October 1, 2020
Insights into how five COVID-19-impacted sectors are performing—and what the future may hold.
We asked Pacific Asset Management, sub-adviser to the Pacific Funds fixed-income funds, to analyze the gaming, healthcare, hotel/lodging, retail and technology sectors amid the coronavirus pandemic.
Healthcare: On the Mend?
by Shalini Viswanathan, CFA
Director, Pacific Asset Management
Entering 2020, healthcare was already facing headwinds from significant regulatory and legislative issues in addition to a presidential election. But COVID-19 thrust the sector into the most challenging environment in modern times, often in unexpected ways.
In March, the coronavirus and related lockdowns resulted in a collapse in demand/volumes in hospitals and physician offices across most of the country. Liquidity became an immediate concern, especially for companies with highly indebted balance sheets. With relief provided by the CARES Act and other programs, reduced capital expenditure, layoffs and furloughs, liquidity has ceased to be a near-term concern. However, if repayment terms for certain relief programs are not extended, liquidity will be a concern again. Certain sub-sectors such as large dialysis and post-acute-care companies have managed liquidity well and haven’t had to take advantage of the CARES Act.
Many companies have seen demand/volumes improve since the lows early in the pandemic. There is an expectation of continued growth through 2020, although stumbles in that growth are likely, based on resurgence of the virus. Many healthcare providers are finding new ways to reach more of their customers, including telehealth to attract customers unwilling to enter healthcare environments.1 Nevertheless, demand is not expected to return to pre-COVID levels of growth until well into 2021.2
On the positive side, there are some outliers that are expecting strong performance in 2020. One example is managed-care companies that have benefited from lower-than-expected expenses as elective procedures have been delayed.
Looking to the rest of the year, companies will continue having to manage through an extremely challenging environment. Short-term liquidity needs appear to have been addressed for now and volumes are picking up, but understanding and adapting to the long-term implications of the changes driven by the pandemic will be critical to long-term success.
1“Earnings Presentation – 2nd Quarter, 2020.” Community Health Systems, July 29, 2020.
2“COVID-19 Operational Impact Update.” Tenet Health, June 16, 2020.
Technology: What Computes?
by Shalini Viswanathan, CFA
Director, Pacific Asset Management
While some sectors saw a collapse in demand as lockdowns were put in place around much of the world, portions of the technology sector faced an unprecedented demand surge.
Changed work environments, remote schooling and security needs presented opportunities for growthwithin the technology space. Shelter-in-place restrictions elevated demand for streaming, data centers, server CPUs, semiconductors, along with a temporary boost to PCs/notebooks. Despite lowered IT budgets and delayed decision-making for customers, migration to cloud and digital transformation was prioritized. Overall, we expect IT spending to be lower in 2020 compared with last year.
Technology firms adapted their own processes and helped their employees adjust to the new environment. In addition, they engaged in various cost-containment measures, including furloughing employees. They also drew down on revolving credit facilities and issued new debt to ensure adequate liquidity. Software companies revisited marketing/sales strategies to reduce or eliminate in-person meetings. Various semiconductor companies with heavy exposure to the auto sector were impacted by lower auto sales and factory shutdowns, but their diversified end-market exposure ensured that they benefited from growth and new product wins in other areas. Spaces that entered 2020 with long-term challenges such as PCs and printers saw a temporary boost in demand, but managing expenses will be increasingly important in the years ahead as long-term pressures resume.
Technology firms are no strangers to rapidly evolving environments, but 2020 will likely be remembered as one of the most challenging in decades. Companies that view agility as a core competency have had to prove it this year. Some have, but others have stumbled. Our work in the technology sector continues to focus on differentiating the outperformers from the underperformers to find the best long-term opportunities. Companies performing relatively well in 2020 from the work-from-home shift could face pull back in demand as return-to-offices begins in 2021. Bondholders don’t get to experience the lavish rewards equity investors sometimes do, so our focus will remain on avoiding the losers in this ever-evolving space.
Gaming: Winners and Losers
by Michael Long
Managing Director, Pacific Asset Management
Gaming operators across the industry were having a strong start to 2020 before the mid-March shutdown.
A combination of low unemployment and healthy economic growth fueled spending from retirees at riverboat casinos in the Midwest to high rollers filling the mansion suites in Las Vegas. The house may always win in the gambling business, but COVID-19 came close to changing that.
Fortunately, the vast majority of gaming companies entered the crisis with strong liquidity positions, which has served them well during the closures. Banks have been extremely supportive on covenant waivers, and credit markets have remained open for most companies. Most operators have accessed bond markets and bolstered liquidity while cutting costs and reducing cash burn. Concurrently, companies have also been successful at cutting expenses and improving profit margins. Regional companies such as Boyd Gaming Corporation and Caesars Entertainment have been particularly successful in reducing marketing costs and cutting low-margin amenities such as buffets. The higher margins are expected to be sustainable.
Many casinos began a phased reopening in May and June. Operators have been pleased despite capacity restrictions, limited restaurant openings and bans on entertainment. Fundamentals in the regional markets have exceeded expectations, partly because of easy access to the properties and economic stimulus that put meaningful dollars in consumers’ pockets. Las Vegas has lagged regional markets due to several factors, including its reliance on air traffic and convention business, significant non-gaming profit centers such as restaurants and entertainment that have only partially reopened, and their large hotels. Convention business will be way down in 2020, but early indications point to the potential for a solid rebound—though not before the second quarter of 2021.
Sports betting and online gaming (iGaming) are big opportunities going forward and both can be done outside of the physical casino. Sports betting is legal in 23 states and operational in 19 while iGaming is allowed in six states. States focused on replacing lost revenue from the pandemic may seek to further expand gaming to generate additional revenue in the months ahead.
This year, casinos have been driven to adapt to the new environment with lower cost structures. But a more meaningful recovery, especially for Las Vegas, will likely require a vaccine or significant improvement in therapeutics.
Hotel/Lodging: Room at the Inn
by Michael Long
Managing Director, Pacific Asset Management
Few sectors have been as hard hit by the impacts of COVID-19 than the hotel and lodging sector.
Revenues plunged at an unprecedented rate as both leisure and business travelers kept to the couch instead of hitting the road. Even compared to the devastating impact on the travel industry after 9/11, 2020 has set a new benchmark for challenging years. As the economy has gradually, but haltingly, begun to reopen, hotel occupancy and revenue-per-available-room (RevPAR) have improved gradually and many hotels have re-opened.
While hotel operations have focused on implementing new strategies for employee and customer safety, the corporate level has had to focus on liquidity and cash preservation. Employees have been furloughed, hotels closed, operating costs cut, and capital expenditures reduced. Early on, companies tapped their revolving credit facilities in order to shore up cash positions. They were also able to access bond markets to enhance liquidity.
Over the past several months, leisure travel has been improving. Drive-to markets have been performing better than fly-to or destination resorts as people remain nervous about flying. Not surprisingly, the economy/midscale segment has been outperforming due to their focus on leisure travel. For example, Choice Hotels, Wyndham Hotels & Resorts and extended-stay properties have performed well relative to business-dependent chains such as Marriott, Hyatt, and Hilton. Business travel has not rebounded and is likely to remain challenging through the rest of the year and likely well into 2021.
Management teams remain cautious due to continued COVID-19 flareups and the potential for a second wave in the fall. As a result, they have been reluctant to provide earnings guidance for the remaining of the year. I believe there will not be a significant pick up in the sector until Covid-19 can be tamed.
Weekly U.S. Hotel Occupancy and RevPAR
U.S. Hotel Occupancy and RevPAR by Chain Scale for the week Ended 8/1/2020
Retail: Express Lane for Change
by Ron Rangel, CFA
Analyst, Pacific Asset Management
The retail sector has been experiencing rapid change for more than two decades, but COVID-19 has added lighter fluid to the inferno of change that was already underway.
E-commerce demand accelerated rapidly from customers living under stay-at-home orders. Brick-and-mortar stores became an even larger headwind for many traditional retailers and will result in increased industry defaults, more store closures, and a sharper focus on serving customers in their preferred channel. For instance, many companies have accelerated the rollout services such as buy-online-pickup-in-store (BOPIS), curbside pickup, ship-from-store, and have improved their delivery speeds.
E-commerce demand accelerated rapidly from customers living under stay-at-home orders. Brick-and-mortar stores became an even larger headwind for many traditional retailers and will result in increased industry defaults, more store closures, and sharper focus on serving customers by whatever method they prefer. For instance, many companies have accelerated the rollout services such as buy-online-pickup-in-store (BOPIS), curbside pickup, ship-from-store, and have improved their delivery speeds.
Struggling companies have been adjusting to this environment by reducing costs, furloughing or laying off employees and improving liquidity by issuing new shares or debt. Some investment-grade companies have had to issue secured debt using hard assets such as real estate and renegotiate credit-agreement terms with lenders. Companies have also suspended dividends and share buyback programs, cut capital expenditures, suspended internal promotions, cut corporate salaries, and more—all to enhance liquidity to survive the economic disruption. For more indebted and impacted companies, liquidity remains a primary focus and additional defaults are quite likely.
Like other sectors, not all retail companies have struggled in 2020. Retailers featuring products related to home, auto, pets, crafting, sporting goods, casual wear, and electronics have done well as money has generally shifted away from apparel (especially department stores and formal/office wear), travel, and restaurants.
Michaels Stores stands out as a top performer in adjusting to the new environment. It’s been able to roll out BOPIS, curbside pickup, ship-from-store, and same-day delivery within months to meet consumer needs. Michaels has a new CEO who was previously at Walmart in their E-commerce and Sam’s Club divisions, so he’s well-versed in digital channels. Despite having longer-term secular concerns, Michaels has benefitted from increased demand related to COVID-19 stay-at-home orders and their rapid adaptation to the fluid environment has positioned the company well to capture this increased demand.
Looking to the second half of 2020, I think trying to predict earnings is somewhat of a fool’s errand for companies without liquidity concerns. The uncertainty is too high, and I believe investors have already begun shifting their attention beyond 2020 to answer questions such as what the environment may look like post-COVID-19. While adapting to the new environment is critical, I believe the biggest worry for the retail sector is a prolonged economic slowdown in consumer spending. It is difficult to know how quickly the economy will recover once fiscal stimulus subsides and the pandemic is brought under control. Investors can find high yields in the retail sector, but not all sales in this sector will turn out to be bargains.
This publication is provided by Pacific Funds. Pacific Funds refers to Pacific Funds Series Trust. Pacific Asset Management LLC is the sub-adviser for the Pacific Funds Fixed Income Funds. The views in this commentary are as of September 8, 2020 and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector or index, or to predict performance of any investment. The opinions expressed herein are subject to change without notice as market and other conditions warrant. Any performance data quoted represents past performance which does not guarantee future results. Any forward-looking statements are not guaranteed. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. Sector names in this commentary are provided by the Funds’ portfolio managers and could be different if provided by a third party.
Pacific Life Insurance Company is the administrator for Pacific Funds. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.
Pacific Funds and Pacific Asset Management are registered service marks of Pacific Life Insurance Company.