Novum Alpha - Daily Analysis 2 December 2020 (8-Minute Read)
Winding into Wednesday and I hope it's working out to be wonderful for you!
In brief (TL:DR)
In today's issue...
Like the town crier, central bankers and finance ministers are warning that things are likely to get a whole lot worse before they get any better.
Yet one couldn't tell by peeking into markets, with stocks looking to set all-time records.
Traditional measures of valuation have gone out the window and the pandemic has made traders of us all, and the willingness of both central bankers and governments to act will only pump markets further.
But that may be a "later me" problem as investors have jumped into risk assets with abandon, even as surging debt loads threaten to derail any robust growth plans firms have post-pandemic.
In Asia, a fresh spate of coronavirus infections led to a mixed bag, with Tokyo's Nikkei 225 (-0.10%), and Sydney’s ASX 200 (-0.26%) down while Hong Kong's Hang Seng Index (+0.86%) and Seoul’
1. Debt, Debt, Everywhere, But Not a Dollar to Spend
With optimism over coronavirus vaccines fueling a resurgence in value stocks, many investors are pricing in a recovery in the prospects for airlines, hospitality and other sectors badly hit by the pandemic.
Economists at the Federal Reserve Bank of New York are however less bullish.
For companies that were already nursing a heavy debt load before entering the pandemic, fresh debt will slow their recovery prospects by as much as 10%.
In a blog post, Kristian Blickle and João Santos suggest that firms in industries most affected by the pandemic, in particular tourism, travel and hospitality, could grow as much as 10% more slowly than in ordinary times, if the current crisis plays out in a similar way to the economic decline between 2007 and 2009.
According to the Fed economists, companies with higher levels of debt experienced 3% slower growth during the 2008 financial crisis compared to less indebted peers, with the gap closer to 2% under normal conditions.
And given the unprecedented amount of debt that some firms in industries badly hit by the pandemic have had to take on, that gulf between the indebted and debt-free could provide serious dents on growth in the coming years.
Airlines which were grounded and cruise operators which ran aground because of the coronavirus have taken on an enormous amounts of debt with negligible revenues over the course of the pandemic.
And while the Fed has pledged to keep borrowing costs low until 2023, these debt loads will eventually put a drag on profits, in particular for airlines, where operating margins are notoriously thin.
Blickle and Santos suggest,
“The Covid-19 outbreak has the potential to have an even bigger effect on the economy through the channel of debt overhang than what we identified in the Great Recession.”
In the decade after the 2008 financial crisis, interest rates and inflation barely budged, fueling a post-crisis period of economic growth and low levels of unemployment in the United States.
But right now, some of America’s most storied names, from Boeing (+2.55%) to Carnival (+0.90%), Delta Airlines (-0.72%) to Exxon Mobil (+0.97%) and Macy’s (+0.81%) aren’t earning enough to even cover their interest expenses after borrowing billions of dollars over the past few months to get through the pandemic.
The situation appears especially dire for retailers like Macy’s, especially when retail consumption patterns may have changed for good.
Large debt loads also hamper the ability of firms to borrow money to rapidly expand when the economy starts growing again, as creditors will think twice about lending and even when they do lend, may insist on more onerous terms.
Fragmented ownership of corporate debt and differing maturities on that debt may also further increase the cost of the debt overhang in the aftermath of the pandemic.
While small companies that are over-leveraged may find it difficult to take advantage of the bankruptcy process to ease their debt burden.
So while value stocks may be starting to perk up now, the road to recovery is a long one and the immediate aftermath of the pandemic may draw into sharp focus the difference in the fortunes between the indebted and the debt-free.
2. Profits go Zoom?
Every morning, the first thing I do when I roll out of bed is look at my phone.
It then takes me a full 7 seconds to walk through the door of my study and get on the first video call of the day, normally via Zoom.
Before the pandemic, my commute to the office took about 45 minutes. That’s 45 minutes that I could have spent more productively and 90 minutes of my day that I’ve gotten back every day, 5 days a week.
And assuming that I work an average ten hours a day (it’s often more), that’s 495 hours of my life that I’ve just gotten back in a year or about 20 days.
Put in those terms, it’s hard for me to justify a full return to the office for myself or my staff.
True, I miss the camaraderie of the office, the smell of freshly ground coffee and the hustle and the bustle of the city.
But I don’t miss the traffic, the crowds or the commute.
And I’m willing to bet that more than a handful of people feel the same way.
“Sow a thought and you reap an action. Sow an act and you reap a habit. Sow a habit and you reap a character. Sow a character and you reap a destiny.”
- Ralph Waldo Emerson
For millions of people around the world, the pandemic has now stretched to almost a year, with periods of lockdown interspersed between periods of self-imposed quarantine.
Social distancing has gone from an imposition to a habit.
And while humans are social creatures, technology has enabled us to do just that without meeting face-to-face.
The number of video communications apps that line up my taskbar have increased exponentially since the start of the pandemic.
Depending on who I’m speaking with and where they’re from I could be using any number of tools, but the one that the vast majority seem to fall back on is Zoom.
But investors are now betting that Zoom Video Communications may not be able to hold on to it’s market lead after its third-quarter results brought the high-flying stock’s rally to a grinding halt.
Analysts are now questioning whether the video conferencing company’s momentum can be sustained post-pandemic, as more people return to working in offices and traveling to visit friends and family once a coronavirus vaccine is widely available.
But such analysis underestimates the durable nature of some of the changes that have taken place in both the office and in social interactions.
Whereas companies previously wouldn’t think twice about jetting their executives thousands of miles across the planet for meetings and conferences, justifying such expenses, especially when companies are nursing debt loads, becomes harder.
And with many workers evacuating cities, some of these moves will prove permanent, with towns and the countryside reinvigorated as people become more accustomed to telecommuting as opposed to the physical variety.
Zoom’s revenue forecast for the current quarter was at the higher end of analyst estimates but suggested a drop in its explosive growth, highlighting concerns that 2021 won’t be great for the firm.
To be sure, anyone who needed a Zoom account probably already has one, but analysts may also be underestimating the network effect that Zoom enjoys – it costs more for a user to not have a Zoom account if everyone else around them does, the bigger question is whether it’s a paid or free account.
With a price-to-earnings ratio of 270, Zoom is looking frothy.
And because Zoom is a bit of a one-trick-pony, it is at risk of going the route of Netscape, an early internet browser that was eviscerated when Microsoft (+1.00%) bundled Internet Explorer for free with Windows 95.
There are other video communications apps outside of Zoom that could relatively easily copy its user friendliness, including Google (+2.33%) Meet and Microsoft Teams.
Facebook (+3.46%) has also shown a willingness to enter into the video communications fray, to cover our more social interactions, and let’s not forget Apple’s (+3.08%) user-friendly Facetime.
While companies may lament the days before Zoom, it’s prime may be over if it doesn’t pull some additional tricks up its sleeve.
Given the popularity of Zoom for webinars, Zoom may want to consider looking into beefing up its software to offer virtual conferencing and exhibition services.
Otherwise the company exposes itself to the risk of going the way of Netscape.
3. I'll See Your Bet & Raise You A Digital Yuan
As the pandemic prevented Chinese gamblers from getting their fix in the Chinese gambling mecca of Macau, revenues at the former Portuguese colony plummeted by US$27 billion.
And while visitors are slowly returning, there is a bigger threat looming on the horizon for the world’s biggest casino hub – the digital yuan.
China’s central bank-issued digital currency has already enjoyed a successful trial in four major cities, with several million dollars’ worth of digital yuan “airdropped” in denominations of US$30 to trial participants for spending through digital wallets.
Macau has long been a hotbed for wealthy Chinese to both get their game on and get their money out of the Middle Kingdom.
And while no formal plans have been announced, the prospect of a digital yuan (that is inherently traceable) has already seen some junkets, businesses that work to attract high rollers to the gambling capital, exit the market in search of opportunities elsewhere.
The imposition of a traceable, government-linked digital currency could be the final nail in the coffin for Macau's junket industry, which has already been hobbled by the pandemic’s impact and stricter rules surrounding high-stakes gambling over the past few years as part of Chinese President Xi Jinping’s moves to clamp down on corruption and money laundering.
According to reports by Bloomberg, some casino operators say that they have already been approached by Macau’s gaming regulator over the past few months to discuss the feasibility of using digital yuan to buy casino chips.
Currently, casino chips are denominated in Hong Kong dollars and a shift would make it that much harder for Chinese looking to spirit away their wealth out of China.
Introducing the digital yuan to Macau’s casinos would mean that high rolling Chinese gamblers would no longer need to convert their yuan to Hong Kong dollars, reducing the role of junkets in providing credit, and giving Beijing greater insight into cash flows through Macau’s casino halls.
A digital yuan would also reduce the ability to launder money through Macau’s junket system as well.
Nonetheless, the move could also help make Macau more attractive to leisure travelers and middle-class Chinese tourists, for whom digital payments via Alipay and WeChat Pay is near universal.
The convenience of using a digital yuan to buy chips in Macau would appeal to consumers who normally would have bring cash or credit cards, the latter of which are uncommon in mainland China.
In the meantime, Macau’s junket operators are fanning out to Russia and the Philippines in search of other opportunities.
For Macau, the digital yuan stakes couldn't be higher.
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Dec 02, 2020
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