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Summary
Market update After sell-offs in March, global equity markets rebounded in April. Sentiment was buoyed by measures from governments and central banks around the world to support citizens and companies, thereby providing a positive signal to risk. In addition, the Chinese economy showed initial signs of a recovery from lockdown measures. Within the fund, at a stock specific level, 16 stocks provided double-digit returns over the month. Amazon was the top performer, gaining 26.9%. As expected Amazon has seen increased levels of business as people turn to internet shopping. In addition, take up of the group’s Prime entertainment service and web services have also increased. At month end, the company released quarterly results with revenue 2% ahead of expectations, although earnings were 20% lower. The company also announced its intention to spend all of the expected second-quarter profits – about US$4 billion – on responding to the coronavirus pandemic. Ecolab and Facebook were close behind in terms of performance. Ecolab reported results which were 6% ahead of expectations and provided a positive outlook, although this was to be expected in the institutional hygiene space. While some end markets, such as hotels and restaurants, may take some time to recover from the lockdowns, Ecolab’s growth potential and business model positioning remains positive in the long run. Facebook, meanwhile, has seen increasing engagement during the lockdown period and, despite advertising reductions in March, the company reported in line quarterly results. Encouragingly, Facebook management indicated that April’s growth was flat year on year, suggesting that the company has successfully transferred to advertisers whose products can be consumed during lockdown. The fund’s holding in Disney was sold during the month, although we continue to respect Disney’s world-class franchises, such as Star Wars. The mutually reinforcing model of theme parks, movies and merchandise seemed unbeatable last year but, in the short term, theme park closures and empty cruise ships due to COVID-19 will be painful for the group. The company’s sports channels will also likely lose revenue this year. The new streaming service, Disney+, has seen impressive uptake and will likely be a success in the long run, but for the next few years the new offering is forecast to lose money. A focus on debt levels suggests some concern to us over covenants should lockdowns extend, or if capacity at theme parks is restricted due to social distancing. While we could easily own Disney shares again, at present are not comfortable with the possible balance sheet stresses that may lie ahead and we see a better blend of risk and reward elsewhere. New positions were purchased in Yum China and Vermilion Energy. Yum China is the largest quick service restaurant chain in China (which includes brands such as KFC and Pizza Hut) with more than 9,000 stores. The firm is well-positioned for more store roll-outs as a result of its world-class distribution chain. At 7-8% per year, the growth outlook for the company is exciting. Furthermore, we believe that economic recovery is likely in China before much of the rest of the world. Despite a difficult January to March period, April’s sales were only 10% lower than last year as China began the process of exiting lockdown. Vermilion Energy is a small Canadian-listed cash generative conventional hydrocarbon producer. The firm is well diversified by geography and end market. Being one of few qualified purchasers of on-shore gas assets in Europe allows Vermilion to make super normal margins in acquiring and better managing operations shed by energy majors. Improvements in capital efficiency mean that the firm’s depreciation (non-cash) charge is way in excess of its required maintenance capital expenditure. While the low oil price is negative for the company, it has hedged forwards for most of its commodity price exposure in the short term. A rebound in oil prices would likely result in a resumption of dividends, a re-rating and re-inclusion in the Canadian index. Our central case continues to be that economies will rebound after the deep drop experienced as a result of global lockdowns. While this was necessary to prevent a humanitarian crisis, the uncertainty now turns to how best to reopen economies. This new normal is likely to feature more nuanced measures, potentially including restricted travel zones, increased sanitation requirements, increased testing, government enforcing localised lockdowns and isolation of the elderly. Many firms are working on vaccines for the virus, and some will begin to report results within four to five weeks. Success in the clinic will likely result in vaccinations beginning to be rolled out by year end. Once more economic certainty emerges, investors are likely to rapidly reassess the prospects of companies. For those with operations relatively unimpacted by the pandemic and with strong enough balance sheets, investors are likely to look through poor short-term results. The world remains awash with liquidity due to the stimulative efforts of central banks. Quality growth companies remain our focus and we remain vigilant for opportunistic entry points should they arise. Over the long term we believe this provides scope for continued outperformance.
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