Nirgunan Tiruchelvam: How to ride the vaccine recovery

Thanos is a villain who appears in Marvel Comics. At 8 foot 3 inches and weighing over 700 pounds, he can intimidate — and it is not just because of his size. The villain has a double-edged sword that penetrates any armour. The sword can slice Thanos opponents with ease.

But, there is a hitch to the weapon. The two blades can cut both ways. If Thanos is not careful, one of the blades may destroy him. The sword could cut the hand that wields it.

The Thanos sword has an equivalent in finance — operating leverage. This term refers to the degree to which a company’s profits are dependent on a change in revenue. If a company (like a hotel) has high fixed costs, the Covid-19 closure can wipe out profits. On the other hand, if a company has low fixed costs (like an online store), a collapse in revenue will not affect profits much.

Even Thanos’ sword could not have been as destructive as the pandemic. Those with high fixed costs have been hit hard. The profits of these companies have been wiped out. The SGX-listed Mandarin Oriental, has seen a 67% drop in revenue in 1H2020. Its drop in operating profits has been more than 500%, which implies operating leverage of 6x.

Hotels have heavy staff costs, leases and overheads like electricity. It is not possible for them to eliminate fixed costs, irrespective of the revenue. Even if they retrench the staff and close every floor, they still have to pay their landlords.

There is now a high chance of a vaccine emerging in 1Q2020. AstraZenaca is developing a Covid-19 vaccine. This week, AstraZeneca announced that it would resume its vaccine trials after reports of harmful side effects.The data from the trials conducted by Pfizer and Moderna are expected shortly.

The Western drug companies are moving gingerly. The frontrunner may be in China, currently the producer of four of the 11 potential vaccines that are in advance trials.

Just as the pandemic struck suddenly, the discovery of a vaccine could jolt the market. The vaccine will be a magic potion for some stocks.

Apart from Mandarin Oriental, there are two pandemic-stricken stocks that may benefit exponentially. Village Roadshow, an Australian cinema and theme park operator, is down 45% ytd. It runs the Golden Village chain of cinemas. In Australia, it has theme parks like Warner Bros and Sea World in Australia.

The pandemic has been a nightmare for this fantasy park operator. The theme parks and cinemas have been closed indefinitely. Australia has imposed a draconian lockdown. In Melbourne, people were restricted from travelling beyond 5km of their homes.

Village Roadshow has high fixed costs. It has to pay its workers and its landlords, in the lockdown. The rides and rollercoasters have to be maintained. Red ink looms large on this colourful company. Its losses in 1H2020 were three times its 1H2019 and 2H2020 profits.

However, even a hint of a vaccine could reverse the stock’s direction. The theme parks and cinemas could reopen in 2Q2021. This could be music to investors’ ears.

Operating leverage can cut both ways. A 10% increase in its revenue could have an even higher impact on profits. Village Roadshow could be a prime beneficiary of a vaccine.

Another company that may leap to the sound of the vaccine is Minor International. This Thai-listed hotel giant has more than 12,800 luxury rooms. Its brands include Four Seasons, St Regis and Marriott.

Minor’s debt has also been a major burden on its stock price. It doubled its net gearing at the worst possible point. It acquired a European hotel operator just before the pandemic. It bought NH Group for US$2.5 billion ($3.3 billion), which was funded by debt.

The pandemic has obliterated its operations. Its occupancy in Europe has been 5%. In Thailand, it was worse at 1%. Their landmark Peninsula Hotel is now a ghost town overlooking the Bangkok river.

The stock has halved in 2020. It is trading at book value for the first time since the dark days of 2008.

A gradual reopening in 2021 will turbocharge its revenue. Even a basic meal is like gourmet for a starving man. Investors need to look beyond the pandemic. As the sword wielding Thanos said, “the hardest choices require the strongest wills.”