Janus Henderson’s Neil Hermon has "counter intuitively" increased his position in four leisure stocks in his investment trust, declaring "new ideas are a luxury we do not have time for".
Hermon, who manages the £420m Henderson Smaller Companies investment trust, said his conversations with companies have changed tone since the start of the coronavirus pandemic and ensuing lockdown in many economies. "Forget what happened in 2019 and the first two months of 2020," Hermon said.
"Questions now focus around leverage, debt facilities, liquidity, monthly cash burn, and so on. It is more a matter of whether corporates can get through this maelstrom."
The manager added that conventional valuation measures are "irrelevant" and dividend yields "illusory" in the current market environment. "Corporate earnings will be sharply down in 2020 [while] last week we saw a slew of corporates passing on dividends and cancelling those already declared. [We] expect this to continue."
As a result, Hermon said he was focusing on his own portfolios, including the open-ended funds he runs, "cutting positions where we lack conviction or where we feel the company is poorly placed to deal with the current situation [and] adding to portfolio positions where we believe the share price has fallen too far".
Topping up leisure holdings
Hermon said that had led him to increase the trust's position in leisure stocks, topping up his holdings in Cineworld, Hollywood Bowl, Gym Group and Mitchells and Butler. "Share prices of these stocks have been hit very hard," he explained.
"[However], all are very strong franchises, have good management teams, and, as long as this does not go on too long, will emerge in a strong position.
"Leisure and retail operators are clear beneficiaries of business rate relief and Government's commitment to pay 80% of staff wages."
In the example of Cineworld, the cinema chain has reportedly been laying off workers and claimed its existence as a business could be in jeopardy due to coronavirus. Meanwhile, credit ratings agency Moody's downgraded the firm two notches last week and said it was at threat of a further move down.
But Hermon claimed that while Cineworld had high leverage, it has "covenant-light debt and can survive months of no revenue". "Given the delay in big budget films, the slate will be very strong when cinemas re-open."
Other companies Hermon has topped up include DFS Furniture, Cairn Energy, housebuilder Bellway and pharmaceuticals firm Clinigen.
"[Cairn has been] severely impacted by the declining oil price, but investors seem to have forgotten that it has an ongoing court case against the Indian Government which, if they win, would result in proceeds almost three times its current market capitalisation.
"Bellway [is] now trading well below net asset value and has a very strong balance sheet to weather the storm. Clinigen's share price collapsed due to having leverage but is very cash generative and operates in non-cyclical markets."
Significant corporate failures unlikely
Hermon said we are currently "seeing an economic shock unlike any in modern times", with demand drying up and economic activity effectively ceasing. However, he countered, governments were "throwing the kitchen sink at the problem" with an unprecedented fiscal and monetary response.
In markets, meanwhile, volatility has spiked and liquidity, particularly in the mid- and small-cap space, has reduced due to "a buyers' strike".
But Hermon noted there had been "significant director buying across the market" recently, with "some tremendous opportunities" in certain areas. "Markets historically recover, it is just a matter of when."
While Hermon sees the likelihood of more dividend cuts or cancellations, he does not think we will see much significant corporate failure, as "this is a situation where we are all in it together".
"The banks will be under significant pressure not to ‘break' companies. Expect covenant waivers and extension of facilities. Companies will have to ‘pay their pound of flesh' in higher interest margins and some fees but that is preferable to insolvency," he reasoned.
"Governments have thrown extraordinary amounts of money at the banking sector. This is not 2008-09 - the banking sector is well capitalised and in good health.
"The UK Government is also doing its bit [by] paying wages for staff who would have been laid off due to Covid-19 and allowing deferral of VAT, PAYE and NI payments.
"There will inevitably be some requirement for equity re-capitalisation once we can see the other side. That is the function of equity markets and will provide some fantastic opportunities."
In the one month to 24 March, Henderson Smaller Companies investment trust has lost 45.5%, compared to a 36.3% loss from its benchmark Numis Smaller Companies excluding investment companies index, according to FE fundinfo. Over a five-year period, the trust has returned 4.3% compared to a loss of 11.5% from its benchmark.