Most parts of the world have been in a lockdown mode over the last 5-7 weeks with the objective of ‘flattening the curve’ to reduce the impact of Covid-19. Compared with the original fears over Covid-19, the situation, though still bad, does not seem as dire as it was assumed earlier. Moreover, India seems to be less affected than many other parts of the world. The focus for businesses and the government is now beginning to shift to the economic impact of the lockdown and how we can slowly move back to a situation of greater normalcy. Over the next few weeks, one should see a gradual withdrawal of the lockdown in India. One can also expect some form of economic stimulus measures to be announced by the government. A big challenge would be to get demand back, as both businesses and individuals are moving to a cash conservation mode given the overall uncertainty.
Even with the best of measures that have been employed, one can’t ignore the fact that most companies have been badly affected in the short term. These are challenging times for investors. With the stock markets down sharply, on the one hand we see attractive stock prices; on the other hand, the future is unclear and one needs to carefully evaluate the impact on the individual businesses, as the impact varies depending on the business. Safety first has always been our investment motto and that becomes even more important in times like this.
We are sticking with the simple and predictable businesses in our portfolios. Many businesses are not dramatically affected due to the lockdown or they expect to get back to ‘near’ normalcy within a few quarters after the lockdown is lifted. In a few cases, we can expect companies to benefit as they gain from favorable long term change in customer demand patterns or gain market share at the cost of weaker competitors. The worst affected are businesses where customer demand patterns may never return to their original trajectory and in our best opinion we have little exposure to such businesses.
We have always focused on investing in companies with very strong balance sheets, and apart from the strong banks & NBFCs in the portfolio, almost all portfolio components are cash rich companies with little or no debt. Such companies have a natural advantage in such times, especially compared with asset heavy companies with high amounts of debt. Cash flow is a serious problem in current times, with delayed customer payments, broken down supply chains, force majeure clauses calling for cancellation of orders or having to service debt with no operating cash flow to pay interest. Having a strong balance sheet helps in creating faith with all partners in the company’s eco-system – customers, employees or suppliers. Strong relationships are built in periods like this, the benefit of which in terms of strengthened competitive advantage or moat, will be reaped over several years.
Finally, the challenge for investors is to juggle between the potential upside – as and when the businesses return to normalcy – and the risks of a further drop in stock prices, if the Covid-19 related risks persists for a much longer period than currently anticipated. There is also this cloud of the fiscal strain the government needs to carry. Given current valuations of many companies, the potential rewards can be fairly attractive as long as one can manage the risks. More so in an environment where alternative investment options like fixed income or even real estate are beginning to face high levels of uncertainty.