Santeri Korpinen, Sifter Fund

Assurances and great opportunities – Sifter’s approach to the coronavirus crisis

When the coronavirus crisis hit the stock markets, Sifter’s analysts rolled up their sleeves. Over the course of the past few weeks, we have carried out a three-stage analysis of all 30 companies in our portfolio.

The protective and restrictive measures taken in response to the coronavirus pandemic are significantly changing the economy and the operating conditions of companies. In the first stage of our analysis, we wanted to make sure your investments are safe.

We reviewed the portfolio companies one by one to assess their ability to survive a potentially prolonged crisis.

The fact that Sifter’s approach to choosing stocks favours companies with strong balance sheets means that their average ratio of net debt to EBITDA is substantially lower than the stock market average. For many of the companies, their cash assets exceed their interest-bearing liabilities.

The average net debt to EBITDA ratio of the companies in our portfolio is 0.4x.

In other words, the companies Sifter invests in could pay off their debt in six months if their EBITDA remained unchanged.

The average net debt to EBITDA ratio for the companies that make up the S&P 500 index is 1.9x (31.3.2020).

In our analysis, we focused particularly on companies whose profitability will be hit hardest by the upheaval caused by the coronavirus pandemic. As a conclusion Sifter Companies’ credit ratings were strong and outlook stable (Median being A)

We also paid attention to the maturities of their loans. Would they be able to pay off their maturing loans using their free cash flow even if demand were to decline significantly?

Of course, we also had to take each company’s special characteristics into account in our evaluation. In the case of the aircraft engine manufacturer Safran, for example, its customers — and the customers of its customers — operate in the aviation industry, which is perhaps the industry suffering the most from the coronavirus crisis.

Airline bankruptcies are likely, which will have an impact on Safran’s largest customers: Boeing and Airbus. Nevertheless, it is unlikely that they will be allowed to go out of business.

Once we had determined that there is a high probability that the companies will survive, we focused our attention on their business.

We prepared estimates for this year, 3rd and the fifth year for all of the companies in our portfolio. The estimates are pessimistic but, of course, they are also very rough.

The rule of thumb that we applied was that demand and profit would decline about 30-50% for 2020 and recovery would start 2021. What would happen to profits?

We calculated three scenarios for each company: basic, optimistic and pessimistic. All of the scenarios are naturally very inaccurate because of the high level of uncertainty in the current situation. Even the duration of the crisis is anyone’s guess.

We applied a five-year evaluation horizon. What level of earnings would the companies have five years from now?

At the start of the year, the five-year earnings yield (profit in year five divided by the current share price) has increased by one-third on average, from 5.2% to 6.7% (currently). By comparison, government bonds offer a guaranteed yield of less than 1%.

We observed that, for some of the companies in our portfolio, the earnings yield at the current share prices rises to more than 10%.

It should be noted that the earnings yield does not represent the expected increase in share price, but rather the expected earnings we believe the companies offer us as shareholders if we invest one euro in the company at today’s share price.

In the third stage of our analysis we adjusted the relative weights of the companies in our portfolio.

When panic selling hits the market, investors quickly sell their shares regardless of their quality and the business the companies in question are in. When investors act out of fear instead of exercising prudent judgement, the markets are exceptionally inefficient.

As a result, some companies end up being priced unreasonably low.

When there’s an opportunity to buy shares in a high-quality business at an attractive price, it makes sense to seize that opportunity.

We are freeing up funds for buying by reducing our holdings in those businesses in our portfolio whose valuation has remained high for one reason or another.

The biggest change is that we can now buy the future cash flows of high-quality companies at a 30% discount.

Naturally, the coronavirus crisis has also affected the way Sifter’s analysis team operates. We switched to remote work as soon as the crisis began. We have kept in touch by remote systems as well as daily morning and afternoon calls.

For us at Sifter, the use of remote connections has been part of daily life since long before the crisis. A large proportion of our investors reside in Central Europe and the weekly meetings of the Investment Advisory Committee, for example, are held by videoconferencing even under normal circumstances.

For long-term investors, this is the time to buy. What are the attributes that protect high-quality companies from the effects of the coronavirus crisis?

Santeri Korpinen
CEO, Sifter Capital Oy

Disclaimer. The contents of this page do not constitute investment advice or purchase recommendations for stocks. This page describes our opinions on the companies we have invested in or whose shares we have sold. The past performance of the fund is not a guarantee of future results.
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