- The strategy is based on making investment when milestones of disease containment and economic recovery are reached.
- Risks of a resurgence of new cases and protracted time of recovery caused me to lightly load the portion of capital for the early milestones.
- First milestone, inflection of new cases, has been reached and I bought some Berkshire Hathaway and Visa shares.
- 1Q results provided an early look of an ugly 2Q but also confirmed the strength of these companies.
A March 26 article described a list of companies that I would consider buying when there is “Blood on the Street”. The intention of that article is to share and to solicit feedback on the companies which have the business model, balance sheet strength and ample liquidity to not only survive this Covid-19 induced economic downturn, but will exit the downturn stronger than before. I did get a lot of feedback and added two names to my list.
An April 12 article described a strategy to commit fresh capital to these companies. The strategy is centered around a set of milestones regarding containment of the pandemic and the reopening of the economy. The strategy is to commit a portion of my available capital when these milestones are reached. I also presented a list of risks to watch.
In this article, I will describe the status of the execution of this plan and some refinement to the milestones and risks. I will also provide some takeaways from recent 1Q earning releases. I should caution the readers that I am not a health care or medical science professional. All the information that I gather about the disease are from publicly available sources from which I draw my conclusions to help navigate my investment decision. The purpose of this article is to share my thoughts and solicit feedback to help refine my strategy and to uncover potential blind spots.
A recap of the shopping list and execution strategy
The companies on my “Blood on the Street” shopping list are Amazon (AMZN), Alphabet (GOOGL), Visa (V), Mastercard (MA), Berkshire Hathaway (BRK.B), Charles Schwab (SCHW), ETFMG Prime Cyber Security ETF (HACK), Microsoft (MSFT), and Disney (DIS). The last two companies were added after feedback from SA readers.
My strategy for committing fresh capital is based on milestones for containing the pandemic and the recovery of the economy. I have fine-tuned these milestones since the April 12 article. These milestones are: the inflection of new confirmed cases as percent of new tests; execution of initial reopening of the economy (mostly Southern States); evidence of recovery of economy of countries such as China, Korea and Germany whose economies were affected by the pandemic earlier than the US; evidence of recovery of the rest of the US economy.
To execute this strategy, I have assigned a portion of my available capital to each milestone. The plan is to buy some of the companies on the list as each milestone is reached.
There are underlying assumptions that I have made. I have assumed that both monetary and fiscal policies are and will continue to be supportive of the economy and its recovery. I have also assumed that there will be vaccines available against the SARS-CoV-2 virus and that immunization of the masses will begin within twelve to eighteen months. Hence, any negative development of these underlying assumptions may cause me to raise a red flag and raise cash instead.
There are other risks that I watch, the biggest of which is a resurgence of infection after reopening of the economy. I also watch for any setbacks from reopening in other countries such as China, Korea and Germany. Another risk is a protracted recovery of the economy or an L-shaped recovery. Because of the risks and the largely unknown nature of the disease, I have kept the portion of available capital for the first two milestones relatively small.
First milestone, inflection of new cases, has been reached
I originally tracked only the data of new daily confirmed cases. The data showed that the new daily confirmed cases is not declining (blue line in Figure 1). This is a result of expanded testing capacity, resulting in more people being tested. Hence, I added a new metric of confirmed positive cases as percent of new tests (red line). This metric shows that the percent of new positive cases is on the decline in the US, albeit gradually. For some states, such as Texas and Florida, that are gradually reopening their economy, the percent of confirmed cases is declining and is below 10% (Figure 2). As a result of these data, I have decided that the first milestone of disease containment has been reached. I purchased shares in BRK.B and V with the first portion of my available capital.
Figure 1: US Covid-19 daily new cases and daily positive cases as % of new tests performed. Source: The COVID Tracking Project.
Figure 2: Covid-19 daily confirmed positive cases as percent of new tests for Texas and Florida. Source: The COVID Tracking Project.
1Q results provide an early look of an ugly 2Q but also confirmed the strength of these companies
Most of the companies on the shopping list have reported their 1Q results. The results, guidance and colors provided point to a tough 2Q. Even in the case of AMZN where revenue growth accelerated, the cost of doing business in this environment is projected to be high. Generally, my takeaway from the conference calls is that these companies are managing their businesses prudently and should exit the other side stronger.
GOOGL reported 1Q revenue up about 13% YoY with non-GAAP net of $9.87 per share, slightly below consensus of $10.33. The most important piece of data was that while its search ad revenue exited the quarter down mid-teen YoY but have not seen further deterioration for the month of April. While management cautioned against projecting the quarter from a few weeks, this trend is corroborated by Facebook (FB) when it reported its 1Q earnings. Meanwhile, GOOGL is working to improve its efficiency and to slow hiring in 2020. It also bought back a record $8.5B of its shares in 1Q and expects to continue share repurchase in 2Q. It has $112B of cash on its balance sheet.
I am encouraged by GOOGL’s focus on efficiency improvement. While the biggest hit to ad spend come from the travel and auto industries, ad spend will come back as the pandemic subsides and when the economy recovers. With a more efficient cost structure, GOOGL will exit this downturn stronger than before.
Amazon’s sales momentum accelerated during 1Q. North America sales were up 29% YoY. International sales were up 18%. AWS sales were up 33%. Operating income, however, was down 10%, with North America and International contributing YoY operating income decline while AWS contributed to operating income increase. North America operating income declined even as sales growth accelerated due to increased cost of hiring 175,000 additional workers, increases in compensation, and added expenses for worker safety and protection. AMZN is also investing heavily in developing capacity for Covid-19 testing.
For 2Q, the company is guiding to a 23% YoY increase in sales at the mid-point. While AMZN could generate around $4B of operating income, the company plans to invest this sum, perhaps even more, on getting products to customers and keeping employees safe. The disappointment of a lower 1Q operating income and the 2Q guidance might have contributed to a 7.6% one-day drop in AMZN shares. However, I believe that AMZN is making the proper investment to position itself in this environment to gain share as well as to deal with concerns for worker safety. This will eventually make AMZN a more attractive long-term investment as it is building a wider moat and investing to get ahead of the curve.
Visa and Mastercard
Both V and MA reported consistent growth and profitability trend for calendar 1Q. However, transaction and volume contracted rapidly in the second half of March. Cross-border transaction started to feel the effect of the Covid-19 pandemic in China in February, and fell precipitously in March. April results were dismal, with V showing weekly volume decline as much as 30% YoY. The volume decline showed a moderating trend for the second half of April, with the last week of April showing a 19% YoY decline. The magnitude of the decline is not surprising, as about 25% of Visa’s volume is in the hardest hit areas of travel, fuel, restaurant and entertainment.
Revenue in 2Q will no doubt contract. The companies are not providing guidance in revenue as they have no control over the shape or the speed of the recovery. The companies are reducing expenses, something they have control over. The pandemic will probably accelerate the long-term trend of e-commerce, on-line transaction as well as the move away from cash. These trends will benefit V and MA. With the cash that I have allocated, I opted to buy shares in V because of its dominant position.
Berkshire’s 1Q operating profit was about $5.9B, a 5.7% increase YoY. Increases in operating income from insurance investment and “other” offset the decline in insurance underwriting and all the other businesses. Other than the insurance business, revenue fell across the board. As expected, Berkshire took a large mark-to-market loss of $55.6B against its investment portfolio. Cash and cash equivalent increased a bit to over $137B from $128B. Berkshire bought back $1.7B of its own shares and made a net purchase of $1.7B of equities, both sums are relatively modest. Mr. Buffett indicated during the shareholder meeting that he intends to maintain a large cash balance because of uncertainties in the development of the pandemic and the recovery of the economy.
At the May 1 close of $273,975 for BRK.A, it is estimated that the shares trade at about 1.2x the book value of about $229,000 per share at the end of 1Q, but probably closer to about 1.1x book value with the increase in value of its equity portfolio during the month of April. In the recent past, Berkshire’s share typically traded between 1.3x to 1.4x book value. As such, Berkshire shares are a bargain against historical valuation. I bought some BRK.B shares.
The rest of the companies on the shopping list
Both MSFT and SCHW are on my shopping list and they both have reported in-line 1Q results. DIS will report later in May. HACK has recovered smartly from its low made in mid-March. I am watching the milestones with one eye and the share price of these companies with the other eye for a potential long trade.
The recovery from the pandemic has begun. The country has passed the first milestone that I have set forth, which is the inflection of the new confirmed cases as % of new tests performed. As a result, I have committed a small portion of fresh capital to purchase BRK.B and V shares. I am watching closely the re-opening of the economy of some of the key states for the reaching of the second milestone. There may be volatility caused by the actualization of some of the risks I mentioned. As such, I am keeping most of my available powder dry.
This article was written by
Analyst’s Disclosure: I am/we are long AMZN, BRK.B, GOOGL, V. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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