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Abby Glennie, Investment Director at Aberdeen Standard Investments, considers the effects of Covid-19 on the diverse investment universe of medium-sized companies.
The pandemic is causing highly disruptive and far-reaching issues for individuals, companies and societies. Many companies, from small to large, have had no option but to shut down their operations with distressing consequences for their employees, suppliers and customers.
Yet many quality medium-sized companies (mid-caps), those that are well-managed and resilient, can often adapt more quickly to change than their larger counterparts. We’re seeing these companies not only survive but in many cases thrive – especially if they appeal to the new behaviours and consumerism that are emerging from the pandemic.
We’re seeing these companies not only survive but in many cases thrive.
The pandemic is affecting every company regardless of size – whether they’ve had to shut down, or to adapt their operations to meet social distancing or surging demand. Extremes exist from far-reaching loss to surprising growth. But all have faced change and often significant costs depending on how Covid-19 is impacting them individually.
Of course there are wider trends across sectors affecting companies from small to large. It’s no surprise that travel and leisure have been the worst hit sectors during the crisis. Not only are they losing revenue during lockdown, they’re likely to be at the back of the queue as restrictions are lifted in stages.
Retail is more mixed. Some companies are adapting well to life online, others have had to close their doors. But even larger companies with good online distribution have felt the pressure of additional costs involved in altering their operations: implementing social distancing and additional health and safety; paying overtime or recruiting extra staff; and increasing distribution.
But there are pockets of growth. Significant growth. Gaming, telecoms and technology businesses are doing well as companies demand better IT infrastructure and as consumers demand more technology for their homes. There’s a sharp increase in gaming downloads – this benefits the mid-cap developers and service providers that support the big gaming companies. There are more direct effects too. Take the digital companies, including mid-cap specialists, processing Covid-19 data and the roll-out of the furlough scheme for the government.
Demand remains high for food producers as most of the calories that people consume out of the home – normally around 30% of their overall expenditure on food and drink 1 – have moved into the home. In addition, the UK’s supply chain for food production has remained robust despite the virus – something that’s not been the case in other countries.
We’re witnessing many mid-cap examples of what it takes to survive a crisis like Covid-19, to endure through it – and to plan for future growth.
Even in travel and leisure, the worst hit sectors, we’re seeing management renew their strategic focus. Examples include two companies that, despite operating at near zero revenue, are retaining their IT expertise to improve their systems so that they operate more efficiently going forward. They’re using the enforced ‘time-out’ to make infrastructure improvements that would be difficult to achieve under business-as-usual circumstances.
Meanwhile many mid-cap food producers quickly adapted their own supply chains so that food previously going to the hospitality industry now reaches supermarkets. This willing and quick response to changing demand (from eating out to eating at home) is creating new relationships and strengthening long-term relationships across the different supply chains.
Similarly, smaller retailers acted quickly to change distribution and stock selection. For example, moving stock from closed shops to warehouses where they can support demand online; driving new efficiencies in distribution centres; creating product selections that require less individual handling but that meet the changing behaviours of at-home consumption and gifting.
Management are not just in survival mode, they’re planning ahead. We’ve seen mid-caps proactively raising capital during this period – not as an emergency measure but to acquire other businesses and support future growth plans. And alongside this, is a visible social consciousness. Companies are offering discounts, sometimes significant, to NHS staff and keyworkers – and, where they can, are making up the shortfall in furloughed staff’s wages.
While many small and mid-caps have performed well, year-to-date they’ve underperformed their larger counterparts, especially during the early part of the crisis. We believe this is partly due to investors’ perceptions that larger companies are more resilient and liquid, and that they’ll gain support from global exposure. Certainly large-caps may benefit from exposure to countries that lift restrictions before the UK, while mid-caps have relatively more domestic focus. However, many mid-caps have already demonstrated their strength and resilience. And many are exposed to areas of growth and resilience – cyber security, defence and data – or to areas, such as construction, that we believe can recover quickly.
Of course, significant uncertainty remains over the lifting of lockdown, consumer confidence, economic growth and how companies manage costs coming out of furlough. In this environment, we believe quality is key. We look at financial strength, liquidity and management in incredible detail.
While it was difficult for companies to provide guidance at the start of the crisis, the recent reporting season has seen a huge effort to provide detail to investors whether that’s by phone or video conference. Active engagement is crucial; it helps investors to make informed decisions even at a time when none of us know when ‘normal’ may return, or what it might look like. Challenges may loom but opportunities exist in the considerable diversity that mid-caps offer.
1Source: Gov.uk: National Statistics Family Food 2017/18; UK average expenditure on food and drink, per person per week, 2017/18