Hospitality stocks such as CDL Hospitality Reit has been heavily ravaged throughout the entire period of the pandemic.
The unprecedented impact on the global economy due to the Covid-19 pandemic, which led to an initial global close down and the few weeks of a circuit breaker, has never before been seen in the human history of mankind.
This shock factor leads to the rapid market crash back in March which accentuated the problems due to the debt-heavy fuelled model with cheap liquidity over the last 10 years since the GFC days.
During a pandemic event like this, naturally, industries such as airlines, cruises, retails, and hospitalities become a casualty as tourism fled countries and people shy away from temporarily flying to these hot-spot areas.
As a result, this causes businesses to fail, hotel occupancies to rise (that leads to a drop in the unit economic ARPU) and jobs are lost.
In fact, since the start of the year (as a matter of case using CDLHT as an example), the company has fallen by more than 60% from the peak to the trough since the start of the year. The stock has recently rebounded off the low but is still down by more than 40% since the start of the year.
So why should investors accumulate hospitality stocks now rather than later, perhaps when the sky is clearer or when international gateways are allowed to reopen.
First, because of the magnitude of the drop.
Dropping from the peak to the trough by more than 60% for a temporary once-in-a-lifetime event like Covid-19 is a little overreaction from the market. In fact, I would argue that events like this are not exactly once in a lifetime because the world has gone through the Spanish Flu, SARS, and MERS outbreak, and each time these companies are able to revamp and bounced back stronger.
Heavy asset industries such as airlines and companies with weaker balance sheets might face a harsher outlook because they have to revamp the whole organization and put on strong covenants in place. But stronger companies with good fundamentals and a decent balance sheet would usually prevail from the crisis.
The strong companies will get stronger as they try not just to heal their wounds from the crisis that hit them but also emerge stronger by eliminating weaker players in their competitive domain areas.
Second, most people often forget that stocks are longer duration assets.
If CDLHT (as a case used again as an example) drops 60% from its peak in a market crash, that would wipe out 60% of its market capitalization, which means at the current 15x earnings multiple, the market has just subtracted more than 7 years of future profits worth from the valuation.
Or you can read it as the market has priced in permanent damage at future 15x earnings multiple from, say the original 25x.
That is not true – because we know the damage of Covid-19 to the business is not permanent.
In fact, most of the hotel operations have started to commence in Q3, opening up to local domestic consumption. The increased earnings from the domestic consumption would push the earnings multiple lower or higher share price at the same earnings multiple.
Third, Covid-19 is a priced-in event.
A priced-in event is an event that the market has already discounted for in their market distribution because of an initial shock from heightened emotion and unexpected shift in investor’s asset allocation.
In other words, the repeated voyeur of daily increase cases around the globe that we always see on television or social media has little to no effect on the volatility of the market movement of the share price anymore.
The market would only react negatively only if there is a new unknown event hitting the news.
Second-wave is not a new unknown event because everyone already is expecting it. But a second-wave with new economic closures would throw off all bets. But I think the risk of that happening would be low.
As a case for reference, the Gfc in 2008 lasted about 17 months and the market bottomed in the early half of 2019 and strongly rebounded and took off from there never looking back despite the persistent damage and uncertainty on the economy.
Because of this, the risk-reward might tilt towards a recovery mode more than the other way round, and this is one of the reasons why I have been slowly accumulating recovery plays such as retail, hospitality, cruise, and transportations.
Disclosure: Author is vested on CDL Hospitality Trust
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