Comment on Q2 2020: Adapting to a new reality
Since the start of the covid-19 virus outbreak in the first quarter, global investors and citizens have been quick to adapt to a new reality. As a result, both markets and economic data have improved incrementally, though from a public health viewpoint the situation remains highly uncertain. Especially for some of the more densely populated emerging and frontier markets, the outbreak is far from being contained, and the only silver lining for many of these countries is their demographics, as their younger populations are less vulnerable.
The key economic impact from the pandemic has been from the unprecedented lockdown measures deployed by governments to combat the spread, which are now being gradually lifted. Re-openings have a positive impact on domestic demand, with the caveat of more social contact and thereby renewed risks of virus resurgence. From an international point of view, cross border travel remains muted, but is expected to pick up through the remainder of the year, as tourism-dependent countries have little choice but to stay open. When it comes to business travel, along with most other companies, we remain grounded. But we have increased our digital interactions - not just for maintaining a close relationship with the companies we invest in and keeping our promise to be a truly active owner, but also to maintain the very important relationship we have with our clients. During the quarter, we held multiple online webinars that attracted a high level of interest, and at the end of June we also held our first ever virtual investor forum, creating a platform for dialogue with some exciting portfolio companies.
While the pandemic has impacted global demand, with great implications on trade and commodity prices, the first quarter also brought a supply chock to the oil market, as OPEC+ discussions broke down. Since then, things have been looking brighter. On the supply side, OPEC+ members have found their way back to cooperation, while oil demand saw a surprising uptick from a sharp increase in car transportation, as people started to avoid public transport.
Stable and higher commodity prices have generally positive implications for commodity producing countries, while increasing demand implies that emissions will once again rise and the environment’s short-term respite may soon be over. We note however that the greening of the economy has been given a significant push, especially visible in some of the stimulus packages that have been announced (or proposed), where spending will be directed at the transition to carbon-neutrality. At East Capital, sustainability is at our core, and we focus our resources on where we can really make a change. As one example, we are co-lead investor within the global initiative Climate Action 100+ on engagements towards the largest oil and gas producers in Russia - Lukoil and Gazprom - where the result from cutting GHG emissions by 10% for the latter would correspond to almost twice the annual emissions produced by road traffic in Sweden. As a recognition for our hard work in the area, and something we are very proud of, we received an award in April as the sustainable fund achievement of the year.
Throughout the crisis, not all sectors have been impacted equally. While the worst hits have been on travel and hospitality, sectors less reliant on physical contact have performed well, with e-commerce and online services seeing a sharp acceleration in user activity. This has been positive for several of the companies we invest in, both within tech and omni-channel retailers. As a few examples, we might soon add Amazon to the description of Yandex, as the combined Google and Uber of Russia, after seeing a 30% revenue growth for its online marketplace in Q2. Elsewhere, in Poland, some retailers showed even more staggering numbers. LPP, a clothing company, reported y-o-y growth of 121% for its e-commerce business, now at 43% of total revenue, while CCC, a leading shoe-retailer, announced a doubling of its online sales.
At the beginning of the year, we touted Russia’s resilience thanks to the country running a twin surplus with additional support from its National Welfare fund. While Russia has not come through the crisis unscathed, the decline has not been as large as might have been expected when looking at the correlations to the oil price just a few years ago. For us, this strengthens the thesis we had at the beginning of the year, and we see many interesting investment opportunities in this market.
Looking forward, we expect the long-term investment case into emerging and frontier markets to remain intact, and we remain focused on our investment process to identify and invest in companies with exposure to structural growth, competitive advantages and highly-skilled management. We also note that the dispersion in valuations between growth and value stocks is record high, which we believe provides great opportunities for us.
