Dear IFAC Member
The first quarter of 2020 saw a dramatic drawdown in risk assets. The trigger was the global pandemic that began in the heart of China’s industrial centre and then, in February and March, spread rapidly to all parts of the world. The social distancing and containment actions taken by authorities to reduce loss of life saw many businesses come to a complete stop and the world economy drop into a sharp recession. Global equities plunged into a bear market at the fastest ever rate.
The universe of food companies was not immune to this simultaneous external shock to supply and demand. Closure of offices, schools, sports & leisure venues and restaurants led to a collapse in food consumed out-of-the-home. In the US, casual dining restaurants saw up to a 90% fall in revenues. As virtually all parts of society across the world went into a lockdown in their homes, we saw a partial offset from grocery stockpiling and a spike in at-home food consumption. Nevertheless, the overall impact of a recession led to a repricing of growth and risk, even for the shares of companies with sales relatively unaffected. The fund unit price fell 22% during the quarter.
Despite the tragic loss of life, suffering and economic shock, the long-term structural drivers for the food economy look to be largely in place. Population growth, rising living standards and urbanisation are trends that will continue to occur after a temporary interruption. Themes such as healthy eating, food away from home, and technological development in agriculture and the wider food chain are powerful social and business drivers that reinforce strong growth in parts of the food economy over the long-term. They remain attractive areas to find investment ideas.
We also think the pandemic will help catalyse and accelerate consumer behaviours, such as the use of online grocery and food delivery, as well as an increased focus on dietary health, nutrition, and immunity.
Given the rise in demand for online shopping, it was no surprise that Ocado, the largest holding, was also one of the best performers in the portfolio, with the share price down only 4% in the quarter. The contribution to performance was helped by a timely addition to the holding below £11 per share as equity markets weakened (they ended March at £12). We think Ocado’s online software and automated warehouse technology will become even more attractive to potential new supermarket and grocer partners in a post COVID-19 world.
For the second successive quarter, Genus shares contributed strongly to fund performance, falling only 1%. In China the government are now looking to rebuild the country’s pig herd, impacted by African Swine Fever over the past 18 months. Genus is ideally placed to supply the new breeding stock and we had a good meeting with Genus’ new CEO, which underlined the long-term investment case.
The worst contributor to performance was US catering equipment stock Welbilt, with the shares falling 74%. All of this damage occurred in the two-week period in mid-March and reflected concerns about the balance sheet, with the company caught in the midst of a financial restructuring. Food equipment spending by Welbilt’s restaurant customers is likely to be postponed for many months given the lockdown in multiple countries and their cash flows will be severely interrupted. Our call with the company uncovered the requirement for a covenant waiver from their lending syndicate and given the ongoing risks to where the business will re-emerge into FY21 and beyond, we decided to sell the holding.
As part of our risk assessment we also took early action to reduce exposure to emerging markets, where sadly it looks like some of the economic impacts will be hardest. We completed the sale of the holding in Mexican chicken producer Bachoco and sold the entire position in Indian biscuit company, Britannia Industries, which has been a very successful investment. We also completed the sale of the Japanese agricultural machinery company Kubota. It has about 20% of sales in EM but also sells machinery to the construction industry, which is likely to see orders down significantly.
We are using the market volatility to find new ideas that will emerge from this pandemic with stronger positioning and investment cases. We added a holding in Health & Happiness, a Hong Kong based company that sells infant formula and nutritional products for adults, mostly in China. We also reintroduced a holding in Kerry Group, building on themes around snacking, plant-based meat, and nutrition.
The pandemic will cause economic disruption and permanent change in some businesses around the world, but we believe the underlying drivers of growth in the global food economy remain positive. A recession may temporarily slow the rise in incomes of middle-class consumers, particularly in some emerging markets, but the wider trend of improving standards of living is inexorable.
We do not expect broad urbanisation trends in developing countries to change and, fortunately, the loss of life will not cause sufficient change in the demographics to interrupt the rise in the number of mouths to feed each year. These trends underpin the theme and allow continuing opportunities for investment across the spectrum from ‘field-to-fork’. We remain positive on the outlook for the Sarasin Food & Agriculture Opportunities fund.
As ever, if you have any questions or would like to discuss aspects of the portfolio in more detail, please do not hesitate to get in touch by email.
We hope that you and your families and colleagues keep well.