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Coronavirus and stock markets so far – the shares that have caught our eye

We take a look at the companies and trends that have caught our share research team's attention in the last couple of weeks.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Nicholas Hyett, Sophie Lund-Yates and Emilie Stevens
Equity Analysts

Published on 14 May 2020

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

This is uncharted territory for stock markets. Global lockdowns are weighing heavily on economic activity and lots of companies are taking drastic steps to deal with the conditions.

We’ve asked our share research team to pick out the companies and trends that have caught their eye so far.

This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments rise and fall in value, so you could get back less than you invest.

A market firmly in two minds

Nicholas Hyett, Equity Analyst

The current market is full of contradictions.

UK banks have made huge provisions for future bad loans and warned there could be more to come. Bank investors have taken these warnings to heart, and the five banks in the FTSE 100 are currently trading on an average price-to-book ratio of just 0.37, well below the historic average.

Meanwhile the gap between interest rates on lowest risk government bonds and top rated corporate bonds has increased by over 50%, as investors worry that companies may struggle to pay their debts.

The financial industry is predicting some major defaults implying companies are struggling to survive, increased unemployment and probably a painful recession. But look at other corners of the stock market and you wouldn’t get that impression at all.

Halma is a top quality business. The group specialises in health, safety and environmental protection and has increased its dividend by 5% or more every year for 40 years. However, even its historically resilient earnings are expected to be impacted in a recession – and while still growing, analysts have downgraded profit expectations for 2021. But you wouldn’t know its outlook had soured from the share price though. Not only are the shares down less than 1% year to date, the group’s two year forward price-to-earnings (PE) ratio is at an all-time high.

Halma’s an extreme example, but other high quality businesses like Experian has also remained resilient (down just 5.3% year to date with a two year forward PE higher than any time before late 2019). Nestle (down only 5% this year with a two year forward PE ratio well above its long run average) is in a similar position.

This is something investors should be very wary of though. High quality, defensive companies are likely to perform better than weaker businesses in the downturn, but they will still suffer to some degree. Investors are paying a premium for the safety, but it’s not clear if the prices really reflect the risks.

Facebook's unexpected path

Sophie Lund-Yates, Equity Analyst

Economic downturns are bad news for companies relying on advertising revenue.

When the outlook is uncertain and costs need to be cut, expensive marketing efforts are one of the first things to be trimmed. We’ve heard from the likes of ITV recently, which saw advertising demand plummet 42% in April. Any reality TV fans will know Love Island’s been cancelled too – and even if the show isn’t your cup of tea – it’s a big loss for ITV. The show’s popularity makes it worth a lot to advertisers.

Given all that, we were expecting Facebook to add to the bad news.

The social media group is an advertiser’s dream, with marketing teams queuing up to get in front of Facebook’s huge number of users, and harnessing the data those users leave behind. But the group has a lot of exposure to smaller and medium sized local businesses, which are often more likely to unplug marketing spending at times of crisis.

Now the group didn’t get away unscathed – it experienced a significant reduction in demand for advertising, as well as a related decline in the pricing towards the end of its first quarter. But what’s really interesting is the declines have started to temper, advertising revenue is now reasonably stable and at a level similar to last year.

We have a theory for this – it could be that businesses switched off their ads in the early days of the outbreak, but some are now back online offering adapted services.

Whatever the driver – and we may have to wait a little while to find out – this was a real positive for Facebook. Adverts made up 98% of the group’s $17.7bn quarterly revenues.

To be clear, overall revenue trends are much slower than this time last year, so we’re not saying everything’s peachy. But Facebook’s stemmed the outflow when others haven’t.

To that end, we think coronavirus has accelerated existing trends. We’ve known that marketing was moving online and away from traditional media campaigns for some time. But the current crisis seems to have sped the transition up, and shows how resilient, and in-demand, digital ads are.

McDonalds – looking beyond the headlines

Emilie Stevens, Equity Analyst

Coronavirus has hurt many businesses, but sometimes the real impact can be hard to see by looking at the headline accounts. In many cases investors have to dig a bit deeper to see what’s going on.

A good example is McDonalds, where revenues have fallen thanks to the lockdowns and the ways customers have changed their behaviour in response to the pandemic. In the most recent quarter comparable sales fell 3.4%, although the drop really happened in March when sales fell 22.2%. However, this fall in sales hides a much larger and potentially more troubling gyration in cash flows.

To understand why, we need to explain how the McDonalds system actually works. About 93% of McDonalds restaurants are run by franchisees. McDonalds either owns the land outright or controls it on a long term lease, and invests alongside the franchisee in getting the restaurants up and running. The franchisees then pay McDonalds rent and a percentage of their sales – this makes up the vast bulk of McDonalds’ income.

But many of the franchisees are struggling now that coronavirus has disrupted usual business. To help them out, McDonalds has agreed to postpone payments due in March and April – about $1bn in total. And due to the timing of different payments, McDonalds expects to have negative cash flow in the next quarter. In effect, McDonalds is lending $1bn to its franchisees to help them through the crisis.

McDonalds is still recognising this money as revenue – even though they haven’t got the cash yet. It may not get all of this cash either, because even with support there’s a chance some franchises go bust. This means McDonalds could have to take some exceptional charges against future profits.

To be clear, we think McDonalds is doing exactly the right thing. If a significant number of the franchises go under McDonalds would be in real trouble, so it’s worth lending them some money now even if it doesn’t get paid back in every case. And as the relationship between McDonalds and its franchisees is very close these are also going to be pretty easy debts to collect on.

We think that McDonalds is likely to get the bulk of its $1bn back and none of this ends up being a problem. Even so, there’s an outside chance that we enter a severe recession and the level of support can’t keep some franchisees afloat. This could mean McDonalds ends up receiving lower revenues going forward and writing off some of the revenue they’ve already recognised. If this was the case, McDonalds’ losses could start to mount quite quickly.

This is the sort of thing that investors wouldn’t get from a quick scan of the top line numbers, but it’s a big talking point among professional analysts. It underscores the importance of really understanding the businesses you’re invested in, and taking the time to research them closely.

Don't be dazzled by Reckitt Benckiser detergent

Emilie Stevens, Equity Analyst

Just a few months after announcing the start of a big strategic refresh, Reckitt Benckiser reported its best quarter of sales growth in 20 years. With a portfolio of brands that includes Dettol and Cillit Bang, coronavirus has provided Reckitt with an unexpected jump start. Sales were up 13.3% year-on-year, ahead of the 0.8% growth managed the previous year. Expectations for the year ahead have been raised and that’s not something we hear much of at the moment.

While such growth is exciting, there’s a few things to bear in mind. First and foremost is that the sales boost may be short-lived. Reckitt said it was proving hard to distinguish between stockpiling, effectively bringing forward future sales, and an underlying increase in demand for hygiene goods. With a vaccine not likely anytime soon and disinfectants a proven defender, a general increase in hygiene sales is not impossible. But for how long and how high it’s still too early to call. As it stands analysts expect business to return to more normal levels in 2021 meaning this could be short lived indeed.

If that’s the case, 2021 is when the real work begins.

Behind dazzling detergent sales, Reckitt has some tough stains to tackle. Sluggish growth is one of them, particularly in the group’s largest division – Health where brands from Gaviscon to Scholl fail to excite. It’s also where you’ll find the struggling Infant Nutrition business, which was born from Reckitt’s £12.3bn acquisition of Mead Johnson in 2017. Just this February the group had to write down its value by £5bn, realising original growth expectations were unachievable.

Longer term Reckitt’s premium price point for what are fairly generic goods could also prove a challenge. As panic buying dies down and customers are faced with choice again, against a backdrop of tough economic conditions, we wonder if paying a fiver for Ibuprofen may lack appeal.

Reckitt’s first quarter showed us that there are some businesses that will do better not worse in light of coronavirus. But when thinking about which companies to invest in, it’s important to look at a business’s performance over a longer time frame, not just the future but the past too - check back and see how the business was faring before the crisis.

We aim to help investors with that task. Our share research comes in two parts. The ‘update’ is a brief summary of the facts, what the company said. The ‘HL view’ puts the results in context of the business’ longer term performance and covers things investors should know before investing.

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.

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