Coming out of lockdown

From next week, non-essential shops will be able to reopen with cafes, pubs and restaurants following if the government’s targets for managing COVID-19 are met. The Association of Investment Companies (AIC) has gathered comments from managers about how holdings like JD Sports, Hollywood Bowl and JD Wetherspoon have coped with lockdown, their strategies to manage social distancing and their longer-term outlook for the retail and hospitality sectors.

Coping with lockdown

Sue Noffke, Manager of Schroder Income Growth Fund, said: “The management team of Hollywood Bowl began to draw up plans to implement social distancing at their sites in mid-February, before the virus was widely known to be spreading in the UK. This put them on the front foot in managing the situation when the UK did introduce distancing measures in mid-March. Measures included closing alternate lanes, encouraging more pre-booking from customers, changing the layout of bar areas and temperature-checking staff during shifts.

“When full lockdown was enforced, the group’s preparation allowed them to quickly go into ‘survival mode’ to conserve cash. They closed all sites, suspended dividends, cut executive pay, placed 98.6% of staff on furlough and negotiated with landlords for rent-free periods or deferrals. To ensure they kept their balance sheet strength, on 17 April the company raised £10m through a stock market placing of 5% of their share capital. This covers more than six months of ‘cash burn’ in full lockdown.”

David Smith, Portfolio Manager of the UK portion of The Bankers Investment Trust, said:

“During the lockdown JD Wetherspoon moved quickly to reduce its monthly ‘cash burn’ from £80m to £3m, benefitting from the government furlough scheme, business rate suspensions, rent reductions, capex deferrals and head office cost reductions. As its pubs reopen, the majority of these costs will come back without the full level of revenues in the short term, hence we don’t expect the company to return to full profitability over the medium term. However, over the longer term we believe the company will be one of the winners in the industry. Given the strength of the business model, Wetherspoons can continue to provide a value offer to its customers in a safe environment and maintain the investment in its estate.”

Abby Glennie, Manager of Aberdeen Smaller Companies Income Trust, said: “Some of the retailers that have weathered the crisis better than others are the ones that have committed to and invested in developing an online platform. For Dunelm, the strength of its online investment has come through during the last few months. Homeware sales were resilient in the last recession, and with COVID-19 people are happy to spend money on homes as they are spending more time there. Similarly, Hotel Chocolat has experienced a strong shift to online. Its management team have adapted and driven the business well through the situation, for example pre-bundling products and limiting ranges for distribution efficiency. It has shown community spirit through a 50%-off NHS keyworkers offer, which should also have helped its brand and attract new customers.”

Guy Anderson, Portfolio Manager of The Mercantile Investment Trust, said: “While stores remain closed until mid-June, there has been a partial offsetting of lost sales through increased online revenues. Retailers with strong multichannel offerings have been particularly successful in this regard. For example, Dunelm reported significantly higher online demand versus pre-COVID levels following a phased reopening of this channel during lockdown.

“Meanwhile B&M, the discounter, benefitted from its status as an essential retailer and enjoyed strong demand even through the lockdown period – like-for-like sales grew by 23% year on year in April and May. Demand was strongest in DIY and gardening, but like-for-like sales grew by 10% even excluding this category. Forty-nine stores had been temporarily closed due to adverse trading conditions at the beginning of lockdown, but these are now open and trading again.”

Katen Patel, Portfolio Manager of JPMorgan MidCap Investment Trust, said: “The key focus for management teams has been on reducing the amount of cash that is being absorbed during the lockdown period and ensuring there is enough liquidity for the business to survive an extended period of little or no revenue. Cutting expenditure on more discretionary items such as overseas travel or big marketing campaigns are obvious areas, but also spending a lot of time renegotiating terms with landlords has offered up large cost savings. Leading retail outfits such as Dunelm are prized tenants and therefore landlords are more willing to renegotiate terms with them to ensure they don’t move to alternative properties.”

Prospects post lockdown

David Smith, Portfolio Manager of the UK portion of The Bankers Investment Trust, said: “When pubs are allowed to reopen it clearly won’t be business as usual. Capacity will have to be limited due to social distancing rules, while costs are likely to rise to cover extra equipment to safeguard employees and customers. After the company’s capital raise, JD Wetherspoon is in a stronger financial position to adapt its business to these challenges. Also the company benefits from an estate that has larger than average sized pubs, a wide range of trading throughout the day and their already successful order and pay app.”

Abby Glennie, Manager of Aberdeen Smaller Companies Income Trust, said: “Greggs has a great value offering, and social media has really driven new customer engagement in the past couple of years. Like many high street names, they have some challenges with footfall and social distancing, but their store base is quite diverse in terms of location and before the crisis they had been investing in digital areas, such as click and collect, and working with delivery partners. Games Workshop has already reopened shops in some other countries and will open its UK shops as and when government guidelines allow. This is a benefit of its global footprint. Their primary product – fantasy games – is well suited towards home entertainment, which will remain in high demand beyond the peak of the crisis.”

Katen Patel, Portfolio Manager of JPMorgan MidCap Investment Trust, said: “Those companies that have been showing strong growth in recent months and years, taking market share from others, and have had the balance sheet muscle to cope with the crisis, will come out of this well placed and should benefit the most. JD Sports is a great example of this, a global sports fashion retailer with very strong relationships with key suppliers. They have a net cash balance sheet and should emerge from the crisis well placed to resume the strong growth they have seen in recent years, driven by well invested stores, global expansion, a good online offering and access to exclusive products. Competitors with weaker balance sheets will not be able to invest in their stores or multi-channel offering and therefore may be less likely to get the exclusive product they want from key suppliers, further cementing JD’s position.”

Guy Anderson, Portfolio Manager of The Mercantile Investment Trust, said: “As lockdown measures begin to lift, we believe that one company that may be set to benefit is DFS, the furniture retailer. With some housebuilders and estate agents reporting renewed levels of interest in recent weeks, a bounce in the housing market, potentially helped along by supportive government policy, could feed through to increased demand for DFS.”

Outlook for the longer term

Sue Noffke, Manager of Schroder Income Growth Fund, said: “Hollywood Bowl entered 2020 in good shape. The UK’s leading operator of ten pin bowling alleys had a robust balance sheet, was generating strong cash flows and had a multi-year runway of growth ahead of it. However, as a result of COVID-19, all of their sites are now shut, revenues have fallen to zero, 98.6% of their staff have been furloughed and cash is flowing out of the business as they still have to pay fixed running costs such as rent and utility bills. Despite these significant near-term headwinds, their management of the crisis has given us confidence that the company will exit it in an advantaged position so that they will ‘carry on where they left off’- continuing to capitalize on the growing trends of ‘experiential leisure’ and ‘competitive socialising’.”

Katen Patel, Portfolio Manager of JPMorgan MidCap Investment Trust, said: “The retail sector is going through a period of significant change currently, accelerated by the lockdown measures put in place on their physical sites. Consumers that have been reluctant to experiment with multi-channel retail options have had to adapt and embrace it, which will benefit those that invested in their multi-channel offering in recent years to benefit from these trends. This is not to say that physical stores are dead, however, physical sites will need to adapt to the new environment and work harder to attract consumers.”

Abby Glennie, Manager of Aberdeen Smaller Companies Income Trust, said: “The retail landscape was evolving over the last few years and the pandemic has accelerated these changes. There has been a sharp rise in the trend to online shopping, but much of this will be sustained as and when lockdown eases. It’s not the end for bricks and mortar. Many destination stores and locations will continue to attract shoppers. A combination of bricks and mortar and a strong online platform will be a solid grounding for growth.

“There remains much uncertainty around consumer confidence and spending habits. Many furloughed employees are being paid 80% of their salaries but this will change as furlough unwinds and true unemployment rises. Not all retailers will survive and come through the recession. The strong will get stronger and the weak will get weaker. This is why we’re very selective. We feel confident that we are invested in resilient businesses with strong balance sheets, multiple distribution channels and importantly experienced management teams.”

Guy Anderson, Portfolio Manager of The Mercantile Investment Trust, said: “The UK continues to face significant economic headwinds, which the retail sector is not immune to, but we do feel that there are some bright spots that remain compelling. B&M may benefit from its market positioning as a discount retailer. Against an uncertain economic backdrop, there will likely be a switch to discount-oriented supermarkets as consumers look to save on essentials. In addition to this, with people spending more time at home, B&M should also continue to benefit from its wide product offering, including toys, cleaning products and a much improved homewares range.”

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Notes

1. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment. Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. As at the end of May, the AIC had 361 members and the industry had total assets of approximately £197 billion.
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