How We Think

Covid-19’s Economic Impact

The global economic impact of COVID-19 has been stunning.  The resulting trillions of dollars of lost wealth will be borne by many, with some of the immediate impacts obvious while the longer-term, second-order effects are less clear.  Just in the United States since February, 25 million private sector employees are no longer working, and millions more have had their hours cut.  Business owners have experienced a collapse in profits as revenues have fallen anywhere from modestly to severely to almost completely.  Many landlords are losing large portions of their rental income as both commercial and residential tenants cannot or will not pay during the shutdown.  Lenders are losing interest payments as borrowers are extended forbearance due to their inability to service their debt.  Governments are spending trillions of dollars to support the economy.  Taxpayers may have to pay trillions of dollars in the coming years to repay the borrowings that are funding these programs, or governments may try to inflate their way out of the exponential growth of sovereign debt.  In that case, bondholders and everyday savers could lose trillions of dollars if inflation does play a role in diminishing the burden of future taxpayers from current spending.  Many of the decisions about who pays for these losses will be made by voters, politicians, and judges in the next decade.

To be expected with this uncertainty, global stock markets have experienced dramatic price volatility this year.  Long-term investors must avoid being overly influenced by this volatility; instead, they need to look through to the underlying performance of the business that a stock represents.  This effort requires a parsing of COVID-19’s short-term impact from its long-term effects.  Our response has been to re-underwrite every company in our portfolio, with a focus on two primary considerations.  First, we assess how our expectations for each company’s revenue, earnings, and cash flow over the next several years impact its near-term liquidity and balance sheet strength.  We must understand how each company is likely to navigate such a sudden and deep global recession.  Second, we consider how the current environment may change the long-term earnings power of the business, including its ability to maintain or grow its current base.

As we shared in March, our businesses are resilient (i.e. relatively non-cyclical), have pricing power, and enjoy financial flexibility.  The concurrent operating results of our two Chilean businesses illustrate this resilience and predictability.  Chile has endured successive economic shocks in the past year.  In October of 2019, a few weeks after our latest research trip to the country, rolling mass protests in Santiago and other cities and towns around the country significantly disrupted normal business activity in the fourth quarter.  These demonstrations and the resulting political uncertainty depressed economic activity and led to an estimated GDP contraction of 2.1% in the fourth quarter, which was well below third quarter growth of 3.4% and 2018 growth of 4.0%.  Then, COVID-19 led Chile to one of the earliest shutdowns in Latin America on March 18th.  Despite these shocks, Coca-Cola Embonor grew volumes 7% and revenues 10% in the fourth quarter of 2019, and then the company again grew volumes 5% and revenues 11% in the first quarter of 2020.  Similarly, VTR, which is Liberty Latin America’s Chilean subsidiary, grew revenues 1% and operating cash flow 6% in the fourth quarter of 2019.  In the first quarter of this year, VTR grew revenues a little more than 1% and operating cash flow 2%.  Second quarter results will be worse for virtually every business in the world, including ours, but the range of operational outcomes for our businesses should be much narrower.

We continue to monitor our businesses closely to track what is happening in real-time and to better predict what is to come.  We are meeting virtually with our companies, their competitors, suppliers, customers, and peers.  We are collecting information from our proprietary network of contacts that live in the places our companies operate.  Additionally, we are gathering data through company reports, industry trade associations, pricing surveys, local social media, and the local news media.  Similar to how ill-informed a nationally-focused ESPN personality can be about Alabama Football compared to a knowledgeable local fan, we are frequently bemused to see how poorly informed the English-speaking media can be about what is really happening in the countries where our companies operate.  Our experience strongly suggests that it is necessary to source independent local information to build an accurate view of conditions on the ground.

We view the Fund’s portfolio as a collection of high-quality businesses.  While public markets afford us the opportunity to take advantage of mispricings, we would be happy to own this “conglomerate” of businesses if public markets closed for a decade.  We expect each company to generate free cash flow this year despite the brutal economic environment, and the long-term earnings power of each business remains intact.  The portfolio has been marked down well in excess of the slight erosion to its collective intrinsic value.  Accordingly, the Fund trades at historically attractive valuations.  The strength of the U.S. dollar may well have a further impact on near-term returns, and we do not profess to know when this valuation gap may close.  However, given the nature of these businesses and the growth in owner earnings on the horizon, we are excited about prospective returns from current prices.  We have profiled each of these businesses below, including some of our recent findings, and we would encourage you to reach out if you would like to discuss any of these businesses in greater detail.