Investment Insight | Reopening
In many parts of the world, people are beginning to return to a more normal life. Schools and restaurants are open, and people can travel freely. The combination of a percentage of population that has had COVID-19 and high vaccination rates means that governments are willing to relax restrictions and begin to re-open their economies.
This path to reopening received a boost recently with the announcement of positive trial results for an anti-viral drug from Merck. This drug, Molnupiravir, cuts hospitalisation rates of COVID-19 patients by about half. Importantly, it is also in pill form and is the first oral treatment that has shown promise in treating COVID-19.
The other current antiviral, Remdesivir, can only be administered intravenously which makes it difficult for people to access before they are sick enough to be admitted to hospital. Having the option of a pill allows treatment earlier, when the patient is less sick.
NZ Funds’ Investment Team have been considering which companies will benefit from a broader reopening of the economies. Here are a few examples that are now in client portfolios.
Rubbish
GFL Environmental is a US$15 billion waste business with operations in Canada and the United States. Now, when you are thinking reopening a rubbish business is probably not the first company that comes to mind. However, there are two reasons why this is a business that is well suited to a post-COVID-19 world – volume and inflation.
Volume improves: The core residential rubbish collection business is very stable throughout the economic cycle. However other areas such as business waste are more cyclical and dependent on the level of economic activity. Business waste, i.e. the skip bin out the back of a business, is dependent on those companies operating. Equally, GFL has an infrastructure and soil remediation business which is highly depended on large scale projects. This was shut down for much of last year and is the last area of activity to come back into operation. Additionally, it is an area of focus for government spending going forward.
Inflation is a positive not a negative for waste businesses: Municipal and large corporate rubbish contracts are long-term contracts of five, seven or even ten years duration. Given the length of these contracts they are annually reset based on inflation. This means that GFL’s business is likely to enjoy both better volumes and better pricing during a period of economic expansion.
Airlines
Globally, airlines are still operating on reduced schedules compared to where they were prior to COVID-19. The level of revenue and earnings recovery is highly dependent on where the airline is located.
For example, some United States and European airlines have recovered revenues to around 70% – 80% of their pre-COVID levels. This is because their core markets in the United States and Europe are largely free of travel restrictions. However, many Asian and Pacific airlines are still only generating revenues of around 50% of pre-COVID levels as many Asia-Pacific countries are still operating under restricted travel to keep COVID-19 cases low. Examples of airlines impacted in Asia-Pacific include Air New Zealand and Qantas.
We are invested in airlines where we believe the expected revenue and earnings recovery over the next 24 months is not yet reflected in its valuation. Air New Zealand and Qantas do not fit these criteria. While they have significant earnings recovery to come, we see this as already reflected in their valuations. Air New Zealand also has a significant capital structure issue which needs addressing which may include a well-publicised capital raise. Should Air New Zealand raise capital, it becomes an investable airline, and we will look to take a position at the right valuation.
Two specific examples of airlines we do own are Hawaiian Airlines and Southwest Airlines – both with very different value propositions. Hawaiian Airlines international business is yet to recover. However there remains significant upside to its earnings as global travel fully opens and travellers flock to holiday destinations like Hawaii.
Southwest Airlines is one of the best run budget airlines in the world. Its investment case is centred on the fact its low-cost operation combined with its strong balance sheet have allowed it to take market share during COVID-19. This is enabling it to grow earnings to levels well above its pre-COVID earnings as the world comes out of lockdowns.
Opportunities abound
Other companies we are looking at include events or experience companies which are starting to see a significant recovery in their business as vaccination levels increase and lockdowns subside. Examples include Live Nation, one of the largest producers of live concerts and events in the world, and Six Flags Entertainment which operates theme parks across North America.
On the other hand, there are companies which have performed well while economies were ‘locked down’ because consumers went online to buy their products, and companies with customers who have rushed to buy products as they have come out of lockdown. This ‘pent-up demand’ tailwind does not tend to last as the world returns to normality and some of these companies may see flat or decreasing revenues and earnings. This tends to be focussed in areas like retailers like Bed Bath & Beyond or technology companies such as Zoom.
Stock pickers environment
We believe now may be the best time in recent history to invest with an active approach in shares. A reflation of the global economy - driven by vaccines, economic stimulus and continued supportive monetary policy - is contributing to greater market breadth and dispersion as cyclical shares have begun to outperform the narrow group of shares that benefitted most from stay-at-home orders which led the equity markets higher in 2020. Clients’ portfolios are positioned to take advantage of this rotation.
This path to reopening received a boost recently with the announcement of positive trial results for an anti-viral drug from Merck. This drug, Molnupiravir, cuts hospitalisation rates of COVID-19 patients by about half. Importantly, it is also in pill form and is the first oral treatment that has shown promise in treating COVID-19.
The other current antiviral, Remdesivir, can only be administered intravenously which makes it difficult for people to access before they are sick enough to be admitted to hospital. Having the option of a pill allows treatment earlier, when the patient is less sick.
NZ Funds’ Investment Team have been considering which companies will benefit from a broader reopening of the economies. Here are a few examples that are now in client portfolios.
Rubbish
GFL Environmental is a US$15 billion waste business with operations in Canada and the United States. Now, when you are thinking reopening a rubbish business is probably not the first company that comes to mind. However, there are two reasons why this is a business that is well suited to a post-COVID-19 world – volume and inflation.
Volume improves: The core residential rubbish collection business is very stable throughout the economic cycle. However other areas such as business waste are more cyclical and dependent on the level of economic activity. Business waste, i.e. the skip bin out the back of a business, is dependent on those companies operating. Equally, GFL has an infrastructure and soil remediation business which is highly depended on large scale projects. This was shut down for much of last year and is the last area of activity to come back into operation. Additionally, it is an area of focus for government spending going forward.
Inflation is a positive not a negative for waste businesses: Municipal and large corporate rubbish contracts are long-term contracts of five, seven or even ten years duration. Given the length of these contracts they are annually reset based on inflation. This means that GFL’s business is likely to enjoy both better volumes and better pricing during a period of economic expansion.
Airlines
Globally, airlines are still operating on reduced schedules compared to where they were prior to COVID-19. The level of revenue and earnings recovery is highly dependent on where the airline is located.
For example, some United States and European airlines have recovered revenues to around 70% – 80% of their pre-COVID levels. This is because their core markets in the United States and Europe are largely free of travel restrictions. However, many Asian and Pacific airlines are still only generating revenues of around 50% of pre-COVID levels as many Asia-Pacific countries are still operating under restricted travel to keep COVID-19 cases low. Examples of airlines impacted in Asia-Pacific include Air New Zealand and Qantas.
We are invested in airlines where we believe the expected revenue and earnings recovery over the next 24 months is not yet reflected in its valuation. Air New Zealand and Qantas do not fit these criteria. While they have significant earnings recovery to come, we see this as already reflected in their valuations. Air New Zealand also has a significant capital structure issue which needs addressing which may include a well-publicised capital raise. Should Air New Zealand raise capital, it becomes an investable airline, and we will look to take a position at the right valuation.
Two specific examples of airlines we do own are Hawaiian Airlines and Southwest Airlines – both with very different value propositions. Hawaiian Airlines international business is yet to recover. However there remains significant upside to its earnings as global travel fully opens and travellers flock to holiday destinations like Hawaii.
Southwest Airlines is one of the best run budget airlines in the world. Its investment case is centred on the fact its low-cost operation combined with its strong balance sheet have allowed it to take market share during COVID-19. This is enabling it to grow earnings to levels well above its pre-COVID earnings as the world comes out of lockdowns.
Opportunities abound
Other companies we are looking at include events or experience companies which are starting to see a significant recovery in their business as vaccination levels increase and lockdowns subside. Examples include Live Nation, one of the largest producers of live concerts and events in the world, and Six Flags Entertainment which operates theme parks across North America.
On the other hand, there are companies which have performed well while economies were ‘locked down’ because consumers went online to buy their products, and companies with customers who have rushed to buy products as they have come out of lockdown. This ‘pent-up demand’ tailwind does not tend to last as the world returns to normality and some of these companies may see flat or decreasing revenues and earnings. This tends to be focussed in areas like retailers like Bed Bath & Beyond or technology companies such as Zoom.
Stock pickers environment
We believe now may be the best time in recent history to invest with an active approach in shares. A reflation of the global economy - driven by vaccines, economic stimulus and continued supportive monetary policy - is contributing to greater market breadth and dispersion as cyclical shares have begun to outperform the narrow group of shares that benefitted most from stay-at-home orders which led the equity markets higher in 2020. Clients’ portfolios are positioned to take advantage of this rotation.
Source: Bloomberg.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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Mark Brooks is Portfolio Manager for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. Mark's comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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Andrew Curtayne is Portfolio Manager for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. Andrew's comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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