Is the US about to experience a nasty spike in coronavirus cases?
With markets bouncing it is worth making a couple of observations. Firstly, there were periods during the Global Financial Crisis when the market rallied as much as 10 per cent. Secondly, there is a solid relationship between really ugly COVID-19 case spikes and inadequate early testing.
If a country fails to conduct tens of thousands of early tests and then follows those tests up by tracing the source, they experience nightmarish spikes in COVID-19 cases. Italy is discovering this now as it’s delayed testing program finally ramps up and finding a 17 per cent detection rate.
The US is well behind Italy in terms of testing and we currently expect it will soon be witness to massive spikes in confirmed cases, just as Italy has.
South Korea has tested 4000 people per million. Cumulatively, the US has only tested 26 people per million! And, unsurprisingly, the more you look, the more you find. The difference between the US and South Korea is that South Korea knew they had a problem and went really hard on testing. The US has not followed that path and they are behind the curve. Compounding the issue for the US is their tests, until now, haven’t been working.
In terms of impact, airlines are on the COVID-19 frontline. Our national carrier, Qantas has materially cut its domestic capacity by 5 per cent and its international capacity by 23 per cent in response to the fall in demand for travel – something we predicted when we noted the panic could be worse than the pandemic.
From the company’s fleet of twelve A380s, only two aircraft remain in service. Capacity cuts and massive fare price discounting will act to hit revenue hard. On the costs side of the business, Alan Joyce has announced he won’t be taking a salary for the rest of the year, nor a bonus (valued at an estimated $23 million), and staff have been asked to take paid and unpaid leave to limit the need for redundancies. Almost 2000 staff are reported to have been furloughed while some executives will accept a 30 per cent pay cut. Qantas has also suspended its A$150 million buyback, which was only announced in February.
Our channel checks have revealed that management believe the issues won’t be resolved until at least September. Eventual recovery is therefore something to expect in the first or second half of FY21.
The hit to earnings means the company’s leverage ratios are likely to climb and interest coverage ratios fall. Nevertheless, the balance sheet appears solid, with almost $2 billion in cash and another billion dollars in undrawn facilities.
With the worst of the COVID-19 case numbers and fatalities still ahead, Qantas will need every cent.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Trent Russell
:
Thanks Roger,
As always you are a font of knowledge….the oracle of Australia:)
Trent
Prasad Gunaratne
:
Thanks Roger. But you start with the US and then finish on Qantas :)
Alan Joyce was more upbeat about their prospects on recovery at the press conference. though!
Roger Montgomery
:
Hi Prasad, The only thing moving faster than the speed of thought is the markets at the moment!
Greg McLennan
:
G’day Roger,
I think you’re right about the likelihood of a significant increase in reported cases, for the reasons you put forward. That would probably send the market skittering again. I suspect, though, that as testing improves, the reported mortality rate per thousand infections will fall. As it stands, you can bet that the vast majority of victims who died from coronavirus will have been tested (before or after the event). Most people with very mild symptoms, like Dr Chris Higgins last week whose symptoms did not rate against the Aust Government’s guidelines, will not have been routinely tested up to now and therefore will not be included in the mortality rate figures. Currently in Australia we have about 120 reported cases and three deaths – but I would expect that the number of actual cases will be higher than 120.
None of this is to diminish the effects of the virus on those with other co-morbidities who appear to suffer disproportionately to the rest of the population, but coronavirus is not exactly like black plague taking out one-in-three Europeans back in the day.
Roger Montgomery
:
Well put Greg and that is certainly the scenario we are considering hence the finger on the trigger so to speak. if the panic is worse than the pandemic, you can apprciate financial markets might act irrationally though.
Greg McLennan
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Oh yes, I have every confidence that the market will act irrationally. It’s just a crowd of human beings, after all – and judging from the toilet paper aisle at the supermarket this afternoon which I checked just for giggles (bare shelves) – crowds of humans aren’t rational.
During the GFC, I remember you advising something along the lines of “to identify wonderful businesses, wait until they are ridiculously cheap, then wait a bit longer”. I suspect that things are not yet as bad as they are going to get and new ‘bad news’ comes out every day so fear still rules for now.
That said, I would expect that while the number of reported infections will likely increase in the near term due to improved testing, the number of actual infections will start to fall as the northern hemisphere comes out of winter. My guess (and it is a guess) is that the worst of the news relating to the virus itself will be out within a month, then markets will start to look forward to recovery, even if it is a bit bumpy as the economic consequences of all the disruption work themselves out. That’s assuming there are no major liquidity events in the meantime…
Roger Montgomery
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I tend to agree Greg!
Trent Russell
:
Hi Roger,
I have never invested in commercial airlines, however have held airbus for a few years now. I was wondering whether you could explain why Warren Buffet has always stated that airlines are a poor investment yet has held airlines now for several years. My question then relates to Qantas, this seems to be a business that has done quite a good job over the last few years of restructuring its business to better position itself against the challenges faced by the industry. Its share price is down close to 40% over the past month due to the obvious concerns about earnings in the months ahead. So Im wondering one, why Warren Buffet now sees these companies as good investments and two, would Qantas now been a business to consider?
Trent
Roger Montgomery
:
With respect to Berkshire’s Airline investments, just remember there are two much younger guys running some of the portfolio for Warren Buffett and Charlie Munger. Here’s Chalrie explaining the reasoning: https://www.youtube.com/watch?v=jEg35ZajeVE. WIth respect to Qantas I am not sure restructuring is the real reason it is performing better. I think management of the company will be the first to have never purchased a plane! SOme of the recent acquisitions were order by Dixon years ago. In other words the performance of the business has been boosted by ageing the fleet to one of the oldest around. The next CEO is going to have to go on a massive capital expenditure program one day. And relatively cheap oil prices have been a huge help too. Not sure the economics of airlines have changed all that much.