint – “We are pleased to report that trading volumes since our sites reopened in June have been better than anticipated and higher than the equivalent period last year with margins at least in line with seasonal norms. Despite this encouraging performance, we remain cautious about drawing any conclusions for our full year prospects given our sites have only been open for a short period of time and significant uncertainty in relation to the impact from Covid-19 remains.
Notwithstanding the period of closure and reduced levels of trade, the Group balance sheet has improved since the year end with net cash levels increasing significantly.”
• Vertu Motors – “June trading was stronger than we had expected. I would like to thank the team for their hard work and enthusiasm as well as for their efforts to ensure the dealership environments remain safe for customers and colleagues. The Group's cash position was much stronger than we could have hoped, despite the fact the Board has made the decision to ensure all suppliers are paid in full, on time, illustrating the discipline within the business. The Covid crisis has driven an acceleration of technology uptake and we are embracing this trend to futureproof the business. As automation progresses, we have made the difficult decision to reduce Group headcount by 6%, which contributes to £10m of on-going annualised cost savings being identified.”
• DX (Group) – “Since the Company's last update on 28 May 2020, trading in both the Freight and Express divisions has continued to improve, and Group revenue for June was only 3% below previous forecast levels (set prior to the Covid-19 pandemic). This improved performance across both divisions mainly reflects recovery in volumes from existing customers but also some new business wins.”
• Halma – “Trading in the first quarter of the current financial year, from 1 April 2020 to 30 June 2020, has reflected the resilience of our business model and the essential nature of many of our products and services. Our order book has remained strong, with order intake ahead of revenue and ahead of the same period last year. Cash generation remains good and we continue to have a strong balance sheet and liquidity position. This has enabled us to alleviate some of the more stringent cost saving measures implemented in the first quarter.
Group revenues in the first quarter were 4% lower than the prior year, and 13% lower on an organic constant currency basis. This resilient performance, achieved during a period of lockdown in most of our major regions, also highlighted the benefits of having a diverse portfolio and agile organisational model. There was a wide variation of performances in our companies, reflecting significant changes in demand in individual end markets, as well as additional production, sales and distribution challenges due to safe working requirements and limitations on physical access to customer sites.
These revenue trends were partially offset by the savings in variable costs referred to above. We expect our companies to continue to manage actively their cost bases for the remainder of the year according to their individual market conditions.
In the Safety sectors, Infrastructure Safety saw the largest decline in revenue, particularly in the UK, which accounts for around a quarter of its revenue. The challenges of gaining physical access to installation sites and the actions of customers in furloughing a large proportion of installers of our products during the period had a significant adverse impact. We expect this trend to improve as lockdown restrictions ease and installers return to work. Revenue in Process Safety also reduced, primarily driven by a fall in demand for safety products in its oil and gas related businesses as a result of the lower oil price.
In the Medical sector, a number of our companies, notably those supporting the monitoring of vital signs and the oxygenation of patients, saw strong increases in demand, while companies supporting elective surgery and discretionary ophthalmic diagnosis procedures experienced significant reductions, leading to an overall decline in revenue. We expect the high demand in vital signs and oxygenation products to moderate over the coming months, and the demand in markets supporting elective procedures and discretionary diagnosis to recover as healthcare systems attempt to normalise.
• QinetiQ – “Order intake throughout the first quarter continued to be strong, despite Covid-19 related disruption in all of our markets. Although revenue and profit have been hit by the disruption, the proactive and robust cost management actions taken have reduced the impact on profitability and delivered a strong cash performance. As we have stated previously, due to the on-going uncertainty of the Covid-19 crisis around the world, we will provide guidance for Group performance as soon as possible to do so.”
• Synectics – “The effective closure of almost all major casino and gaming resorts globally had a substantial impact on the Systems division's first half revenues. Synectics' total revenues from the gaming sector in the half year were down just over 60%, compared with the same period in 2019. Much of the shortfall represented expected repeat work from long-term customers, required to maintain government-regulated surveillance systems, so is not lost and should return once these businesses are up and running again.
Revenue from other customer sectors served by the Systems division, including transport networks, high security applications and oil & gas, was much less affected by the market disruptions. Most of the Systems division revenue from these sectors is government or quasi-government related and, as such, less exposed to current restrictions on commercial activity.”
• Adept Tech – “In the trading statement we modelled new order volumes falling to c25% of the norm for a Q1 period (April to June). This was based on the assumption that the sales team could no longer meet clients face-to-face and that buyer appetite would be curtailed. We are pleased to report that new order volumes have proven to be significantly more resilient than we had initially modelled in respect of both recurring services and one-off projects, which is an encouraging start to the year given the Covid-19 challenges. This performance reflects well on the public / private split of the AdEPT business and our role in the market. This achievement is underpinned by some notable wins including an Avaya Contact Centre contract for the Royal Borough of Greenwich and a wide-area-network for Worcestershire NHS.
INSTALLATION DELAYS – We predicted a drop in project revenues given our inability to visit many customer sites for project related work. Indeed, it has been difficult to turn new orders into revenue in the first quarter, a situation compounded by the fact that Openreach ceased installing any circuits except those for critical infrastructure. This backlog of work in progress is temporary and will unwind as lockdown eases, although it will inevitably have a short-term impact.
However, this shortfall in on-site project work has been counterbalanced, in part, by the AdEPT success with cloud migrations in Education. During lockdown the Department for Education announced additional funding to assist schools in moving to the cloud in support of remote working.
AdEPT is playing a major role in this initiative – and to date is helping over 250 schools with cloud migrations to either Google G-Suite or Microsoft 365. We anticipate further success over the coming months as AdEPT is one of only five approved companies who can migrate schools to both Google and Microsoft cloud platforms.
DEBTORS – We anticipated pressure on credit at the commencement of lockdown and sensibly drew down our revolving credit facility by an additional £7.2m. We are pleased to report that we have been successful in collecting debt with debtor days at the end of Quarter 1 standing at 42 days; compared to 48 days at 31 March 2020.
As a result, we have repaid £8m of the revolving credit facility, whilst also paying the full value of the ACS earn out (a successful acquisition) – a cash outflow of £1.8m, whilst still leaving AdEPT with a healthy cash position. The cash generative business model of the Group has continued throughout the lockdown period.”
• AO World – “The measures implemented by Governments created a unique set of circumstances from the end of March through to the beginning of June. The products we sell are an essential part of people's lives and the electricals market migrated to nearly 100% online overnight.
We therefore experienced strong demand and made significant market share gains across many of our key categories from the start of lockdown on 23 March 2020, the impact of which saw sales above our expectations and an improvement to our working capital. We worked hard with our supply partners to maintain the availability of our products for our customers and we will continue to look for win-win collaborative solutions to meet demand.
While demand remains strong, the recent reopening of the high street means that customers now have more options to purchase their appliances offline from stores. Although customers are able to return to bricks and mortar stores, initial data shows that since stores have reopened the online market has in fact continued to grow year on year.”
• Ocado – “Covid-19 has impacted all aspects of our business, but the immediate effects are predominantly in the Ocado Retail and UK Solutions and Logistics business. The Group has considered the additional costs and revenues incurred as a result of the pandemic and has determined that Covid- 19 impacts should not be treated as an exceptional item.”
• The OBR says the economy is on course to shrink by 12.4% in 2020, with borrowing set to rise to a peacetime high. This would mark the biggest economic decline in 300 years. The UK’s economy rebounded more slowly than expected in May, growing just 1.8% from the previous month, as the gradual easing of the coronavirus lockdown had a modest impact.
• Iran has reinstated restrictions in the capital Tehran to combat a resurgence of Covid-19. City authorities announced that universities, schools, seminaries, libraries, wedding venues, beauty salons, mosques, cinemas, theatres and museums would be closed for one week. Social, cultural and religious ceremonies are also temporarily banned.
• Thailand has suspended all inbound flights after an Egyptian soldier skipped self-quarantine and went to a shopping mall before testing positive.
• New Zealand and the Cook Islands are working on a ‘travel bridge’ to help the tourism trade.
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