As the COVID-19 pandemic hits global economies, equity investors are redoubling their focus on corporate resilience. But what does resilience mean in the current context – and which companies have it?

The coronavirus pandemic has roiled markets and disrupted business models around the world. One consequence of the crisis has been a renewed focus on what makes a company resilient: from the size of its debts to the consistency of its revenue streams.

But resilience is not a static quality. What it means to be resilient will shift under different market conditions, argues Mikhail Zverev, head of global equities at Aviva Investors.

“You need to ask the question: ‘resilient to what?’,” he says. “Like ‘quality’, ‘resilience’ may sound like an absolute concept, but it depends on context. Whether the risk is a theoretical black swan or a clear and present danger, equity investors need to look at a company’s capacity to respond and adapt to change.”

Winners and losers

In the current environment, a firm’s resilience will depend on the interplay between the fundamentals of the business and the fast-changing dynamics of economic activity and consumer behaviour amid severe coronavirus-related disruption.

Clear winners and losers have emerged in the early stages of the crisis. With global tourism effectively grinding to halt, the travel and leisure sector – airlines, hotels, casinos, cruise liners, and events – has been severely impacted. By contrast, software companies have benefited from the rise in demand for streaming and networking platforms during lockdowns.

Investors should have been able to spot underlying vulnerabilities in the worst-hit sectors

While investors cannot have been expected to predict the onset of the pandemic, they should have been able to spot underlying vulnerabilities in the worst-hit sectors. Travel and leisure was already far from resilient: in mid-2019, a KPMG report found almost 12 per cent of UK companies in this sector could be categorised as “zombie” firms, with static or falling turnover, low profitability, squeezed margins, limited cash reserves and high leverage. Faced with such pressures, these weaker firms had little capacity to invest in the new products or equipment that might have enabled them to adapt to a changed market environment.1

Similarly, independent US oil producers were fragile before the recent collapse in energy prices. Many companies were already highly leveraged and dependent on high oil prices to function; it would not have taken a crisis on the scale of COVID-19 to tip them into trouble.

Balance sheets and cash buffers

The troubles in these sectors serve to highlight the importance of strong balance sheets and manageable debt loads. The stock market has been particularly swift to punish companies whose debt includes covenants that would be triggered by a sharp decline in revenues, forcing them to raise equity.

“If a company has a lot of debt – especially debt with covenants attached – and its revenues have fallen to near zero, then its equity will have performed extremely poorly during the crisis,” says Giles Parkinson, global equities fund manager at Aviva Investors.

“Even without the asymmetry of triggering covenants, debt magnifies outcomes. Some regulated utilities, such as UK water stocks, despite being ‘defensive’ businesses, have fallen with the market during the selloff. This is because the high level of debt in their capital structure makes their equities more sensitive to small changes in the overall value of the enterprise,” he adds.

Dominant firms are more likely to be able to sustain themselves during the downturn

By contrast, large, dominant firms are more likely to be able to sustain themselves during the downturn, as they tend to retain access to debt markets at affordable rates, enabling them to roll over existing liabilities when needed.

Stronger still will be those firms that have amassed huge cash buffers in recent years. Tech giant Apple, for example, is sitting on a cash mountain of more than $200 billion, which means it should be able to continue investing in staff, marketing and valuable research and development initiatives during the pandemic – and potentially snap up enfeebled rivals when opportunities arise.

A recent study collated data on companies’ debt-insurance costs, leverage levels and cash buffers to create a league table of the most resilient global companies. Tech and pharmaceutical behemoths dominated the list. Along with Apple, Microsoft (with a cash buffer of $134 billion, or 40 per cent of revenue); Facebook ($55 billion, 51 per cent of revenue) and Alphabet ($120 billion, 34 per cent of revenue) scored highly.2

Supply chains: From efficiency to resilience?

Companies need more than just cash buffers and strong balance sheets to survive a crisis, however, and equity investors are closely scrutinising the impact on supply chains. Consider the share prices of US-based food and ingredients suppliers such as Lamb Weston and Kerry Group, for example, which have fallen sharply in recent months as customers such as McDonald’s close their restaurants during lockdown.

Alistair Way, Aviva Investors’ head of emerging market equities, says it is especially important for investors to monitor the status of international supply chains given the wide disparity in the severity of the pandemic – and government responses to it – across different countries and regions.

“Investors need to ensure companies they invest in have balance sheets, cash flows and capital expenditure commitments that are strong and flexible enough to cope with the massive revenue hit. But they also need to look at supply chains,” he says. “A diverse set of customers and suppliers can help companies withstand sudden shocks.”

Way cites China-based Apple supplier Hon Hai as an example of a company that has taken care to ensure its customer base is properly diversified. Hon Hai’s core business – assembly of Apple’s iPhones – may be vulnerable if demand for consumer gadgets slumps. But the company also make telecoms infrastructure, servers and medical equipment, thanks to a concerted effort by its management to increase the scope of its business in recent years. “This strategy now looks spot on,” says Way.

Companies with complex supply chains are still grappling with the immediate impact of the pandemic

Companies with complex supply chains are still grappling with the immediate impact of the pandemic, and the longer-term implications are yet to become clear. But it is possible the “just-in-time” supply chain model that became the norm during the boom years of globalisation may give way to a more conservative “just-in-case” approach as the pandemic recedes, as companies seek to build larger inventories to ensure they are resilient against sudden shocks.

“Two recent events – the trade war between the US and China, which is far from over, and now this pandemic –have reminded people that global supply chains are not always reliable,” says Zverev.

“Companies in the tech sector are taking the view that if demand returns to normal – at a time when highly complex supply chains are still liable to malfunction – they need to build inventory. Firms in the semiconductor industry have already started building up inventories in the expectation demand will bounce back. This may be a transitory phenomenon, but it’s an interesting development investors should keep an eye on,” he adds.

ESG: A key to corporate resilience

Attention to environmental, social and governance (ESG) factors is another key component of resilience. No company that ignores ESG risks can be described as resilient, when climate change poses a looming, existential threat to business models everywhere.

Better-managed, ESG-conscious companies will also have been more resilient to the specific risks associated with COVID-19, such as vulnerabilities in supply chains. This is because such firms tend to take a more careful and holistic view of their operations and those of the companies they are associated with, according to Jaimie Ramos Martin, global equities fund manager at Aviva Investors.

Companies that are leaders in ESG are focusing on the resilience and sustainability of their business models

“Companies that are leaders in ESG are focusing on the resilience and sustainability of their business models,” he says. “Take supply-chain management: in order to be a leader in ESG, companies would have needed to better understand the carbon footprints and labour practices of their suppliers, which will have prepared them for the disruption when COVID-19 hit.”

Over the medium term, governments may seek to allocate stimulus packages on the basis of a company’s track record on climate change, says Martin, which is likely to benefit businesses with stronger ESG credentials (although it is also possible that environmental issues may drop down the list of priorities as policymakers seek to kick-start economic growth in the short term). 

What seems certain is that government support for the private sector during the crisis will lead to a renewed focus on social responsibility among policymakers and the public. Aggressive tax avoidance, poor labour and community relations and a substandard environmental record will be harder to defend in a world that has suffered through the collective hardship of COVID-19; companies that have demonstrated they are willing to do the right thing are more likely to retain the loyalty of their staff and customers.

Parkinson says it is important for equity investors to keep track of these kinds of qualitative measures – and take steps to improve them through engagement with company management teams – as they assess the resilience of their portfolios.

Such factors are also important determinants of value. Whereas quantitative factors can be plugged into a Bloomberg terminal and tend to be quickly arbitraged away, qualitative metrics like corporate behaviour are more difficult to assess, and therefore more rewarding for investors willing to do their due diligence.

During the last financial crisis some companies emerged stronger relative to their competitors because they adapted quickly

“Some company executives have pledged to take a salary cut during the crisis; others have extended support to their customers and suppliers. The effects of this may last beyond the pandemic. We saw during the last financial crisis that some companies emerged stronger relative to their competitors because they adapted quickly, continued to innovate and maintain customer relationships, grew market share, and expanded their competitive advantages,” says Parkinson.

Investing on the right side of change

COVID-19 reveals a business tension between efficiency and resilience that has been gnawing away at corporate behaviour for some time. The tension between short-term profit maximisation and long-term success also highlights resilience is not an immutable quality, but a set of characteristics that shifts depending on the market and social environment. A recent McKinsey study tracked how 1,000 publicly traded companies fared during successive crises: it found an ability to nimbly adapt to new conditions was a hallmark of the best-performing firms.3

This ability to adapt can take many forms but a few recurring factors stand out. First is people; flexible, skilled and loyal staff add to a company’s adaptability and resilience. Second is diversification, both in terms of customers and supply chains. Third is cash; having a large war chest improves a company’s chances of withstanding pressure during a crisis. Fourth is culture; a strong management team that is open to change and willing to make tough, but socially responsible, decisions can significantly enhance a company’s reputation and bottom line. Together, these elements can create a resilient business.

Openness and ability to change might have the most influence in separating the weak from the strong

However, with such profound changes to society and the corporate world inevitable in the wake of COVID-19, openness and ability to change might have the most influence in separating the weak from the strong. From the increase in home working to rising demand for cashless payments and cutting-edge medical equipment, resilient companies will already be thinking about how they can adapt and respond.

For investors, this may open up opportunities to spot which firms are likely to thrive in the post-COVID era. At these kinds of inflection points, investors tend to overlook the early signs of corporate repositioning, Zverev argues.

“You need to think about resilience in the context of change,” he says. “Change works both ways; it can be an opportunity and a threat. This is because change creates inefficiency. When something is changing in a business, when the future isn’t equal to the past, the market is more likely to misunderstand and misprice it, because when investors can’t continue to extrapolate from the past, they have to work harder to connect the dots.”

Resilient by design

In a world with little certainty, delivering resilience in investment requires discipline and a heritage of managing risk. Find out how we take a different approach to resilient portfolio construction.

Find out more

Freedom has its own style

Equity investing without style bias. We are active, fundamental and responsible investors that have the freedom to invest wherever the best opportunities arise. We use the power of connected thinking to help keep you on the right side of change.

Find out more

Want more content like this?

Sign up to receive our AIQ thought leadership content.

Please enable javascript in your browser in order to see this content.

I acknowledge that I qualify as a professional client or institutional/qualified investor. By submitting these details, I confirm that I would like to receive thought leadership email updates from Aviva Investors, in addition to any other email subscription I may have with Aviva Investors. You can unsubscribe or tailor your email preferences at any time.

For more information, please visit our privacy notice.

Our latest resilient views

Important information

THIS IS A MARKETING COMMUNICATION

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.