Consumer ripple effects and the coronavirus

We have recently noticed a recurring area of conversation with clients, colleagues, and family members around the economic ripple effects of social distancing.

 

The discussion goes something like this – "If I can't go out, I am not buying my daily McDonalds coffee. I am no longer going to restaurants for lunch. And I won't be going to the gym anytime soon. Even if they lifted all the restrictions tomorrow, you wouldn't see me on a plane travelling in 2020. These kinds of changes in consumer behaviour will have massive effects on the economy, so how is it that the stock markets seem to be missing this?"

 

A very sound line of thinking and the short answer is - the ripple effects of social distancing is taking its toll on the economy. But just how big are these areas of the economy versus others?

 

We want to provide some context into the degree of the economic hit. The Bureau of Labor Statistics (BLS) in the U.S. puts out detailed data on consumer spending. The Canadian experience wouldn't be all that different, the numbers would just be smaller.

 

Below is a list of industries that make up the largest victims of social distancing, the "taboo categories." These are the parts of the economy where consumers will be reluctant to return.

 

Category                                                     Annual Expenditure

travel (lodging for out of town trips)                   $69.9B

Air fares + cruise ship fares                                  $76.1B

Restaurant + Bars + Eating out                            $492.7B

Sporting events + Concerts + Movies                  $79.0B 

                                                                               $717.7B

 

As you can see, the "social distance" victim categories total ~$718B in consumer expenses. However, when you consider that total personal consumption in the United States on an annual basis is a number over $8 TRILLION (after deducting payroll taxes and health care expenses), these problem areas for the economy only make up about 9% of total consumption.

 

Suppose consumers are slow to come back to these categories in a post-recovery world, and we assumed a 33% drop in spending - in rough math, 33% of $717B would be $239B. The hit to overall consumer expenditures would be less than 3%. Some of that cut will be offset by spending more money at home on groceries, dining in, etc. Also, the near 40% price drop in the cost of gasoline adds ~$110B back into the wallets of consumers. All this to say, there are so many puts and takes on the consumer wallet at the moment. Big picture when we reopen the economy, the risk of a serious drag on economic growth overall due to weaker spending in the "taboo categories" is unlikely in our view given that these areas of spending account for a smaller share of wallet than is apparent from headlines.

 

Shopify - Is there a new sheriff in town?

 

A couple of weeks ago, we talked about some of the characteristics we look for in a good business. We are curious people by nature and also skeptical. These are two traits that we believe serve us well in our roles as portfolio managers. This week saw Canadian technology company, Shopify, briefly surpass Royal Bank as the largest company (by market capitalization) on the TSX.

 

For those unfamiliar, Shopify provides a platform designed for small and medium-sized businesses to have a sleek web presence and functionality that would deliver a similar user experience one would expect on the websites of large corporations such as Best Buy or Costco. Shopify's mission-critical software enables merchants to manage product and inventory, process orders and payments, build customer relationships and leverage analytics and reporting across all of their sales channels. All told, Shopify has a very compelling value proposition, and it is a very strong business.

 

Now consider that last year, they had revenues of $1.57 billion and a net loss of roughly $125 million. Sure they are growing fast; revenue was up by 47% in 2019. Then there is Royal Bank; in 2019, Royal posted revenues of $46 billion and profits of $12.8 billion. Of course, Royal is growing a lot slower than Shopify but recall our quote from two weeks ago - "Stock markets don't make money, companies do."

 

We know which stock at today's price we would buy.

 

The challenge with a business like Shopify from a portfolio management perspective is one of valuation. There are loads of great companies out there, but we are not going to pay any old price to own them. In the case of SHOP, it currently trades at 32.8x 2021 sales. Contrast that with e-commerce giant Amazon, which trades at a mere 3x sales. Two years ago, analysts were saying 10x sales was fair; now, it is 30x sales. It seems that some investors are losing sight of what this means. People who believe that Shopify can grow sales at 30% per year over the next six years are also saying they will add more revenue in year six than they have added in their entire 12-year history. We may be proven wrong, but we are taking the "under" on that assumption.

 

We will end this discussion with some words of wisdom, once again from Warren Buffett:

"For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments."

 

Stay safe and keep your focus on yourself and your loved ones.

 

And, as always, if you have any questions or concerns, please contact us. Our entire team is available to listen and speak to you. We are also available to speak to family members or friends who might like to be reassured.