27 April 2020

COVID-19 WINNERS AND LOSERS

We can be thankful that as a single nation occupying our own continent we are able to effectively isolate ourselves; one massive cruise ship mistake aside.  Right now our infection rate is among the lowest in the world and our recovery rate amongst the best.

Winners

As with previous major events affecting the financial world there will be winners and losers.  Among the winners will be the major supermarket operators Woolworths and Coles as Australians prepare more meals at home with restaurants limited to take away trade only.  Restaurants buy their meat, fish, vegetables and fruit at the markets, whereas householders buy most of them at their local supermarket.  Traditionally food and alcohol are among the least affected consumer spending’s in an economic recession.

CSL Limited’s price is below its high for the year but is a long way above its price twelve months ago.  Emphasis on health means that its products are in high demand including record demand for influenza injections.

The big four banks are likely to remain relatively advantaged as the government needs their assistance.  The smaller banks simply do not have the customer reach nor the balance sheet strength.  The Commonwealth Bank of Australia looks to be the best placed.

Government reaction in respect of landlord and tenancy regulations point to a danger in owning residential rental property where legislation increases the landlord’s ownership risk to the advantage of the tenant.  The inevitable rise in unemployment will result in surplus rental accommodation as many younger tenants go back to the comfort of the spare bedroom at mum and dads.  Rents will be weaker on re-letting.  The truth is that residential rental housing has always been a relatively poor investment.  It is generally avoided by the very rich with much of it owned by groups such as schoolteachers, police, nurses and public servants.  ie. people with secure government employment to whom the banks are prepared to lend.

Commercial shopping centre rentals which have been traditionally high and are now coming under sustained pressure which began with the increase in online shopping have been exacerbated since the sale of Westfield Shopping Centres to Scentre Group with Frank Lowy’s family selling out and sending an early warning signal.  The confrontational tactics of the Solomon Lew controlled Premier Investments which operates chains of fashion and clothing businesses signals that rents and therefore income distributions will be much weaker in the future.

GPT Group will be affected but to a lesser degree than Scentre Group.  Stockland’s proportion of retail was falling prior to COVID-19 virus.  However, its land development business will suffer a major hit as increased unemployment means a weak housing market and a dramatic fall in the sale of house/land packages in new developments on the city fringe.

Housing Elasticity of Demand

Housing demand does not increase in parallel to population growth.  There is at any time a huge hidden stock of spare bedrooms, mainly among older Australians.  This runs into the millions of bedrooms nationwide.  In good times with high employment young adults leave the family nest earlier and rent accommodation while some couples are able to become first home buyers at a relatively young age.

When unemployment increases many of the young singles return to the spare bedrooms at their parents or delay leaving the family home, while young couples faced with job uncertainty postpone purchase of their first home.

International Travel

Regardless as to when international travel barriers are removed, it is likely that many Australians will be far more reluctant to travel outside of Australia.  With lower landing fees and falling rents from concessions particularly in international terminal duty free areas and less parking revenue, airports will struggle.

We have long regarded the investment in Australia’s airlines as being too risky as evidenced by the demise of the debt laden Virgin Australia 90% owned by major foreign investors, and by the years in which Qantas was unable to pay dividends.

Infrastructure investments such as gas pipelines owner APA Group should continue to be safe as nobody is going to build a parallel set of gas pipelines.  Nor is anybody going to replicate Transurban’s toll roads.  Road traffic will rebuild.

For many of our clients owning dental and veterinary practices the best real estate investments are their family home and their practice premises.  Some country practitioners with very low rents may be the exception.  Generally, the amount of capital invested in fit out, including the amount of expensive plumbing and wiring means that in order to get long term return on capital costs of fit out, ownership of premises is highly desirable.

Impact of Past Major Events

• The introduction of capital gains tax tended to freeze ownership of assets purchased prior to the 20th September 1985.
• The introduction of dividend imputation spurred the share market at the time as the elimination of double taxation encouraged companies to raise dividends and led to a more efficient application of capital.
• The 1987 stock market correction was a body blow to heavily geared entrepreneurs such as Alan Bond, John Elliott, Robert Holmes a Court, John Spalvins, Christopher Skase and others.
•  In 2001 the introduction of the small business capital gains tax concessions meant that henceforth it was a better strategy long term for most dentists and most veterinarians and other small businesses to own their premises outside of their superannuation funds rather than within.  This is a fact still not recognised by many accountants.
• The Global Financial Crisis exposed businesses who had substantial shareholder directors who had geared their shares via margin loans.
• The 1991 commercial property collapse coupled with rising interest rates exposed previously unrecognised structural weaknesses in unlisted commercial property syndicates.
• The timber plantation investments pushed hard by many well known accounting firms in the 1980’s through the early 2000’s were structurally flawed from the outset and were pushed upon their clients in order to gain obscenely high commissions.  Synstrat is proud never to have recommended these investments.

The current COVID-19 event will be substantially detrimental to airports as well as airlines, travel agencies and real estate housing developers.  It may advantage major supermarkets including their liquor stores, CSL Limited and some other health product providers, restore the reputation of our major banks, reinforce investment in APA Group and Transurban Group, and in due course once interstate travel boundaries come down, be positive for ARB Corporation as more people choose to holiday within Australia.

Recent Australian Corona Virus figures as at 27 April 2020:-

• Confirmed cases – 6,719.
• Deaths – 83 = 1.2 per cent.
• Recovered – 5,541 = 82.5 per cent.
• Currently active cases – 1,095 = 16.3 per cent.

Clients should treat the above as general advice only and speak with their Synstrat advisor as appropriate.

Best wishes to all,

GRAHAM MIDDLETON

Disclaimer

The information contained herein is of a general nature and no specific action should be taken without individual advice. Speak with Synstrat staff as appropriate.  Prepared by Synstrat Management Pty Ltd for clients of the Synstrat Group.  Synstrat Management Pty Ltd is the holder of Australian Financial Services Licence No. 227169.  ABN 57 006 295 325