Let the buyer beware

As Europe and the USA debate lifting their COVID-19 lockdowns, investor thoughts are increasingly turning to a post-lockdown / pre-vaccine world. Following unprecedented levels of support announced by the Fed, the ECB and the Bank of England, one could argue that recent corporate bond performance has yet to fully reflect divergent prospects across sectors.

There is much to consider. Exit strategies still need clarification. Will we have a staggered release of the population, with those under the age of 40 leading the charge back to work? Which industries will reopen first? (Spain restarted construction activity last week, but will the same pattern follow in each country?) Trump’s three phase reopening plan gives guidance at a federal level as to the order of reopening. Leaving aside the potential for individual state governors to demur, it’s interesting to see large restaurants and sports venues included within Phase 1, notably with the proviso that strict physical distancing protocols should be in place.

Some form of social distancing is certainly likely for the next few months and too few appear to be questioning the impact of this on consumer behavior and demand. Not only is mask wearing and observation of the two metre rule likely to dramatically reduce consumption in many industries (particularly leisure and retail), it will also increase costs due to lower capacity utilisation as well as increased spend on cleaning and distancing management. Has this adequately fed through to company estimates and asset prices? Or does this matter less when there are buyers of last resort with seemingly bottomless pockets? Last week we saw new car sales had plummeted to unprecedented lows, yet Ford, newly returned to high yield territory, was able to tap the US bond market with ease.

For some industries, it’s clear that the effects may be fairly long-lasting and certain sectors are clearly going to take the initial brunt of the crisis – namely the travel related industry. For other industries, credit assessment needs to be more nuanced. For example, the performance of gaming bonds is dividing fairly neatly into those companies with a significant online presence and those that rely on large public gatherings (casino and bingo hall operators). Furthermore there are many seemingly ‘safer’ credits that have large earnings exposure to social gatherings – Diageo has already predicted a large hit to earnings from its bar and restaurant business. And what about the utility-like public transport operators? Will the recent experience of home working and ongoing fears for personal safety result in ongoing lower use of public transport, well beyond the lifting of the curfew?

The staggered nature of this crisis across the globe gives a good insight into what might happen in the next stage and, worryingly, highlights the risk of second waves of infection. China may have re-opened, but it’s definitely not yet business as usual. There is likely to come a point when the discrepancy between economic reality and asset prices becomes unsustainable; the phrase ‘caveat emptor’ (let the buyer beware) has never been more appropriate.

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Auto consolidation evidence of a challenged industry

This week’s confirmation that Fiat Chrysler and Peugeot have approved a possible merger, to create what would be one of the world’s largest auto groups, is no surprise. Fiat had been in merger discussions with Renault earlier this year, and this is the continuation of a trend seen throughout the industry. By joining forces, car companies seek to cut costs and benefit from economies of scale.

Fiat’s fortunes were transformed under the aegis of the late Sergio Marchionne, who believed that the auto sector was in desperate need of consolidation. A Fiat/Peugeot combination would offer huge cost-saving opportunities, economies of scale, and strength in areas where each group is individually under-represented; Fiat‘s North American business (Chrysler) has been outperforming, whereas in recent quarters its European auto business has been barely profitable. Conversely, Peugeot lacks North American exposure.

The combined group would have a market cap larger than Ford and on a par with BMW, although there are many hurdles to jump before these initial talks become anything more solid. What theoretically sounds like a good idea may become mired in the details of what would be largely a cost-cutting exercise – in markets where job reductions are notoriously difficult (Italy and France).

Auto companies are currently facing the double whammy of weakening consumer demand alongside the expense and time of developing an electric vehicle portfolio to comply with stringent emission targets and an increasingly environmentally conscious consumer. Whilst no other auto mega-mergers are known to be on the cards currently, collaboration across technologies and platforms will continue; Ford’s joint venture with Volkswagen on electric vehicles and autonomous driving technology is a case in point.

The global outlook for car demand is resoundingly negative. Whilst I’m not suggesting we are about to revisit the dark days of 2008/9, when European auto CDS spreads blew out to eye-watering levels and two of the big three filed for Chapter 11 bankruptcy, the direction of travel is decidedly downward and forward visibility opaque.

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