Another risk is before-and-after pandemic stock comparisons. Many companies have emerged in a different form after COVID-19. Some issued many shares due to emergency capital raisings. Others sold assets, shelved operations or retreated from new markets.
Valuation is the biggest risk. It’s a no-brainer that Qantas Airways will benefit as people fly interstate and eventually overseas. Or that Webjet or Flight Centre Travel Management will gain as holiday bookings soar. But valuations for many reopening plays already reflect that.
Paul Biddle, executive chairman and portfolio manager at Celeste Funds Management, says investors should not buy stocks purely as reopening plays. “They need to know a company’s earnings will rebound and believe the stock can grow faster than the broader market over the next three to five years.”
The key, says Biddle, is owning stocks that benefit from structural rather than temporary change after COVID-19. “Investors need to identify companies that used the crisis to permanently cut their cost base, develop new markets or rationalise their operations. Companies will benefit over the next few years from an acceleration of trends in e-commerce, store rollouts and consumer services.”
Biddle says investors should look beyond the “usual suspects” in reopening plays. “You don’t have to buy airline or travel stocks to benefit when borders reopen. Some of the best recovery plays are less obvious – for example, a recovery in dental appointments when lockdowns end or more people test-driving a new or used vehicle next year.”
Steve Black, co-manager of the Pengana Emerging Companies Fund, says investors should look at sectors where the market is too sceptical about life after COVID-19.
Pathology is an example. Healius and Australian Clinical Labs rallied as demand for testing skyrocketed. The market now expects pathology demand to drop dramatically. Black sees it differently.
“The overseas experience suggests coronavirus-related pathology demand has not fallen away anywhere near as materially as you might think after lockdowns eased,” he says. “People will continue to get tested due to travel and workplace requirements.
“We expect elevated COVID-19 pathology demand for longer. Being a largely automated process, this is very high margin revenue for the labs.”
Black favours Lovisa Holdings and City Chic, two long-term holdings in his fund.
“While a lot of growth has been priced into those stocks, we think consumers will re-stock their wardrobes and jewellery boxes as the world reopens,” he adds.
Burman Invest chief investment officer Julia Lee is focused on behavioural trends from the pandemic. “What will happen to demand for casual clothing and shoes if people spend more of their week working from home? Will there be an increase in demand for co-working spaces or virtual offices if people spend less time in the head office?
“Will the death rate revert to the mean level if people change their healthcare behaviour, and less influenza is spread? What will happen to pet care when pets are left at home as people return to work? There are pockets of opportunities across the market from COVID-19 behavioural change.”
Not all industries will rebound. Lee says some sectors could face problems for years. “I’m seeing an increase in vacant shops during the pandemic. Retail property trusts that own shopping centres should face lower margins if they have to provide greater tenant incentives.”
Ironically, as the market looks for less obvious reopening plays, the big winners could stare investors in the face. Fat Prophets CEO Angus Geddes remains bullish on Qantas Airways. “Qantas will emerge from the pandemic as a much leaner company with bigger profit margins and weaker domestic competition.”
Geddes also favours integrated leisure resorts. “Casino stocks in Macau took an absolute pounding during COVID-19, trading at their lowest valuations in 10 years. Their recovery has a long way to run. Australian and New Zealand casino stocks, such as The Star Entertainment Group and SkyCity Entertainment Group, should benefit from a similar recovery in gaming demand when lockdowns end.”
Geddes believes corporate earnings could rebound more than investors expect when lockdowns end. “The rebound will be faster and larger than the market is pricing in. The sharemarket rally will continue next year, albeit with pullbacks or corrections.”
He says a “massive amount” of pent-up consumer demand will drive the sharemarket higher. “In some states, consumers have been starved of entertainment and other services for months. We’re getting closer to the end with lockdowns, but some stocks are still trading at similar valuations to a year ago, even though their outlook is rapidly improving.”
Few doubt that stronger demand is on its way. But the usual investment rules apply: buy quality companies that will benefit from structural change and are undervalued.
Investors should be wary. The reopening trade is a catchy idea for analysts to promote and the overseas experience, for now, supports their optimism. But COVID-19 is a formidable foe. It wouldn’t take much for the virus to reopen its attack on the market.