JEAN PIERRE VERSTER: Winning with losers
It is often easier to identify future losers than future winners
Generating an above-average investment return is hard. It isn’t complex, though. All you need to do is hold shares in companies that sustainably grow earnings at an above-average rate for the long term, letting the wonder of compounding do its thing.
The hard part is to determine, in advance, which companies will sustainably grow their earnings at an above-average rate far into the future.
The inverse is also true. One can make money by shorting shares of companies whose earnings will shrink in the future. It is often easier to identify future losers than future winners. There are more companies which generate a below-average investment return over the long term than those which generate an above-average return. This has been particularly noticeable recently. A few exceptional companies have driven many global market indices to near-record highs, even while most constituents of these indices have underperformed. Let’s look at some potential candidates for long-term shorts:
The rapid adoption of video communication due to social distancing will probably lead to significantly less business travel in future. While leisure travel is expected to recover, business travel might take many years to get close to historical activity levels. This is not good for commercial airlines such as American Airlines or Deutsche Lufthansa. Second-order consequences would affect airplane manufacturers such as Boeing and Airbus, aircraft parts suppliers such as Rolls-Royce and TransDigm, as well as electronic booking systems such as Amadeus and Sabre.
The jump in global online retail sales over the past few months has come at the expense of physical stores. While convenience stores and those operators focused on outlying areas have been more resilient, owners of large malls in metropolitan areas are battling to maintain their rental income levels and dividend payouts. SA investors have seen, up close, the demise of Intu Properties. Globally, companies such as Scentre (in Australia), Simon Property Group (in the US) and Klépierre (in France) are in a precarious position. Due to Reit tax rules around the world, where almost all profits should be distributed, it is near-impossible for these companies to de-gear without significant tax leakage or the dilution of current investors.
Oil & gas
With decreasing fuel use, the losers in a less carbon-centric world would be companies operating in the oil & gas value chain. This includes upstream players (those who extract oil) such as ConocoPhillips, midstream players (those who transport and store oil) such as Kinder Morgan and downstream players (those who refine and sell oil/fuel) such as Chevron. We expect this industry’s relative winners to be the owners of convenience stores next to fuel stations, if they successfully adapt to the changing utility of the forecourt.
In the most recent earnings announcements of the major global investment banks, trading income saved the day. The volatility in equity, fixed income, currency and commodity markets year-to-date have allowed banks to reap a profit bonanza from trading. As volatility subsides, continued overall profit growth will depend more on strong fee and lending income growth. In the short term, capital raising and balance sheet restructuring fees will be a boon, but in the longer term, lower economic growth will depress corporate activity.
Exceptionally low interest rates will also severely compress lending margins. Widespread corporate failures, perhaps delayed rather than avoided, would also have a negative impact on investment banking profitability. We believe that London-listed Barclays and Standard Chartered could struggle, as could Tokyo-listed Mitsubishi UFJ and Sumitomo Mitsui.
With advertising spend chasing eyeballs on social media platforms, revenue earned by traditional linear TV stations such as the UK’s ITV and Germany’s ProSiebenSat.1 could be structurally lower in future. An increasing proportion of viewers are getting used to video-on-demand subscription services such as Netflix and Amazon Prime, making linear TV feel unnatural and antiquated. With Netflix venturing into producing local content, a niche that has been a refuge for local TV stations is now also under threat. It is difficult to see how the traditional linear TV industry will not go the same way as the traditional print industry (where profitability is, literally, gone).
The big money is made by holding great companies for the long term, but don’t dismiss shorting mediocre companies. There is money to be made in identifying tomorrow’s losers.
- Verster is CEO of Protea Capital Management
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