The earnings for the quarter ended 31 March 2020 provided the opportunity to see part of the damage inflicted by the coronavirus on our companies and the market in general. The coronavirus has caused a shock to the global economy, so we need to assess how our companies will make it through.
Our investment strategy remains intact and the virus will not change our approach. Our investment universe consists of global companies that own the best brands in the world, and we select those with the most substantial free cash flows and the lowest debt to equity ratios. Our strategy has always excluded banks, except those owned indirectly through Berkshire Hathaway, because of their high debt-to-equity ratio, and we avoid resource companies because they are cyclical.
The earnings reports for the quarter show our companies will survive despite the virus, and some are thriving because of the virus. We are not selling any of our investments.
Massive sales declines
The biggest challenge facing many companies is that their customers have disappeared. For example, sales at restaurants and any business dependent on people gathering have declined.
Our companies are not immune. In the first-quarter YUM! China showed sales declines of 40-50%, Starbucks sales in China declined 50%, and McDonald’s showed a sales drop of 37% in international markets outside the USA. These companies have shifted almost exclusively to a drive-through and delivery model. The Walt Disney Company has closed all theme parks and hotels and cancelled all cruises, and the ESPN Sports Television Channel was affected by the cancellation of all sporting events.
Our luxury companies LVMH and Kering have seen sales decline due to international travel bans and deserted high streets in the world’s largest cities.
The food and beverage companies have also suffered sales declines. Coca-Cola saw a 25% sales decline under lockdown conditions. Their away-from-home business has declined.
ABInBev and Constellation Brands, our two beer companies, have seen revenue decreases due to the closure of all restaurants, bars, social venues and sporting and other events. Home consumption has increased but cannot make up for all sales lost in other channels.
PepsiCo’s mix of beverages and snacks enabled a sales increase for the first three months of the year despite the virus. Nestlé, Procter & Gamble and Johnson & Johnson showed how indispensable their products are as they also increased sales. Unilever had a small sales decline.
Walmart and Amazon have both increased hiring to fulfil online orders and other sales. Both have been deemed essential to the distribution of food and other must-have items.
The technology companies have held up well with Microsoft and Google increasing sales. Both reported that forced remote working has caused more people to use their services than ever before. Both companies have grown their cloud business and seen demand for video conferencing and other collaboration tools. Apple also exceeded expectations.
The next quarter’s sales are likely to show a similar pattern as the results reflect a slow opening up in China and the impact of the US and European shutdowns. Most companies withdrew guidance for the rest of the year due to uncertainty regarding a solution to the virus.
We can expect a weak and potentially worse Q2 set of results in June.
Our businesses will prevail.
All our companies have confirmed they have access to funding for a protracted lockdown, should that materialise. None of our companies required government loans or bailouts to date.
A slow opening-up
The process of opening up the world’s economy will progress slowly. As seen in China, people are still afraid to leave their homes even when “stay at home orders” have been relaxed. Restaurants and shopping malls remain empty. Only an effective and available treatment, a vaccine or herd immunity will provide the certainty needed to return to mass social gatherings.
Our brands have weathered many crises before, but the scale of coronavirus is unprecedented. We believe they have the resources to prevail because they remain essential to humans, and they can access finance if need be. They have low debt-to-equity ratios. They will emerge leaner and geared to operate in a “new normal”, whatever that ends up meaning.
Warren Buffett says that “You can only see who is swimming naked when the tide goes out”. Now is the time to see which businesses are built for good times, as well as bad. Those with too much debt, weak cash generation and unsustainable propositions will not make it, regardless of the trillions of dollars the US Federal Reserve is providing. Failing companies means less competition for the leaders in each market segment. While we do not wish failure on any business, it will mean increased market share for those who prevail. We expect our companies to emerge the crisis with increased market share.
Our investment thesis will not change. We remain focused on the very few great companies, and we continue to build concentrated portfolios for our clients.