Ivy Sector Insights – Industrials
Commentary as of April 17, 2020
“Shelter in place” orders have put the brakes on almost all forms of transportation. What are we seeing in these industries?
Airlines. We believe it’s generally accepted that it will take time before airline flight schedules and capacity return to normal. Right now, these companies are suffering. Flight bookings, including cancellations, were down greater than 100% for the week of April 6. Domestic capacity is down about 80%, while international capacity has fallen 100%. Airlines are crucial to keeping the economy moving, so once consumers and businesses returns to some semblance of normalcy, the industry needs to be available. The comprehensive Coronavirus Aid, Relief, and Economic Security (CARES) Act includes about $25 billion in grants to the airline industry, which should provide support in the near term. A second package will be available in September, but this relief is likely to be in the form of loans rather than grants.
The industry is experiencing a nearly complete shutdown, with companies experiencing a zero-revenue environment. Our analysis focuses on a company’s liquidity position and cash burn, while relying less on and topline numbers. Airlines are high fixed cost businesses, with considerable labor and capital costs. It can get ugly quickly under these circumstances. Our analysis typically favors higher quality carriers with solid balance sheets, which could be crucial at this time since the lower quality companies will need to contend with higher debt on balance sheets from possible government loans and lower revenues. We believe more “bargain” carriers could have a harder time recovering from this downturn.
Autos. Car sales were trending downward before the COVID-19 pandemic, but now are simply abysmal. The seasonally adjusted-annual rate of sales is typically around 17 million per annum, but is projected to fall to near four million. On top of that, every auto manufacturing factory in North America has been shut down. The larger manufacturers have impressive stockpiles of cash, but these same auto makers will burn $25 billion in cash in the next two months, so liquidity is a concern. Companies that have access to capital markets or have recently raised capital appear to be in a better liquidity position, and could be set up to outperform on the other side of this cycle. One positive note, China is beginning to reignite its economy, so companies with reasonable exposure to China may be in better position than those only with U.S. exposure
Trucking and rail. Trucking stocks have fared well. There are few big players in the space that could likely survive this environment. These companies have the ability to handle large capacity, which we believe could be pushed to the brink in the next couple of quarters. In addition, railroads are likely to experience a volume headwind, but may be positioned well for long-term success due to recent cost-cutting initiatives and from the benefit of operating as a regional duopoly.
Another area in your universe of coverage is insurance. Are there segments within the industry that are in better spots than others?
There are primarily two types of insurance: property and casualty (P&C) and life. On the P&C side, the majority of people currently are working from home. They are not driving as much right now, which is an ideal environment for these insurers. This has led to some insurers returning premiums to customers in part to avoid possible backlash from state insurance commissioners in the form of rate reviews, and possible reductions. Once rates are lowered, it is hard to raise them again, so many insurance companies view one-time payouts as a more attractive option.
Conversely, life insurance companies are facing multiple headwinds. As the COVID-19 mortality rate climbs, these companies are seeing an increase in death claim payouts. In addition, this is all happening in an extremely low interest rate environment, which impacts the profitability of these companies’ investment portfolios. If rates remain low for a long time, that will create a meaningful headwind for life insurers.
Past performance is not a guarantee of future results. The opinions expressed are those of Ivy Investments and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
Risk factors: Investment return and principal will fluctuate, and it is possible to lose money by investing. Securities of companies within specific industries or sectors of the economy may periodically perform differently than the overall market.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.