As the corona crisis has been stealthily making its way through the global economy, it has been racking up a body count more swiftly than a knife through butter. As Warren Buffett has been wont to observe, it’s only when the tide goes out that you see who has been swimming naked. Warren himself found out the hard way recently that it pays to be careful, if not fearful with what you own.
It was somewhat bemusing to see Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) hastily exit their $8B portfolio of holdings across the airline industry. Buffett made what appeared to be a panicked run to the exits to dispose of stakes in United Airlines (UAL) and Delta (NYSE:DAL) among others, at prices significantly less than what Berkshire paid for them several years ago. I’ve always found Berkshire’s push into airlines somewhat surprising given the cyclicality of these businesses.
While the airlines generally have done much to improve the structural efficiency of performance by slashing excess capacity, they’ve always been prone to sharp economic downturns. The effects of the coronavirus on this sector have been admittedly somewhat extreme, though it only amplified the fundamental issue that airlines are challenging businesses to own over the long haul.
Unfortunately, if the downturn for the aviation sector becomes more prolonged, that may extend further up the chain to even higher quality businesses like the aircraft manufacturers including Boeing (BA). Boeing’s troubles with the 737 Max have been well and extensively documented and don’t bear repeating here; however, one of the more significant things that Boeing had going for it prior to the corona crisis was a large and extensive demand backlog. An implicit question in Buffett’s actions is whether this backlog will slowly vaporize.
What was also interesting about Buffett’s reaction with the fire sale of these holdings at deeply distressed prices is an acknowledgment of a “new normal,” where there are likely to be more permanent impairments in the valuation and economic performance of various sectors. If the great man himself has such a healthy level of paranoia that he’s willing to make a hasty run for the hills, it pays all self-directed investors to look skeptically at their own holdings and ask themselves whether they have long-term staying power.
Another sector that deserves similar critical attention is the hospitality sector. It’s not a stretch to make the case that if the new normal for air transportation is likely to be a muted demand, then this same distressed condition is likely to be something that will affect major global hotel chains like Hilton (HLT) and Marriott (MAR) which could soon be plagued with excess capacity as fearful consumers go on a travel strike and worried businesses find alternate ways to transact business (Zoom (ZM) anyone?).
The struggling rental car industry, which was already in a state of despair as a result of disruption being brought on the sector by the likes of Uber (UBER) and Lyft (LYFT), faces the very real risk of being permanently kneecapped by the corona crisis. News that Hertz (HTZ) was looking at a major corporate restructuring was not particularly inspiring to investors and sent the stock price of the company down 17% on the day.
High-yield dividend investors have rightfully been in a state of shock over the last few months, dealing with body blow after body blow. Dividend cuts from the likes of Royal Dutch Shell (RDS.A) (RDS.B), an energy bellwether and strong dividend payer for years, have had investors rightfully scratching their heads and asking themselves, what is safe?
The listed REIT sector is challenging enough to understand and analyze at the very best of times. Complex and opaque financing structures and multiple tranches of debt with different classes mean that it’s difficult to understand at any point what one’s underlying exposure truly is in as far as cash flows that ultimately flow up to equity holders. Mall REITs such as Simon (SPG) and shopping center REITs such as Tanger (SKT) have been a little suspect for quite some time as changes in consumer behavior have seen overall traffic declines away from malls and shopping centers towards transacting online.
Enforced lockdowns have had the effect of even top quality tenants like Cheesecake factory (CAKE) tell high-quality shopping mall REITs that they can’t pay the rent. While secular shifts in consumer behavior have been impacting the space for quite some time, a sector that has been relatively immune but which may start to see some pressure soon is the commercial property space.
The effect of this corona crisis pandemic has had many large commercial tenants reassessing their plans for high-density commercial occupation in centralized locations. One of the likely implications of the pandemic will be a reassessment of methods and styles of working, with expectations already high that there will be continuation of remote work as well a trend to branch office and away from centralized, prime real estate locations, possibly affecting office REITs like Boston Properties (BXP) and commercial property managers such as CBRE (CBRE).
In an environment where consumers are fearful, big-ticket items are certainly ones likely to suffer. Reports abound that car dealerships aren’t accepting delivery of stock, with fleet sales down and rental car sales nonexistent. This will add to the pain of the large car manufacturers like Ford (F) and GM (NYSE:GM) who already have low levels of profitability and significant debt.
Discretionary retailers have been a pin cushion that’s been endlessly poked over the last few years with good reason. However, things appear like they may be getting distinctly worse, with Neiman Marcus’s bankruptcy filing likely to pave the way for other retailers to follow, including J.Crew. J. C. Penney (NYSE:JCP) and Macy’s (M) may make it through, but the question will be whether they become permanently hobbled indefinitely in the aftermath?
What of high-end dining and fast-casual restaurants? While I don’t expect fast food and fast-casual restaurants such as McDonald’s (MCD) and Chipotle (CMG), where people are in and out relatively quickly to be adversely impacted long term, it may be more of an issue for higher-end dining concepts such as Cheesecake Factory and Brinker (EAT). Having to be socially distanced and potentially masked up while in line and waiting, and even possibly dining may prove to be a significant challenge for many of the concepts.
The few bright spots in the global economy at least over the near to medium term are likely to be found in the technology and healthcare spaces. Both benefit from strong underlying trends and secular drivers that will promote longer-term demand. However, even within these segments, investors should be picky and focus on businesses that are benefiting from secular tailwinds which will propel growth and benefit from existing category spend flowing from one area to another. Digital advertising, e-commerce and cloud computing are examples. More than ever, it pays investors to be critical and even fearful of what they hold, and ask the hard questions of whether the holding will survive and thrive in a ‘new normal.’
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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