Perspectives from our Portfolio Managers

Given recent market volatility we wanted to share some thoughts in case they may be of value.

It does appear to us that much recent trading has been driven by fear. The VIX volatility index has been at historically high levels along with credit spreads. We are told that a high percentage of trading is being generated by ETF’s and computer trading algorithms.

At times like this in the stock market and in life, it is important to remember that panic is never a good strategy.

A sense of urgency from authorities about COVID-19 is, however, probably a good thing. Recent examples of countries in Asia that took aggressive action, and those from more distant history, seem to show that social distancing is worth it. We have listened to many epidemiologists and virologists, and the key thing is that social distancing measures serve to flatten the peak number of cases and may ultimately lower the number of fatalities. Flattening the peak helps to avoid overwhelming the health care system. Although it has been too slow in coming, we are starting to see increasing efforts in the United States and Europe to take action on social behavior.

At the same time, monetary authorities are lowering interest rates and intervening in capital markets. While this does not have a health care impact, it may serve to provide some support and to inject liquidity.

Another part of the approach is fiscal measures, which we are starting to see. Governments around the world are looking to provide support to health care providers, businesses and their employees.

Social distancing, whether voluntary or enforced, is likely to slow the global economy. We do not know whether there will be a slowdown or a recession. Either way it will eventually pass. Our base case assumption in our valuation models has been a coming recession, and we have had this in place for over a year. We didn’t know this situation would be the reason, but it has been our assumption nevertheless.

The fact that share prices for our holdings have been driven to massive discounts to our models during this episode tells us that markets are probably divorced from fundamentals. A great example is Gartner, a technology research company we have owned for over a decade and which we know well. Gartner has a $4 billion top line, with about 10% of that coming from its Events business. The vast majority of the company’s revenue comes from its Research business, which has a very high gross margin and is delivered largely online and through analyst calls. Gartner’s guidance for 2020 has been that the Research business would grow 9.5% - our model has been assuming 0% since last year. Our model value at the start of 2020 was around $160 per share.

Given the virus issues, we have tried a few different scenarios. Eliminating the Events business for all of 2020 takes the model down slightly. Eliminating the Events business forever and including a knock-on effect where new client recruitment is affected would still only take the model into the $140’s. The share price recently touched $100.

Another major holding of ours is Carter’s. We get that retail activity will decline, and that the company has significant sourcing from China. However, children’s clothing is less discretionary than other apparel categories and Carter’s already does about a third of its business through digital channels. At a conference this week, management said its Chinese suppliers (about 15% of total sourcing) are back up and are working hard to get to full production. They see two to three-week delays for some early Fall deliveries but as of now Labor Day (which is the company’s second biggest holiday season) looks like it is on track. Carter’s has the largest market share by far in the North American children’s apparel market. This position gives it more heft with suppliers and a dominant cost advantage. If anyone is going out of business in children’s clothes, it will likely not be Carter’s.

A market with obvious concerns is air travel. We had dinner with the Spirit Airlines CEO last week. While he certainly expected weakness in the months ahead, the company has $1 billion cash on its balance sheet, the highest level relative to size in the industry. Spirit also has a cost advantage relative to other airlines, and since it does not have any corporate travel to speak of, it is less cyclical than other airlines.

Last week we also met with the CEO and CFO of Premier, in which we are one of the biggest shareholders. Premier’s core business is a GPO or group purchasing organization for health care providers. As one of the largest GPO’s in the United States, Premier manages a significant percentage of supply chain activity in the health care industry. It is true that there are issues getting access to Personal Protective Equipment, especially N95 masks. The company is doing its best to allocate supplies where they are most urgently needed. There are some positives – the CDC has allowed for the use of Industrial and “expired” masks which should increase supply by 20%, there are a few domestic manufacturers who have unused annual capacity to make 60 million masks, and Chinese suppliers are back online. As for test kits, while progress has been slow they did believe 4 million test kits would be sent out this week.

We could go on and on about our companies, but in the final analysis we believe that all of them provide products and services that make their customers’ lives better, faster and cheaper. We also believe that all of them can survive an economic recession and come out of it in good shape to grow and prosper.

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