A sustainability lens can help discern the trends that matter

In a crisis, it’s easy to miss the long-term trends while dealing with the near-term fall-out. But for investors to thrive over time, it’s the big picture that counts. Without ignoring the short-term risks of Covid-19 that are still present, it’s worthwhile to start elongating the time horizon of the outlook. By focusing on the sustainability of businesses, we can differentiate between the drivers that are fleeting, and those that are truly influential.

As we move through the Covid-19 crisis, deciding which trends are transitory and which are lasting requires answering many questions related to consumer behaviour patterns, business structures, government interventions and the real earnings power of businesses. But one particularly central question is whether lower short-term earnings can lead to an increase in the long-term value of a business. To answer this and judge between trends, we can use a framework that prioritises the sustainability of businesses and extends the investment horizon. 

This approach looks beyond short-term profits, which may not necessarily lead to long-term success, and instead puts more weight on long-term value creation. By using this mindset, we can often reach different conclusions from consensus expectations.

 

Extending the investment horizon by using a sustainability approach

A number of companies are benefitting from this crisis including those in ecommerce, gaming, food delivery, software as a service (SAAS) and healthcare. Many of them were already positioned for established trends that accelerated from the effects of Covid-19, such as greater penetration of mobile payments. Consequently, these companies’ stock prices have risen, rewarded by what I view as the market extrapolating Covid-era trends well into the future. But it’s not a given that these companies will thrive in the long run just because they are doing so now; instead this will depend on whether the trends driving current success will still determine who wins in the future.

Contrary to the market’s short-term focus on earnings, some companies are using this period to protect and build the long-term value of their businesses. This strategy is different to maximising short-term profits (which does little to ensure lasting success and may even harm it) because it seeks to increase the value to all stakeholders rather than prioritise one group at the expense of others.

According to a recent book by Professor Alex Edmans of the London Business School, companies following this ‘grow the pie for all’ mindset, as opposed to a ‘slice the pie in favour of some’ attitude, tend to be the ones that can deliver sustained value creation over time. In that sense, while it may seem like shareholders are at the receiving end of Covid-related pain through lower earnings and dividend cuts, the reality could be that many of these companies will be able to enhance value for all stakeholders (including equity holders) over time. By cushioning the impact of Covid-19 for some groups of stakeholders and ensuring no party is disproportionately carrying the burden, the seeds may be being sown for long-term prosperity.

 

Real world examples of growing the pie 

As an Asian equities fund manager, I am seeing several examples of this long-term sustainable approach in action. 

Chinese dairy producer China Mengniu has kept its commitment to buy milk from dairy farms and honoured its procurement obligations through this crisis despite lower expected end demand. Mengniu has also provided zero-interest funding to support farms with temporary liquidity problems. Not only will this help farmers survive, but it also stops a lot of raw milk from going to waste. Mengniu plans to convert this raw milk to milk powder to store as inventory for future use. This will hurt margins in the near term, but crucially it protects its supply chain and the sustainability of its business over the long term.

Banks have been in the eye of the storm during the virus outbreak with many of their borrowers facing severe business disruption, including interruptions to cash flows. Several banks such as Bank Rakyat in Indonesia are proactively restructuring loans, while in India, in line with the central bank’s recommendations, all banks have extended loan moratoriums to several types of borrowers. This will almost certainly hurt near-term earnings as interest payments are forgone and credit costs rise, but by helping borrowers survive and enhancing customer loyalty during these difficult times, many of these well-capitalised banks will see their long-term value rise.

Chinese sportswear makers, Anta and Li Ning, have implemented a series of initiatives to support distributors including buying back inventory, providing subsidies, cutting or delaying future shipments and extending credit terms to ease a profit and liquidity squeeze. Importantly, it also protects the brands from excessive discounting to safeguard the franchise value in the future.

As Edmans points out in his book, Grow the Pie, one of the advantages of companies adopting a ‘purpose’ is that it attracts motivated talent who relate to it. A good example is Indian pharma company Cipla, which embeds affordable drugs into its mission and has consistently demonstrated care for lower income groups. Cipla’s employees voluntarily contributed an impressive US?? $400,000 to add to the company’s own recent Covid-related donations. Companies that make a genuine effort to help the community tend to benefit from a motivated and purpose-aligned workforce.

 

Discerning between trends  

With Covid-19 case rates falling to manageable levels in many parts of the world and lockdowns being eased, we can start to think beyond the immediate effects of the virus and towards the path to normality. Of course, without a vaccine or herd immunity, Covid-19 continues to pose a threat. But, in this still uncertain environment, it’s worth trying to identify trends that will persist beyond the outbreak. 

Using sustainability as a core criterion can help assess whether the strategies a company is deploying will create long-term value or are merely generating short-term profits for shareholders at the expense of other stakeholders. By helping to judge between trends, this yardstick can make a significant difference to investment outcomes.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment. Investments in small and emerging markets can be more volatile than investments in developed markets.

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