5 November 2020
The imposition of another lockdown will clearly have a material impact on the domestic economy, particularly in the build-up to Christmas. However, the impact should not be nearly as deep as the first lockdown, given that most businesses will continue operating. This note looks at the similarities to and differences from the first lockdown and our initial thoughts on its impact on our sectors and companies. We will update further as more details emerge.
Will it be extended?
The lockdown is due to last from 5 November to 2 December. The inference is that the driver for leaving lockdown is the R rate falling below 1 (compared to the current level of 1.1-1.3). Clearly this could change, but it does mean that it would be sensible to assume that an extension is likely. In any event, after lockdown England will return to the tier system, so a level of restrictions will still apply.
Key differences to the first lockdown
The lockdown is intended to last for 27 days, whereas the first lockdown lasted >70 days for non-essential retail and >103 for most leisure activities. The key difference this time is that schools, colleges and universities will stay open and childcare will be allowed. This is important, as it ensures parents can remain economically active. The main businesses being forced to close are in leisure and non-essential retail. Other businesses are being encouraged to continue operating, including construction sites and manufacturing. Importantly, the government has extended the CJRS, which enables employers to pay staff on furlough at least 80% of their salary, up to £2,500 per month, and the mortgage holiday scheme for six months.
The experience of Lockdown 1 does provide some benchmarks to work from when trying to estimate the likely impact on UK economic activity, although obviously the degree of uncertainty remains extremely high.
The Bank of England meets this week & publishes its Monetary Policy Report on Thursday. The bulk of the economic analysis would have been completed before yesterday’s news, so it faces the choice of a very hasty rewrite, or a holding statement pending new forecasts. Some of the more dovish MPC members will surely be tempted to vote for additional monetary stimulus straightaway. But, given that the review of negative interest rates is ongoing, and the impact of the extended fiscal support will not be evident for a few more months, it would seem more sensible to wait. It is not clear that additional asset purchases would make much difference anyway right now, given that gilt yields remain at rock bottom levels and credit seems to be flowing effectively to those who most need it.
With the other major European economies in a similar position to the UK, one would assume that the negotiators would be keener to reach some common ground and reduce the threat of even greater disruption from a ‘no deal’. The bigger issue on the UK side may now the be the lack of time available for those companies that need to introduce new processes and legal frameworks in time for 2021, while simultaneously coping with lockdowns, furloughing, redundancies, remote working, and in many cases sharply lower turnover. So a possible ‘super slim’ deal, featuring compromise on some of the key areas of disagreement but leaving more time for the regulatory details to be finalised next year, may be more attractive to politicians and businesses. In these circumstances such a fudge could be more acceptable.
There will be winners and losers in the consumer sector, with the renewed emphasis on eating at home positive for food producers focused on home cooking, particularly protein and basic food producers. The main beneficiaries are Premier Foods# (Buy, TP 120p), Hilton Foods (Buy, TP 1,350p) and Cranswick (Buy, TP 4,200p). The proviso is that the broadening spread of the virus could impact on facilities. This has greater implications for Cranswick, given the self-suspension of exports to China from Ballymena in August and Watton in October (c50% of slaughtering capacity). The hope is that it takes around two months to regain regulatory approval, but this is dependent on a bureaucratic process. Cranswick’s Watton facility is now operating with a skeleton staff to avoid disruption to the national food chain. The number of workers with Covid-19 has risen to 248 out of 767 (32%) and all 1,416 employees are being tested.
For most parts of the Financial Services sector, there is a limited direct impact from the lockdowns that have been imposed. The Asset Management sector is clearly exposed to the impact that the current measures will have on asset prices, although if there is a short-lived impact, there should be a relatively modest impact on profitability. There will almost undoubtedly be a continuation of the more challenging environment for flows, with greater uncertainty and volatility likely to impact investor sentiment and the willingness to invest in the short term. As was the case in the initial lockdown, those asset managers with exposure to certain strategies can continue to outperform – for example, we would expect the demand for sustainable investment strategies to remain positive, benefiting the likes of Impax#. Ashmore continues to offer greater exposure to Emerging Markets, where the yield attractions are ever more noticeable given the level of interest rates in developed markets.
The impact of the new measures imposed by the UK Government is relatively limited for our coverage. Though there are a few notable exceptions (such as companies with exposure to NHS outsourcing or UK care provision), the UK is generally a modest proportion of our companies’ end market sales, and in most cases the degree of exposure to consumer demand is low.
Housing, Building Materials and Builders Merchants
In contrast to Lockdown 1, the wider housing and building sector will remain open during the new lockdown period. This means building sites, tradespeople in homes, builders merchants, DIY stores and estate agents, will all be able to carry on operating as previously. Consequently, the direct impact on the sector from this second lockdown is likely to be much more muted, if not negligible, compared to the first. The fact that the construction and housing sectors are being left to continue operating is a clear indication to us of how important the sector is to the wider economy, given the impact on other consumer areas.
A series of Lockdown 2 measures across the world is clearly not a great backdrop for Q4. If, as we hope, key end markets remain around current normal levels, compared to March and April this year, then the sector is in robust shape, but we have to accept that even if there is limited direct impact in the short term, capex and planning decisions could move to the right in 2021. This has been reflected in guidance (where it has been restored). A repeat of factory closures between March and May clearly has a significant bearing on where our 2021E and beyond forecasts might go. A plus is that nearly every subsector is running with inventories at low levels, so a month of lockdown is an opportunity to refill.
As we move into a second lockdown four months after coming out of the first, UK Non-Life Insurers will be in a better position to manage the consequences, we believe, and remain prudent in the way they set reserves and seek to hold surplus capital going into 2021. There will continue to be differences in the way the second lockdown affects UK personal lines and commercial lines insurers.
The impact of the nationwide lockdown on the media sector needs to be considered in terms of five key themes.
- 1) Timing of the lockdown to impact pre-Christmas advertising
- 2) Minimal impact to UK events
- 3) Capex spend to continue
- 4) Changes in behaviour to benefit digital beneficiaries
- 5) Digital platforms serving impacted industries
While the UK November lockdown itself should not have any major direct operational impact on the Mining sector, due to its lack of operational exposure to the UK, potential changes in risk sentiment should have an impact on the sector from a more thematic perspective. In summary, we expect the recent UK lockdown announcement to favour the UK golds going into year end.
Oil & Gas
With the forces that drive the oil and gas industry being global in nature, it is difficult to single out individual stocks that will be particularly affected by the new lockdown measures being announced across Europe. However, concerns about the reduction in consumption of transportation fuels have markedly weakened the demand outlook, a dynamic that has already caused Brent to fall 11% since last Tuesday. Rising supply from OPEC and the US has added further downward pressure and will in our view increase the likelihood that when OPEC+ meets at the end of this month, the previously planned +2MMbbl/d production increase due to come in after January 2021 will be postponed.
The obvious losers are those exposed to sectors that are forced to close: namely retail and leisure landlords, where we expect rent collection and valuations to be hit once more. NewRiver REIT, Capital & Regional and Hammerson (despite the recent rights issue) also have the added complication of high levels of debt.
For many retailers, particularly in the unquoted space, the timing could not be worse, and comes at a time when retailers are looking to liquidate stock and generate cash in the so called ‘golden quarter’. Things will be a little different this time, we believe. Back in March, consumer focus was on ‘survival’ and we stockpiled food, toilet roll and pet food, with demand across non-essentials initially collapsing. Indeed, even the likes of ASOS and boohoo saw sales drop by 40-50% over the first two weeks of lockdown. No doubt we will still stock up on some goods, but we believe we are unlikely to see the same level of panic as last time, when non-essential spending collapsed. So what happens to the retailers?
Johnson Service Group (UK 100% of 2019 revenues) was severely impacted in 1H by Covid-19, with revenues down 31%, driven by HORECA (61% of 2019 sales), where revenues fell 50% (April -97% vs January and February +8%), and operations ceased completely in most plants as hotel and restaurant customers closed. In contrast Workwear (39% of sales) revenues fell only 4% (April -12%), as the business benefited from its exposure to the resilient food sector (c.40% of revenues or c.70% of volumes). All Workwear sites remained open and continued to operate throughout the period. We would expect a material impact on HORECA (albeit in a seasonally quieter period), as restaurants and the overwhelming majority of hotels close, but a lesser impact on Workwear vs March/April as manufacturing sites remain open.
Our channel checks of Asian countries that have gone into lockdown suggest B2B tech is negatively impacted by slower sales cycles, as closing meetings are deferred. Project-based activities, such as systems implementations, have slowed due to access/collaboration difficulties. While this in theory defers revenue, the second wave of lockdowns has tipped those on the fence to allocate budgets for digital transformation (DX) projects that fully embrace working from home (WFH) and an online-first world. In a way, the new lockdowns are putting to rest any plans for a ‘return to normal’, which is ultimately beneficial to a technology-powered future: years of progress have happened in months. We expect another wave of B2C volume boost affecting apps, games, media, etc downloads/subscriptions. On the back of that, the enabling technologies like VPNs and payment processors will also see a period of heightened sales.
Lockdown 2 is likely to exacerbate the existing trends, with airlines being heavily negatively impacted by the ban on non-work travel, but little or no difference to the bus and rail sector because of existing contracts and government support. It could benefit the mail and logistics sector, through even higher delivery volumes.
Travel & Leisure
Domino’s Pizza (Add, 425p) is a beneficiary under lockdown, owing to foodservice demand shifting from the on trade to delivery. Without takeaway and a VAT benefit, its LFL sales were up just 5.2% in Q2, even though the on trade was locked down. In Q3, with takeaway and a VAT benefit, its LFL sales were up 17.5%, despite increased competition from an operational on trade. In November, the company should benefit from another surge in delivery demand, with the on trade locked down, takeaway allowed and the VAT benefit continuing. Thus, this should be a favourable backdrop for LFL sales, royalties, National Advertising Fund contributions, franchisee profitability and cash flow. Upside risk to 2020E forecasts should increase as a result, in our view.