3 better performing sectors in the coronavirus downturn

---

We asked clients which topics they'd like to hear more about. This article's been written based on what they told us.

---

With around a third of the world now in lockdown and the question for economic recessions becoming more about 'how long' not 'if' – it’s a tricky time for lots of businesses.

While some sectors, particularly those that rely on us leaving the house to spend our money, are facing low to zero revenues - others are less disrupted.

It should come as no surprise that the sectors faring better in the crisis are those providing essential goods and services that we can’t do without. Take food, power and medicines as examples.

These are traditional ‘defensive’ sectors – providing investors with a degree of shelter when the economy hits a rough patch.

Investing in individual companies isn’t right for everyone. They’re higher-risk as your investment depends on a single company – if the company fails you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

This article isn’t personal advice. If you're not sure what’s right for your circumstances, please ask for advice. Unlike cash, all investments and their income fall as well as rise in value, so you could get back less than you invest. Past performance is not a guide to the future.

The best performing FTSE 350 sectors this year

Past performance is not a guide to the future. Source: Thomson Reuters Datastream, 17/04/2020

Past performance is not a guide to the future. Source: Lipper IM to 31/03/2020.

Tobacco – reliable demand

We understand that tobacco stocks won’t be for everyone, but they have some attractive qualities, especially during periods of uncertainty.

On 17 April Imperial Brands told the market there had been no impact from COVID-19 on the business to date. This tells you pretty much everything you need to know about tobacco stocks. While others are struggling with reduced demand thanks to the lockdown, the tobacconists have so far proved immune.

Demand for tobacco is incredibly reliable and giving the product up is extremely difficult. What’s more, the big tobacco groups sell their products all over the world and have a diversified portfolio of brands.

British American Tobacco did give a list of ways COVID-19 could cause trouble, including volatility in financial markets that may make it hard to refinance existing debt and potential supply chain disruption. But, we think these risks are fairly slight when compared with the sectors that are really struggling.

This means tobacco stocks could offer a degree of certainty in otherwise uncertain times.

However, the long-term picture is less sure. Tobacco volumes are actually falling, and have been for some time now. So far, tobacco groups have been able to raise prices enough to offset this and then some. So while volumes have been falling, dividends have been growing.

There’s no guarantee this will continue though. While smokers seem to be remarkably insensitive to price, at some point they might start to baulk. Perhaps a bigger risk are regulations and tobacco duties, which could mean governments take a lot of the profit from higher prices for themselves.

For a while now the tobacco stocks have been trading on low valuations compared to the broader market. This probably reflects the concerns discussed above, and investors’ unwillingness to invest in a product they may consider immoral.

We worry that tobacco stocks will continue to trade on low valuations, as we can’t see why investors’ attitudes would change any time soon. While the groups may be able to keep growing their profits for some time, we think investors are largely reliant on the dividend for their returns. Imperial Brands currently offers a prospective 12.6% yield, and British American Tobacco a 7.6% yield. Remember that yields are variable and are not a reliable indicator of future income.

See the latest Imperial Brands share price, charts and how to trade

See the latest British American Tobacco share price, charts and how to trade

Pharmaceuticals – still crucial

Pharmaceuticals are a classic non-discretionary item. Chronic conditions, like asthma, cancer and COPD are a vital source of sales for pharmaceutical giants and unfortunately they haven’t gone away overnight. Pharmaceutical demand should be largely unaffected by the current crisis.

There’s always a risk disruption to supply chains might impact manufacturing, but we would expect companies and governments to work quickly to get these ironed out. New drug trials could also be disrupted by lockdowns, pushing future blockbuster drugs further down the road. Generally though it’s no surprise Pharmaceutical stocks have performed well.

Despite a third of the FTSE 100 companies deciding to scrap or cut their dividends, so far lots of pharmaceutical businesses have left their dividends intact. There’s a slight risk that management could decide it’s politically unwise to be paying a dividend at a time of global crisis. But in principle if demand and production is unaffected then profits should also deliver.

It’s tempting to think Pharmaceutical companies are on the front line of the fight against coronavirus. But, in reality most specialise in therapy areas that are far removed from COVID-19. However, one exception in the UK is GlaxoSmithKline (GSK).

GSK has a large vaccines business and over the last month it’s invested significantly in developing a vaccine or treatment for COVID-19. But, even in a best case scenario a commercially viable product is a year or more away, and there’s always the risk a rival gets there first or the project fails to deliver any results at all.

Failing at the final hurdle is a constant risk in pharmaceuticals. Until a drug passes its final trials it could always run up against a brick wall, with hundreds of millions of dollars of research delivering no commercial benefit. However, the coronavirus outbreak will have dramatically increased both awareness and concerns about potential pandemics.

We think investment in vaccine expertise in particular is likely to deliver long-term benefits in a world now much more willing to invest in prevention.

See the latest GSK share price, charts and how to trade

Supermarkets – pandemic pantries

March was the biggest month of UK grocery sales ever recorded. Or put another way, the pandemic has meant we spent more on groceries in March than we have ever at Christmas – unprecedented sounds about right.

For a sector to go from a state of fierce competition to not being able to fill or stack shelves quick enough – it’s certainly a stark contrast to those industries having to close doors.

So what has this meant for companies?

Perhaps not surprisingly, a significant boost to sales was first on the list.

Booming business for Tesco

Panic buying meant a c30% uplift in sales for Tesco, and while that might sound good on the tin, the group was quick to point out it’s been relatively short lived – sales are already starting to look more normal.

Booming business has also been costly. Staff sickness and soaring demand, saw Tesco recruit an extra 45,000 people in just two weeks and focus on increasing delivery capacity by 20%. COVID-19 is expected to cost the retail business £650m - £925m this year, and if things go back to normal by August, those higher costs will largely offset the benefits from selling more.

But, what’s worth noting is the group’s decision to pay a final dividend. In light of uncertainty and to preserve as much cash as they can, we’ve seen lots of businesses have decided to suspend or scrap their dividend – even those only recently announced. It’s a politically sensitive decision too. As a beneficiary of government help at the moment (Tesco will save around £585m from business rate relief), many question if it’s the right time for shareholder rewards.

For a nation in isolation, online groceries is an obvious solution, but while online spending in March was 13 % higher than last year, growth was stunted by delivery capabilities falling short . Lots of us were faced with weeks to wait for our shopping.

See the latest Tesco share price, charts and how to trade

Cue Ocado?

The delivery group’s certainly seen unprecedented demand, so much so it had to take some emergency measures such as temporarily closing the website and app for maintenance and making sure they could meet demand. And while queues at the checkout are a good sign for Ocado, we think there are longer term reasons for excitement.

Having sold 50% of its UK Retail business to M&S, Ocado’s focus is now heavily weighted towards its Solutions business - which provides robotic packaging systems for retailers. This is an attractive proposition and one that could really benefit from a more permanent shift to online grocery.

Booming e-commerce and the increasing threat from Amazon's groceries business means traditional supermarkets are increasingly looking for ways to compete. Ocado's smart platform technology offers the digital answers they're looking for. We suspect the pandemic might well have accelerated the shift to online too.

However, investors should be mindful that despite the opportunity, Ocado has yet to turn this into a profitable venture. For Ocado to deliver, it’ll need to work on finding lots more profitable partnerships.

See the latest Ocado share price, charts and how to trade

Looking ahead

As the pandemic has shown, supermarkets play a vital role in society, so sales aren’t going anywhere.

Once we’ve come out the other side of the pandemic, which seems some way off for now, we’d expect the longer term challenges of fierce competition and the search for sales growth to take centre stage again. That could see online groceries become the next battleground, but we’ll have to see if our shopping behaviours have shifted permanently for that.

Find out more about how the way we analyse companies has changed in light of the coronavirus outbreak.

One of the authors holds shares in Imperial Brands PLC.

Hargreaves Lansdown's Non-Executive Chair is also a Non-Executive Director of Tesco.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

---

Share insight: our weekly email

Sign up to receive weekly shares content from HL

---

---