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Five shares to watch – coronavirus update

Our early thoughts on what the outbreak could mean for this year's five shares to watch.

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.

The coronavirus outbreak has radically transformed the economic landscape in a matter of weeks. Our five shares to watch have not escaped unscathed, particularly as the economic outlook at the beginning of the year led us to choose more economically sensitive ‘cyclical’ companies than in previous years.

We’re in a rapidly changing environment, and the length of the current disruption will be crucial to determining the long run impact of the virus. However, we’ve pulled together our current thoughts on what the outbreak could mean for each of our five shares to watch.

We’ll keep you up to date with more as these companies publish details about the full effects of the situation. You can get our views straight to your inbox by signing up to research updates.

This article isn’t personal advice. If you’re not sure if an investment is right for you please seek advice. All investments fall as well as rise in value, so you could get back less than you invest. Past performance should not be seen as a guide to the future.

Investing in individual companies isn’t right for everyone. Our five shares to watch are for people who understand the risks of investing in individual shares. 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.

DS Smith

Paper is a cyclical industry. When economies are booming trade surges, and demand for packaging increases. Unfortunately the reverse is also true, and it looks increasingly like we’re on the edge of a nasty recession. That’s likely to be bad news for the industry.

However, DS Smith has a couple of traits that should mean it’s better placed than some rivals – although that doesn’t mean it will escape a recession unscathed.

Around 70% of sales are to ‘fast moving consumer goods companies’ (FMCGs). FMCGs will have seen demand for their products spike in supermarkets as consumers rush to stockpile key products. The group is also heavily exposed to the growth of e-commerce – where pretty much every package arrives wrapped in layers of corrugated paper. With e-commerce likely to play a key role in keeping customers supplied during periods of social distancing, there are worse places to be.

Unfortunately the fact many of the group’s end markets are more defensive, meaning they’re less exposed to economic ups and downs, doesn’t mean DS Smith can shrug off a downturn entirely. While DS Smith aims to deliver differentiated products – straight to shelf packaging for foods for example – corrugated card is ultimately a fairly generic product. That means it functions a bit like a conventional commodity with a global ‘market price’. When demand falls the price of paper falls too, and DS Smith will be able to charge its customers less.

We haven’t had a detailed announcement from DS Smith about how current conditions are affecting the group. And the honest answer is that management probably aren’t sure themselves yet. However, using the cash from the recent sales of the group’s plastic’s business to reduce debt to under two times cash profits does help to improve the group’s financial resilience.


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Ibstock

Rightmove recently warned “the speed of the slowdown in the UK housing market has been significant.” In fact we suspect enforced self-isolation has seen both housing sales and housing construction slow to a trickle.

That’s bad news for suppliers into the industry, and as the UK’s largest brick manufacturer Ibstock will be hard hit. In fact sales are likely to have ground to a halt – which is why the group has suspended all manufacturing activity.

The next few months will be all about conserving cash through lower costs. The company will be looking to make maximum use of government support to pay salaries and is slashing capital expenditure too.

The good news on that front is the group’s balance sheet finished last year in relatively good health – with net debt to cash profits (EBITDA) last year of 0.7 times. Still, with EBITDA likely turning negative for the months of the lockdown it’s not a pleasant situation to be in, and it’s no surprise to see the dividend in the firing line.


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Keywords

Gaming looks set to be one of the few areas which sees spending increase during the next few months, with Chinese groups reporting an increase in activity during quarantines there.

Keywords won’t be a direct beneficiary, since it doesn’t make games of its own. However, increased spending in the sector bodes well for a business which is crucial to the development of hundreds of games every year.

The group has offices all over the world and teams are used to working together remotely, which could help mitigate the impact of lockdowns. However, whether the company can transition enough staff out of the office remains to be seen, and it already seems like it’s struggling to meet demand. A good problem to have, but still not ideal.

In the event that activity is disrupted, and to some extent that’s inevitable, we take comfort in the fact the group has a modest €18m net debt. That reflects acquisitions Keywords has made in recent years which have helped turbocharge earnings. Those deals are less likely in the current climate, but conserving cash would be the right thing to do anyway.

We remain, very cautiously, optimistic about the group’s prospects this year. However, it’s worth bearing in mind that the shares have, so far, held up well through the market sell off and trade on a relatively high, in relation to average, price to earnings ratio of 22.6 times. If performance slips then the shares could potentially fall dramatically.


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Novo-Nordisk

Novo has also weathered the market storm reasonably well so far. Its diabetes treatments and insulin are crucial to millions of patients around the world and we expect the group and governments to work together to keep supply flowing through the lockdowns sweeping the world.

Generally speaking the group should be a defensive option, especially as it also enjoys a sizeable net cash balance – although we haven’t yet heard from the company itself on the subject of coronavirus.

However, we would sound a note of caution about the long term. The current outbreak will leave healthcare services stretched and drained. Paying the high prices drug companies, including Novo-Nordisk, charge for their products is unlikely to be popular in that type of environment.

Novo’s pretty healthy operating margins and life-long customers could make it a potential target for regulators.


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WPP

There’s no getting away from the fact WPP is in trouble. Even before the coronavirus outbreak results had been disappointing, and the threat of a global economic downturn will not be doing it any favours.

When companies struggle marketing budgets are often one of the first places to feel the pinch. Recent comments from ITV suggest advertising budgets are already being slashed by a wide range of companies. We only expect that trend to gather pace as consumers are increasingly restricted in where they can travel and where they can spend. As one of the world’s largest marketing groups WPP is at the sharp end of that trend.

One point in the group’s favour at the moment though is that it has significantly reduced its level of debt following the sale of a 60% stake in the Kantar market research group at the end of last year. A significant chunk of the sale proceeds were also earmarked for return to investors via a share buyback, but we suspect that will be re-evaluated given the current conditions.

Nonetheless these are difficult times. When the company does issue an update on the impact of the coronavirus outbreak we don’t think it will make for pleasant reading.


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The author of this article holds shares in DS Smith.

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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    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.

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