Energy (Europe): Tom Robinson, Equity Analyst

What really stood out for you in 2020?

Last year was pretty much the worst on record for the energy sector. European oil shares fell 30 per cent in absolute terms, while oil demand fell so low that prices dropped to their lowest level in 18 years. Earnings were down 75 per cent on average. This instilled a sense of urgency in management teams, who acted quickly to cut costs. They had learned from similar, but smaller, price moves when demand fell in 2014. This time, capital expenditure was cut by a quarter and dividends were slashed. Some took the opportunity to reset their dividend policy altogether to free up investment in cleaner energy sources. Companies also booked significant impairments in anticipation of future price risk.

What will be the key themes in 2021?

2021 is clearly a recovery year. It will look dramatic because of the low baseline, but demand will take time to recover. Company valuations are pricing oil at $50-$55 per barrel over the long term. Net debt should shrink by around 10 per cent and dividends and share buybacks will resume, but at a lower level than before. Small and mid-cap companies look better value against mid-cycle forecasts than the majors. Prices would need to reach $60-$70 next year, demand to snap back and OPEC production to align with demand, for me to be bullish on the sector as a whole. 

Sustainability issues in the oil industry will go global in 2021, having been Europe-centric until now. More environmental regulation and reduced investment in fossil fuels will put incremental pressure on the sector, increasing the cost of equity and, to a lesser degree, debt. Declining terminal values of companies will affect the margins of safety that investors require to invest. The EU’s green taxonomy may not trigger mass selling, but investors will need to justify any lack of alignment with it.

What is the future for energy companies? 

There are several ways companies can navigate a mature industry in decline. The first is to transition towards new technologies. While there are niche restructuring stories, I’m sceptical as to how successfully oil giants can reallocate capital to activities like solar and onshore wind that have low barriers to entry and cheap financing, where they are latecomers. The second approach is to harvest the cash from current assets, by keeping costs low and distributing all your free cash flow. 

European oil companies are adopting a hybrid strategy. But even if they hit their low-carbon production targets, clean energy will still only account for 5 to 10 per cent of their operating cash flow by 2025. I expect that some of the oil majors will spin off their low-carbon operations in the mid-2020s and rebrand, leaving the fossil fuel assets to run off and the clean energy ones to grow. 

Healthcare (North America): Sahil Kapoor, Credit Analyst 

Has the pandemic benefited healthcare?

The healthcare sector is very broad. Of all its subsectors, pharmaceuticals have been among the most resilient over the last 12 months. For those like Pfizer, Johnson & Johnson and AstraZeneca that developed Covid-19 vaccines at speed, 2020 has been a landmark year. Their response to the pandemic improved their reputations, demonstrated the resilience of supply chains and created demand for vaccines that could persist for years to come.

There has been some negative impact. The initial lockdowns in March and April delayed clinical trials and inspections at manufacturing plants for non-Covid-19 related drugs. The number of doctor visits, regular screenings and travel-related appointments fell, which led to fewer new prescriptions and drug purchases.

Other parts of the sector suffered more. Medical technology firms that make artificial hips and knees were hurt in the second quarter of 2020 after dozens of elective procedures were postponed. Hip and knee sales fell 50 to 60 per cent. The market bounced back sharply in the second half of the year, however, after hospitals split into Covid and non-Covid zones. Elective procedures are an important source of profit for hospitals, so there was a financial incentive to bring them back quickly. 

How will these companies fare in 2021?

Second and third Covid-19 waves have weighed on the healthcare sector, but the impact has been much lower than in April and May 2020. Providers have developed better protocols to deal with Covid-19 risk and often monitor trials remotely. 

Many companies are set to profit from longer-term trends such as aging populations, while the pandemic accelerated the move to online doctor consultations and super-charged diagnostic innovation. Firms not only developed Covid-19 tests but ramped up production very quickly, doubling revenues for some and benefitting other parts of the sector like laboratory testing companies. This trend could persist for a while, even once vaccines have been rolled out. 

Demand for healthcare across developed markets will continue to rise, particularly in China. The country is approving drugs more quickly than it has in the past, which has prompted global companies to invest in its domestic healthcare businesses. Strong balance sheets should lead to more M&A in the sector, with a focus on bolt-on acquisitions of innovative drugs and therapies. 

Has Covid-19 changed the way we view healthcare companies?

Big pharma scored a lot of ESG brownie points in 2020. Companies were seen as serving the public good rather than just focusing on profitability. However, I don’t think the virus will have a big impact on healthcare policy over the long term. Governments still need to limit the growing share of GDP spent on healthcare, so will want to drive down drug prices. This is especially true in the US, where any new regulation under the administration of President Biden could affect companies’ ability to price drugs.

Consumer staples and discretionary (China): Ben Li, Equity Analyst 

How did companies cope with lockdowns last year? 

Chinese consumer companies struggled at the beginning of last year after the government imposed rigorous neighbourhood controls and travel restrictions. All businesses (other than supermarkets) felt an impact, as shops closed and opening hours were shortened. Inventory accumulated in the first two quarters and retailers had to increase discounts and subsidise distributors to shift it. 

Consumer discretionary companies were badly hit. Unsurprisingly, hotel and tourism operators were the worst affected. But many Chinese consumer staples companies are more discretionary in nature and rely on present buying, as well as beer and liquor consumption in restaurants and bars. This meant they were also hurt by lockdown measures. 

The first phase of the pandemic coincided with Lunar New Year. Dairy companies usually benefit from high demand for premium liquid milk products during this period, which are a common festive gift. But last year sales were weak and inventory piled up as people stayed at home. Sales of baijiu, a Chinese spirit which people drink at banquets and large gatherings or buy as a gift, were also affected. Half of all beer consumption takes place in bars and restaurants, so brewers suffered when the hospitality industry closed.

The economy started to recover in the second quarter and the outbreak appeared to be largely under control. Consumption continued to recover throughout the year and the restaurant, travel and tourism industries rebounded, though to a lower level than before the pandemic. Some consumer discretionary companies benefited from pent-up demand during the Golden Week national holiday in October, with some sportswear businesses seeing sales rise by 30 to 40 per cent. 

What is your outlook for 2021?

There was a moderate resurgence in Covid-19 cases over the winter and some cities went into lockdown. This happened very close to the 2021 Lunar New Year and passenger traffic was 60 to 70 per cent lower than in 2019, as the government discouraged people from travelling to their hometowns. Some cities imposed restrictions on large banquets, which will have affected the dairy and baijiu industries. 

But even though fewer people travelled, they still went out and spent money in the cities they work in. Travel restrictions could even benefit companies that operate mainly in larger cities. The resurgence was quickly brought under control and there are now almost no new cases in mainland China. Things should be better than last year when there were widespread lockdowns. 

The pandemic also forced people to try things like remote education, health visits and food and grocery delivery for the first time, which has accelerated the growth of online business models. Companies now have the right technology in place and there shouldn’t be as much push back from consumers. 

Not all types of consumer activities are back to pre-pandemic levels, but I expect consumption to rise and drive growth in 2021. The collapse in economic activity last year means that GDP could expand by more than 15 per cent in the first quarter, although the growth rate should fall after that. The recovery is underway, it will probably just take some time for things to fully return to normal.