Coronavirus outbreak and the retail and hospitality sectors

04.21.20

The global impact of COVID-19 remains a moving target. As can be seen in Exhibit 1, depending on the success of social distancing, various scenarios could evolve in the coronavirus outbreak. In the recent Epidemiology of the Markets perspectives, Ivy Investments framed the debate and the ongoing analysis of the volatile investment landscape as a function of three main factors: 1) public health impact, 2) macroeconomic impact and 3) market impact.

Below we expand on our investment team’s insights regarding investment implications in the U.S. consumer sector. Our research emphasis continues to scour the landscape of U.S. consumer product and services businesses, with a view towards framing permanent versus transitory interruptions to earnings and cashflows.

Retail, transportation and hospitality employ more than 25% of the private sector workforce

A negative impact in the U.S. from the social distancing initiatives is beginning to take hold. For the week ending April 11, initial jobless claims jumped 5.3 million. Cumulatively, total job losses related to the coronavirus crisis currently stands at approximately 22 million. We see the impact of the lockdown being more pronounced in certain sectors including retail, transportation and hospitality. For example, as illustrated in Exhibit 2, the weekly retailers’ sales survey for the week ending April 9 dropped to 24.1 (a number above 50 indicates an expansion of activity, while a reading below 50 signals a contraction), the lowest level since 2008 as store closures halted sales in many places.

Chart Showing COVID-19 U.S. Scenario Analysis
Chart Showing COVID-19 TESTS PROCESSED BY CDC AND U.S. PUBLIC LABS
14-Day Predictions – April 6-19, 2020 — April 6-19, 2020
Chart Showing 14-Day Predictions – April 6-19, 2020
Chart Showing 14-Day Predictions – April 6-19, 2020

Source(s): RBC Capital Markets research; CDC reports.

The retail, transportation and hospitality sectors combined employ more than 25% of the U.S.’s total private workforce¹. Currently, the disruption due to the COVID-19 pandemic is fluid and uncertain, but forecasts by some associations help in understanding the potential impact the outbreak could have on the real economy.

Exhibit 2: Evercore ISI retailers' sales surveys
4-week average as of April 9 – 30.8
Chart Showing Evercore ISI retailers' sales surveys

Source: Evercore ISI, as of April 9.

Forecast unemployment to soar to 15% in the second quarter

According to forecasts by the National Restaurant Association, the industry may lose up to seven million jobs if the restaurants are closed for three months². U.S. Travel Association and Tourism Economics estimates by the end of April there will be 5.9 million travel-related job losses in the U.S.³

In the latest employment data, non-farm jobs declined by 701,000 in March. While the loss in jobs was broad-based, the restaurant sector accounted for most of the drop. The unemployment rate increased from 3.5% to 4.4%, the largest one-month increase since 1975. Despite the recently passed $2 trillion fiscal stimulus bill⁴, our base case forecast is for unemployment to jump to 15% with upside risks in the second quarter.

Growth forecasts revised significantly lower

With the above backdrop, we have significantly lowered our global growth forecasts. In the U.S., on an annualized basis, we are penciling in a quarter-over-quarter contraction of 35% in the second quarter. For the year, our base case (around 60% probability) is for U.S. gross domestic product (GDP) to record a negative print of 4%. Meanwhile, globally, we are now forecasting GDP growth to fall by roughly 2%. Given the uncertainty around COVID-19 and recent data, risks to our forecast are tilted to the downside.

What does this mean for investors?

Overall, while tragic, we continue to believe COVID-19 may be a transitory event that will allow us to invest in companies for the longer term at more attractive valuations. Some industry participants are likely to experience permanent damage from the abrupt economic shutdown. Even if the unprecedented fiscal and monetary stimulus can bridge the gap for companies, we think consumer behavior is likely to take time to return to pre-virus norms, and any recovery may unfold in stages. Will the highly levered businesses have enough cash to weather the storm? Or, for those that have thrived, can recent success be sustained under more normal conditions?

As fundamental investors, our common framework across strategies is to evaluate the long-term earnings power of business models. Part of that is developing an understanding of which businesses are strong enough to endure or even emerge with bigger footholds, and which are likely to succumb. In retail and hospitality, below are our main ideas:

In retail, mass merchants such as Walmart and Costco are likely to have a favorable risk-reward profile in the initial phase of the outbreak when most consumption was centered around stockpiling. As we move on to the next phase of the virus, in which the economy is hurt due to the increase in unemployment and job losses⁵, we may see dollar stores such as Dollar General and Dollar Tree perform better. Off-price retailers such as TJX Companies and Ross Stores may have some tailwinds from the pandemic supporting them, as we think the crisis will likely leave a glut of apparel supply on which these off-price retailers can capitalize.

Cyclical companies such as Home Depot and Lowe’s may be interesting once we weather the economic slowdown. We believe housing is one of the sectors that tends to bounce first as the economy recovers due to its interest-rate sensitive characteristics.

Meanwhile, e-commerce companies, such as Amazon are likely to benefit as well, as more people avoid stores where people congregate, instead choosing to go online for their needs. We view this pandemic as a catalyst for further e-commerce adoption, especially for online grocery, where consumers will likely stick with their new-found convenience even when the crisis is over.

In consumer staples, many companies are benefitting from COVID-19-driven pantry loading, proving the sector to be a hiding place in times of market uncertainty. Centerof- store companies such as Campbell Soup and General Mills that have exposure to some of the historically outof- favor categories, such as canned soup and ready-to-eat cereals, are witnessing strong sales momentum with sales up more than 30 % in March. Beyond pantry loading, if a prolonged economic slowdown hits, we think most packaged food companies will continue to benefit as at-home food consumption is likely to pick up during recessions. Overall, we have seen the center-of-store packaged food stocks hold-up up better compared to the rest of the consumer staples pack. As fundamental investors, our job is to understand if these trends can persist and become permanent, or if they represent artificial and short-term earnings growth.

In household and personal care, we have seen companies such as Clorox and Reckitt Benckiser as potential beneficiaries from the coronavirus outbreak cycle as demand for the products (disinfecting and cleaning wipes) has remained strong and is likely to remain high through different stages of COVID-19.

In textile and apparel, athletic and performance brands are likely to be defensive investments as compared to luxury and fashion-oriented brands. As the world becomes more casual, there have been secular tailwinds supporting demand for products from companies such as Nike, Adidas, and Columbia. Moreover, athletic and performance brands benefit from geographical diversification. There is a new demand for athletic products from emerging markets as the middle class grows and people, because of lifestyle changes, purchase more athletic wear. Additionally, these companies have stronger and more successful e-commerce businesses because of their business model and broader ecosystems (such as Nike Training Club app, Adidas Runtastic), which is helpful in the current environment in which more people are shopping online. In our view, many of these athleisure business models were attractive pre-crisis and are poised to emerge even stronger on the other side.

In restaurants, quick-service restaurants with a strong drive-thru, take-out, delivery sales channels, and valueoriented meal offerings have outperformed other restaurants. Companies such as Domino’s have benefitted because of their strong captive delivery system and the perception of good value in pizza as consumers look to save money. Casual dining (full-service restaurants) is a category more challenged by COVID-19 due to state-mandated closures of dining rooms, which typically account for 80% or more of sales. Companies like Darden Restaurants (owner of concepts such as Olive Garden, LongHorn Steakhouse and The Capital Grille) that have healthy balance sheets stand to gain market share as the financial pressures from temporary store shutdowns and weakened consumer demand force many competitors to close.

The above insights into the Ivy Investment team’s perspective on the U.S. consumer landscape frame some of the analysis underlying a broad range of strategies, including in the areas of large-cap, mid- and small-cap and fixed income.

Market dislocation provides opportunities

We believe the COVID-19 outbreak is likely to be a transitory event. While unfortunate, we believe such passing events lead to risk-off market environments, providing us opportunities to seek to take advantage of near-term stock price dislocations to invest in long-term advantaged business models. Looking ahead as fundamental investors, we continue to look for opportunities by laying greater emphasis on the fundamentals and quality of asset classes and sectors.


Chart Showing covid-19-page-image

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1. https://fred.stlouisfed.org/release/tables?rid=50&eid=4881&od=. Total of 33.7 million people

2. https://www.nrn.com/operations/national-restaurant-association-congress-industry-approaching-100- billion-losses-and

3. https://www.hospitalitynet.org/news/4097744.html

4. https://www.bbc.com/news/world-us-canada-52033863

5. For the week ending March 21, initial jobless claims jumped to 3.28M, a record high number.

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