Q1 of 2020 earnings season will be pivotal for investors. With very little COVID-19 economic data to refer to, guidance from corporate executives will be invaluable. While overall earnings and prospects will likely be gloomy, there might also be huge contrasts between sectors.
Many industries such as energy and travel will likely be decimated, while home entertainment and online retailers might have made a killing. Although the overall market faces significant downside risks, some companies are rising from the ashes.
Global recession casts shadow on US markets
As the world economy is already in a recession, investors are scrambling to figure out how deep the dive will be and how long it will last. In a nutshell, as almost every business has been damaged severely by isolation and lockdown measures, this earnings season will be all about choosing the right investment even if some companies have missed out on earnings.
What will matter most is the guidance and commentary of CEOs and management teams. How are their future orders shaping up, and how fast a recovery in their earnings do they foresee as soon as economies reopen? What if a further delay is on the cards? How large will the impact be on future earnings? Are they laying off people and cutting costs to cope, or are government QE measures enough to handle the recession?
The answer to these collective questions could determine whether the recent bullish correction in equity markets will last, or whether shares have been pushed too fast, and will now turn lower again.
Beyond this, the coming earnings season will reveal two different sides. Some sectors and companies have been hit hard by the virus, particularly by the isolation measures and lockdowns used to curb it. Other sectors have barely been affected, while some have even been benefiting hugely by these measures. Let’s take a look.
The biggest winners: Amazon-Activision Blizzard-Microsoft and more
In this crisis, gaming companies such as Activision Blizzard and Steam are some of the biggest winners as their consumers are staying at home. It turns out that US citizens are calling each other a lot lately and there’s a lot of spare time for TV shows. Shares in telecommunications companies have risen significantly during the lockdowns. According to Verizon CEO, daily phone calls and their duration have increased sharply compared to the pre-virus period. Another great example is Netflix as the firm’s stock is back near its all-time highs. Microsoft is on this list too. With millions of people working from home, cloud computing services have never looked more attractive.
Perhaps the biggest winners are large online retailers. While the economic shutdown has inflicted indescribable damage on smaller retailers and department store chains, it has done wonders for large companies like Amazon and Walmart, both of which have seen their stock hit the roof with new records lately. With so many smaller players now facing default risks, both companies are in a very strong position to expand their dominance in the retail sector. Amazon’s cloud business is booming too.
Not in bad shape but not great either: Nvidia- Exxon- Chevron-Disney
This category fits companies that have been impacted by the pandemic, but not significantly due to their good long-term growth potential, strong management, and healthy balance sheets. Sectors such as energy and industrials could suffer in the short term but could be very attractive in the long run.
Take Nvidia for instance. Although the chip maker’s stock initially dropped, the company has closed a deal with the gaming industry, which is currently booming, and has a healthy balance sheet without huge debt. This would put Nvidia in a good position to handle this storm. The same can be said for its main competitor, AMD, yet it is currently more indebted.
As for energy giants such as Exxon Mobil and Chevron, with the broader US energy industry falling because of oil prices plunging pushing most shale oil producers into loss-makers, the two giants are ready to stand and take advantage of ailing competitors. The oil sector will likely incur huge waves of defaults soon. The bigger players will be ready to buy the assets of insolvent companies at a huge discount, thereby increasing their market share and giving them a competitive advantage in the longer term.
Disney is another example. The company’s stock is still down coming to the first quarter, as there’s no clear timeline on when its theme parks will re-open or when its films will be on air again. Even after the lockdown ends, it may take a while for people to feel comfortable about frequenting crowded places again. Nonetheless, the streaming service is growing extremely quickly, helping to offset the pain.
The very ugly: airlines, cruise lines, smaller oil companies and Boeing
In this section, we’ll examine industries and companies that have been destroyed by the pandemic, and whose futures don’t appear to be very bright. These are super-high-risk but also high-potential-reward players, meaning that some of these companies might face bankruptcy, but the ones that survive could ultimately see their shares recover substantially from very depressed levels. They include airlines, cruise lines, department store chains, smaller oil companies, and restaurant chains.
Starting with airlines, companies such as United Airlines and Delta are some of the worst performers during this lockdown. While industry losses are warranted given the period of time it will take before normal flight schedules resume, an important distinction is that airlines will receive significant government support, so the default risk of these companies is much lower compared with cruise lines.
Cruise line shares are currently the worst-performing stocks on the S&P 500 this year. Cruise line revenues have evaporated, and it’s not known when cruises will resume or how much demand there will be for them. Worst of all, government rescue packages don’t protect cruise liners.
Next are smaller oil producers which have been devastated by the plunge in oil prices, and judging by their stocks, markets have priced a real default premium. Examples of these companies are the likes of Noble Energy, Marathon Oil, and Devon Energy.
Boeing must get special mention with its current share price down 55% year-to-date. The jet maker faced serious problems before this pandemic, and the devastation of the airline industry has augmented those troubles. However Boeing is a special case because it is a “too big to fail” company. The fact is this jet maker is the biggest US plane maker and a huge national employer. Yet it will take a long time to regain its former glory as it won’t be allowed to go into default given its importance to national security.
Make or break: choose carefully
During a crisis, choosing the right investment could be a tricky exercise. There is a list of companies that are making a fortune from the lockdown while some are facing default risks. For investors with a long-time horizon, real value could lie with high-quality names that have taken a hit, but have strong long-term growth prospects and clean balance sheets to ride out this crisis. For investors with a greater tolerance to risk, the most brow-beaten names might also be interesting, as any improvement in the virus saga could trigger an epic turnaround. That being said, we are still in the early days of a recession, so caution is warranted.