Demand in the age of Coronavirus

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The economic shock delivered by the COVID-19 pandemic has been swift and severe for capital markets. In only a few short weeks many market indices are down 30-40% from recent highs.

These large declines in stock prices reflect Mr. Market factoring significantly lower corporate earnings in the future (and a large amount of uncertainty). So, the question arises: how will the economic shock impact different companies and which may see their future earnings impacted the most?

When evaluating the potential impact to valuations, I believe there are two factors to think about: 1) the immediate impact on sales and earnings, and 2) the medium-term impact resulting from the potential economic slowdown or recession to follow.

We don’t know what new developments the future will bring, but given the sharp reduction in demand for many goods and services, it’s likely that we will experience lower GDP growth and potentially an official recession (two consecutive quarters of negative GDP growth).

To illustrate various ways demand (and hence stock valuations) could be impacted, I have selected four representative companies to highlight. These are in no way recommendations to buy or sell these specific securities.

[Firms were selected based on likelihood of general familiarity with their business model and usefulness in illustrating future demand scenarios.]

Netflix (NFLX)—setting aside the recent launch of several competing streaming services, Netflix is likely to see increased demand for their service as more people stay home and other entertainment options close to the public. This could result in customer growth for Netflix and increased demand for content.

Looking to the future, this near-term surge in demand is likely to persist. There is no reason to think all new subscribers will cancel their service in mass once life returns to “normal.” Although an economic slowdown or recession would normally decrease demand for entertainment purchases, I’m guessing—given the relatively modest monthly cost of a subscription—Netflix will come out better than most.

Of course, there will also likely be an immediate reduction in demand from those most economically impacted. Lower income households that lose jobs or see a reduction in income may be forced to cancel their subscriptions (and other spending) to get by.

NFLX was down 7% year-to-date (YTD) (as of March 16, 2020)  

Costco (COST)—many news reports have highlighted long lines and bare shelves (mainly of toilet paper) at Costco around the country. This surging demand will likely lead to robust earnings in the short-term. But it seems likely most of this binge buying is just hoarding supplies that will be consumed in the future at a normal pace—not necessarily creating a lot of net new long-run demand.

People may be just pulling forward purchases that would have been made over time. Although there will be some net increase in grocery consumption as people shift from eating at restaurants to cooking at home.

Not only has future demand been pulled forward, but a recession will further lower future demand for many discretionary purchases. This coming one-two punch for Costco—lower demand because people are consuming goods already purchased and lower demand from a recession—leads me to believe the good current earnings they are likely to see may quickly fade away and start dragging on Costco’s stock performance.

COST was down 4% YTD (as of March 16, 2020)  

General Motors (GM)—auto companies have the opposite challenge as Costco. They are seeing current sales fall dramatically, but demand is likely being pushed out to a future date. People who were looking to buy a new car will delay the purchases while society struggles with the impact of COVID-19. Yet the need largely still exists, and people will likely still want a new vehicle once life returns to normal. The purchase is just pushed out in time.

Unfortunately, a resulting general economic slowdown could obviously have an impact on future vehicle demand. Only time will tell how large the fallout from the country shutting down to “flatten the curve” will be and the longer-term impact on durable goods purchase like automobiles.

Again, for those most economically impacted by the economic slowdown, new car purchases will be curtailed, and we could see an increase in repossessions as people are unable to make their car payments.

GM was down 43% YTD (as of March 16, 2020)  

Delta Airlines (DAL)—airlines, hotels and other companies that sell perishable items are likely to see the largest impact from the fight against COVID-19. They are seeing a massive reduction in demand and most of the lost sales will likely never get recovered.

A product that becomes unsellable at a point in time (perishable) is a core attribute of these types of companies—every unit (hotel room for the night, seat on a departing flight, etc.) not sold is lost to eternity. Canceled Spring Break trips and summer vacations generally cannot be rescheduled for a later date. Perhaps a small amount of delayed travel will add to future demand, but it seems unlikely a significant amount of travel is just pushed out creating net new future sales.

To add insult to injury, economic slowdowns have an outsized impact on airlines with their high fixed costs. It is not impossible that the combination of current lost sales, and a slow recovery, will drive many airlines (and other travel related companies) into bankruptcy.

DAL was down 39% YTD (as of March 16, 2020)

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