2020 first quarter review

Amelia Nunn - Equity Analyst

15 April 2020

These are unprecedented times, and with nearly half the world’s population across 41 countries under some form of restriction, it’s easy to understand why the behavioural and financial implications of the Coronavirus are hitting businesses and economies hard.

The ‘HL Select’ way is to invest in high quality businesses that we believe can prosper over the long-run. But this doesn’t mean their share prices won’t be affected in the short-term. This mis-match between share price and the long-term value we attribute to a business provides ample opportunity in our view.

Market commentary

Equities suffered their worst quarter in over 30 years, with the FTSE World Index down -16.1%, and falling -25.8% from peak to trough. The worst hit sector was energy, largely because of a sudden plunge in the oil price. Travel and leisure stocks, such as airlines and hotels, were also badly affected as governments increased restrictions on unnecessary travel.

As sentiment got increasingly worse over Coronavirus impacts, investors flocked towards perceived ‘safe haven’ assets, pushing up the price of government bonds to record levels in the process. And despite all equity sectors losing value in absolute terms, defensive areas like utilities and consumer staples outperformed. Unsurprisingly, the strongest performing sector was healthcare, as companies rushing to deliver tests, cures and equipment to tackle Coronavirus held up well.

To dampen the effects of the economic slowdown, governments across the world have introduced dramatic monetary and fiscal stimulus packages. In mid-March, the US Federal Reserve and the Bank of England both cut interest rates to joint-record lows and governments announced war-like fiscal spending sums to help people and businesses affected by the crisis.

Portfolio changes

In the UK, we first started to understand the global implications of Coronavirus towards the end of January, as the ‘ground zero’ Hubei province in China was placed on lockdown. At this early stage, we decided to trim our positions in Booking.com, CAE, Shiseido and LVMH due to their Chinese sales exposure or reliance on travel.

As the situation escalated and Coronavirus became a global pandemic, we continued to trim these names, as well as a number of technology businesses we own, including Google, Paypal, ServiceNow and Adobe. We decided to take profits by trimming some technology stocks that had performed strongly, raising funds to reinvest into new ideas as the opportunities arise.Masimo is a great business, selling blood oxygen sensor technologies that are used to monitor patients in hospitals. But investor enthusiasm for the additional demand generated by Coronavirus saw the shares shoot higher, outperforming the FTSE World Index by a large margin, prompting us to take some profits.

We recycled some of the cash generated from these trims into Visa, Philips and Relx. These are all companies we think are more insulated from the effects of the virus. Many businesses that remain open are shifting to digital payments to avoid cash hand-overs. We believe Visa will benefit from this accelerated adoption of digital payments, particularly in the US where contactless payment utilisation is low and cash is still used in 30% of all transactions.

Near the end of the month we started adding back to our positions in Booking.com and CAE as we felt the stocks had been hit hard and their prices fell below the long-term value we attribute to the businesses.

New positions

At the beginning of February we built a new position in Pernod Ricard. Pernod Ricard is the second largest spirits manufacturer in the world and its products include Absolut Vodka, Jameson Irish whiskey and Chivas Regal whisky. We think the spirits industry is a very attractive area within the consumer staples sector. The premiumisation trend (drinking less but spending more) has been supporting growth in the alcohol industry for the last decade, and aged spirits such as whiskies are natural beneficiaries of this. Spirits also have one of the highest gross margins in consumer goods, enabling the business to invest in advertising to grow sales and increase brand value.

Given the uncertainty the world is facing we believed it was the right time to add to consumer staples businesses, so we also added Unilever to the fund. This defensive company is a safe haven in times of uncertainty due to its diverse global operations and portfolio of everyday products. Unilever brands include Dove, Vaseline, Persil, Marmite and PG Tips – i.e. the ‘essential items’ we’re currently allowed to leave the house for.

At the end of March we invested in IDEXX Laboratories, a pet healthcare company that specialises in diagnostics. Pet ownership across the world is increasing and owners are willing to spend an increasing amount of their income on their pet’s health. Animal healthcare is fully private pay, removing the long-term risk of price deflation likely to impact the human healthcare sector due to government pressure. With 42 % market share and strong focus on innovation, we think the business has high barriers to entry, which combined with increasing profit margins and a strong management team, make it a good addition to the fund.

Sold positions

Towards the end of the quarter we sold out of our position in Shiseido. In recent years, sales in Japan, China and from travel retail have driven the bulk of Shiseido’s growth. Whilst the Chinese are emerging from lockdown, international travel is still very much restricted, affecting travel retail sales and Japan’s dependence on tourism. Part of Shiseido’s strategy includes growing their share of the US and European markets and improving their profitability, but with all stores in Europe and the US currently closed, and uncertainty around the duration of the shutdown, we are not confident the business is going to achieve their margin goals.

LVMH held up relatively well and we used that as an opportunity to sell the position and increase the fund’s liquidity. Traditionally, luxury has proved resilient in recessions, but Coronavirus has led to stores closing completely in many locations and footfall in major cities around the world has fallen sharply. This will inevitably have a greater impact on sales than traditional slowdowns. LVMH has greater sales exposure to Europe and America relative to peers, and less exposure to China and Japan. This is a negative in our opinion, as Coronavirus may have a bigger effect on western economies due to poorer containment efforts.

We sold healthcare businesses Coloplast and DiaSorin this quarter, mainly for valuation reasons and large relative outperformances. Coloplast is a resilient business but we saw no improvement in long-term value to justify the move. DiaSorin’s performance was largely driven by high expectations following the announcement of a potential Covid-19 test. However, their installed base of equipment needed to run the test is small, and so this is unlikely to offset the falls in revenue expected across the rest of the business. Quest Diagnostics, a competitor in the US, have reported a 40% fall in overall testing volumes during the last two weeks of March, due to elective procedures and visits to the doctor almost coming to a halt.

You can see every holding in the portfolio and find out why it was chosen, on the portfolio breakdown page.

Unless otherwise stated, all performance data is sourced from Bloomberg and refers to the period 1st January 2020 to 31st March 2020.