The Pandemic Pivot


Imagine the potential rebound if we get a vaccine…

Large companies wasted no time in reacting to the Coronavirus pandemic. Some companies – Amazon and PayPal for example – did not have to change a thing since their businesses benefited from changing buying habits of shoppers. Other companies saw the opportunity to grow new businesses that benefited from on-line shopping and consumers staying home. In all cases, companies reduced expenses dramatically.  Professional service firms eliminated travel, some firms reduced headcount, and all reduced discretionary spending like advertising.

The result has been an earnings season like very few others. More than 80% of companies are reporting earnings above expectations. The last time that many companies were performing above what investors expected – often informed by company guidance – was in late 2009 as some demand returned following the great recession. In fact, the only time this many companies post surprisingly good earnings is following a recession as spending starts to return – the beginning of an economic cycle.

MONTAG has been working for our clients for over 35 years with experienced portfolio managers who have managed through multiple economic cycles. What impressed us with this rebound was the speed with which earnings came back. Picture a CEO who was a mid-level manager in the great recession.  The pandemic hits in late February. Business ground to a halt like it did in September of 2008 when Intel stopped manufacturing computer chips for two weeks. Our CEO friend faces a slowdown of unknown depth and length. In response, all cost cutting plans are enacted which, thanks to planning since 2008, are ready to go with little notice.

The result is a report like O’Reilly Automotive (ORLY). The company cut costs in fear of a sales slowdown that never happened. In fact, home-bound consumers decided to fix the car. Sales grew 19% which, when combined with cost cutting, lead to earnings growth of 67% from the same quarter last year. ORLY now trades at a price higher than before the world knew of Covid.

In other cases, companies got at least a little creative.  Brinker International (EAT) operates Chili’s, Maggiano’s, and now Just Wings. If you have never heard of Just Wings that is because it operates out of the kitchen at Chili’s and is only available for delivery thru Door Dash. Oh, and it has only existed since June 23rd. Based on the first six weeks of operations, EAT expects this brand-new “ghost restaurant” to be $150 million in sales or 5% of the company within the year. EAT is now at the same price it was in 2019.

In some cases, we have not seen the benefit of the reduction in costs. Delta Airlines (DAL) has cut operating expenses by 53% since the beginning of the pandemic. The benefit of these costs cuts was subsumed by a 90% decline in revenue. Once a little revenue comes back the cost cuts will enable the company to get back into the black much quicker than is currently believed. For that revenue to return, people need to feel safe flying again. A vaccine and a more robust treatment regime will likely create this feeling of safety. Several, mostly travel related and gathering related stocks are in this same bucket. DAL is still over 40% lower than it was pre-virus.

Corporate America pivoted in the face of one of the largest unknowns business leaders will ever face in their careers. This swift action led to a “V Rebound” in profits for some companies where cost cutting has resulted in higher earnings than feared. Other companies have taken action but have not seen the fruits of their labor. A vaccine and increasingly robust treatment protocol should benefit this group dependent on consumers returning to old habits from February.

The information provided is for illustration purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action to be taken. These analyses have been produced using data provided by third parties and/or public sources. While the information is believed to be reliable, its accuracy cannot be guaranteed.

Any securities identified were selected for illustrative purposes only. Specific securities identified and described may or may not be held in portfolios managed by the Adviser and do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable.