Across the globe, economies and society as a whole are still faced with the challenge of the coronavirus pandemic (COVID-19). Although many people yearn to finally stop wearing masks, book holidays at their favourite destinations without major problems, or simply go out with friends and family, today’s historically high level of unemployment and a possible second wave of infection constitute the harsh reality that stands in the way of fulfilling these desires.
The recovery underway in large segments of the economy is proceeding apace. But both consumer and corporate capital spending is anything but exuberant. Many businesses are not yet covering their costs, and, especially in the leisure and entertainment industry, small and medium-sized businesses are in no position to resume operations due to hygiene regulations. The follow-on ramifications of the quarantine are still impossible to predict. An additional complication: a new round of government stimulus packages will probably only be introduced gradually at the beginning of 2021 and then take a certain amount of time to gain traction in the economy.
Hardest hit by the crisis is therefore the portion of the economy that is not directly relevant to equity investors, as many small companies are not exchange-listed or included in major quote sheets.
But the coming quarters will also be rough for listed companies and fraught with uncertainties. It is entirely possible that even more larger enterprises will be unable to escape bankruptcy, as the case of car rental company Hertz has shown. Nevertheless, already today, trend-driving forces are emerging that can be quite interesting from an investor’s perspective. Essentially, we have identified four trends which we believe will play a major role in the investment environment over the medium to long term, namely:
The coronavirus pandemic has mercilessly exposed both the advantages and challenges associated with digital transformation. The shopping behaviour of consumers has changed practically overnight, with online purchasing now extending also to the food sector. At the same time, digital technologies such as telemedicine and online communication have helped the public rise to the COVID-19 challenge. Working from home has become an important aspect of employer attractiveness not only in virtually all areas of the services industry, but also in the manufacturing sector. This home-office fad will certainly fade with time: a trend towards greater workplace flexibility and more intensive use of online communication already appears to be gaining momentum.
Equally spoken, shortcomings have been identified with regard to data security and privacy. Apple and Google were forced to adapt their operating systems in response to resolute intervention on the part of the German government. As a result, user data of Germany`s Corona-App can no longer be mined in the background and exploited for other purposes, a tactic previously unbeknownst to many users. Another example: Zoom Video Communication, which specializes in video conferencing. The use of its software has been prohibited by numerous companies due to the lack of data security. Nonetheless, the need for modern digital infrastructure was quickly recognised and state-sponsored infrastructure projects are now set to address this issue. The European Union is investing more than EUR 400 million in the development of 5G network technology, with eleven projects scheduled to start in September of this year. America’s presumptive Democratic presidential candidate Joe Biden goes one step further: he has announced his intention to earmark USD 300 billion for the research and development of new technologies like 5G and next-generation batteries.
Investment theme: “Digital transformation – the path to the future” (series of research reports)
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The quarantine measures introduced for the sake of protection and safety have taken a toll on highly complex, economically interrelated systems. COVID-19 has therefore clearly demonstrated that neither the government emergency plans nor those of companies were sufficient to stem the pandemic. It should be noted that the international exchange of goods and services has only recently been choked off by the crisis. But the flow was already hindered in the past several years by increasing protectionist tendencies. To this day, production and supply chains are in disarray and add yet another retardant to any semblance of a return to “business as usual”. In this regard, the pandemic containment measures of various countries, which remain in force and in some cases vary widely, are not at all helpful. The experiences gained from this matrix of factors will force companies to rethink not only their contingency plans, but also their business model and structure. Thus it is foreseeable that international trade will become more expensive and more regulatorily complicated. To mitigate these negative effects in the event of yet another international pandemic, a reorganisation of the tightly intertwined global value chains is necessary. The creation of regionally independent business hubs is at the forefront of this evolutionary process. Digital industry trends in the direction of additive processing (so-called 3D printing) as well as the use of artificial intelligence and virtual reality are rapidly opening new horizons. This will offer companies not only significantly improved flexibility, but also closer proximity to customers and end users.
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For two years now, the polarising international trade dispute, sparked by the USA, has been the cause of gradually rising costs and increased planning uncertainty for internationally active enterprises. COVID-19 adds even more complexity to this problem. Companies with hair-thin margins and a focus on traditional, yet-to-be-digitalised operating processes are threatened. Why? Because the ever-faster pace of industrial change is narrowing margins even further and has already led to the bankruptcy of very large companies (e.g. Hertz, Chesapeake Energy) or brought them very close to the brink of insolvency, as is the case with Germany’s flagship airline Lufthansa and its subsidiary Swiss. At least the latter two, whether they wanted to or not, could count on state aid. As helpful as that money is, government support has its price. After the experiences gained from the 2008/09 financial crisis, when politicians were accused of having afforded banks an unconditional bailout, today blatant demands are being made with regard to management compensation and shareholder dividend pay-outs. Similarly, politically conceived notions of competition are being imposed. For example, in return for its state rescue, Lufthansa had to relinquish important take-off and landing rights, so-called slots, in Frankfurt and Munich. It goes almost without saying that the eurozone member states as well as other countries have their own domestic economy in mind with all of this. The preservation and creation of local jobs is the central objective.
So aside from regional presence, the balance sheet quality and profitability of a company are also key factors. Shares of companies that can boast strong profit growth, combined with solid management and healthy balance sheets, on average significantly outperform the broad market over the medium to long term. So the goal is to seek out the ones with high ROEs and low debt. Also important is that the company is in a position to generate operating cash flow from its revenues. The “cash conversion rate” sheds light on this aspect and reveals how much of the reported net income resulted in direct operating liquidity. This ratio varies considerably depending on the given industrial sector, whereas high-quality companies have a reading in excess of 1.0. For the coming quarters, those with strong management and deep roots in their home market should enjoy considerable advantages.
The battle against climate change, but also against the unequal distribution of wealth, are two declared aims – at least in Europe – of the current EU plans for state investment. At least half of the pledged funds will be tied to the “Green Deal” presented this past spring. In his own campaign speech, Joe Biden coined the expression “Green Recovery” to describe his idea for boosting the US economy, a notion which relies heavily on ecologically sustainable infrastructure projects. However, this does not even come close to capturing the strategic scope of governmental steering measures for combatting climate change. In an extensive study, Goldman Sachs projects that more than 7 trillion US dollars in government funding and private sector investments will be spent by 2050 in an effort to rise to this challenge. Next year, more money will be invested in renewable energy sources than in the entire traditional, fossil-fuel dominated energy sector. Governments intend not only to offer direct investment support, but also to provide further assistance through favourable credit terms and attractive regulations. According to the planned measures under the latest Paris Agreement, 15 to 20 million jobs will be created in the renewable energy sector by 2030.
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The economic environment in the coming quarters will continue to be fraught with myriad uncertainties. COVID-19 will only be one aspect out of many. Added risks can be ascertained already today from the renewed flare-up of trade disputes and heightened geopolitical tensions. On a brighter note, though, the major industrialised nations are showing unprecedented determination to support the economy with large sums of money, but also channelling that support in a way that helps to achieve their own goals, such as ecological renewal. Some of these developments are already underway and offer not only a good reference point in today’s jungle of uncertainties, but also create promising opportunities for investors with an eye towards the long term.
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