TL;DR — The Big Trade
This past Monday, I sold the remainder of my tech positions that have benefited significantly from work-from-home (e.g. Wayfair, Peloton, Match Group, etc.) and have started buying travel stocks (e.g. Norwegian Cruise Line, Carnival, Royal Caribbean, United Airlines).
I’ll explain my rationale and assumptions below.
New COVID Case Growth Drives Performance of Travel and Technology Stocks
If you read any news website, you’ll see headlines about how COVID cases are worse in the United States than ever before. This has created pessimism throughout the country, with many states taking more preventative measures to stop the spread of the virus (which they rightfully should be doing).
During this “second spike” in COVID cases, capital has flowed directly into technology companies that (1) have resilient business models and (2) benefit from longer quarantine periods (a.k.a. work-from-home). On the flip side, travel stocks have been hammered as hopes of re-opening have simmered.
Running a simple correlation analysis on this, you’ll see that there’s a moderately positive correlation [r=0.4 to r=0.6] between (a) the growth in new COVID cases over the last 7 days and (b) the growth in stock prices for technology companies. On the flip side, there’s a strong negative correlation [r=-0.6 to r=-0.8] between (a) the growth in new COVID cases over the last 7 days and (b) the growth in stock prices for travel companies.
Assumption #1: If COVID cases decline in the US, travel stocks should go up, and outperform tech stocks.
Assumption #2: Travel stocks will continue to trade on sentiment towards re-opening more than anything.
Assumption #3: Over the past month, new COVID cases, not deaths, have had the highest correlation with travel stock performance. This trade assumes that will still be the case going forward.
New COVID Cases Should Decline in the US Going Forward
As an example, COVID-19-projections.com, one of the more accurate COVID models in the world (a model which forecasted a small second bump in the US earlier in the year) is now predicting that we had reached a peak in new infections ~2 weeks ago and given a certain incubation period, that would imply that we have likely peaked in new cases.
There could be a lot of reasons for this:
- Some state and local governments have started to take quarantine and social distancing measures more seriously recently
- The Trump administration has started advocating for masks (finally) and has re-started COVID-related briefings. This may encourage more to socially distance and wear masks
- A lot of big states have already seen their spikes, leaving only smaller states to experience the second wave, which should have a lower impact on total US COVID cases
Assumption #4: Perhaps the biggest of all of these assumptions, you have to assume that we’ve already passed the peak of COVID cases in the US for this trade to work. This assumes no substantial second wave in the near-term.
There’s a Reasonable Probability that We’ll See Good News About a Vaccine This Year
Super-forecasters of a COVID vaccine have gotten a lot more optimistic in recent weeks, with the popular choice being a vaccine coming across between October 1, 2020, and March 31, 2021. Moderna has started its phase 3 trials, which if all goes according to plan, supports an October / November time frame. Similarly, Pfizer and other companies have vaccines far into development. Any positive news towards these vaccines should supply a bump to travel stocks in the near-term.
Tech is Overvalued on a Growth-Adjusted Basis
The software index is already up 38% this year (and we still have 5 months to go). If tech continues to run up, this would be its best year in the past 10 years (we’re only 5% away!).
The thing is, a lot of this growth has come from increases in these companies’ multiples.
In simple terms:
Company’s Value = Company’s Revenue x Revenue Multiple
Example: $300 Billion Enterprise Value = $30 Billion x 10x Multiple
Software companies that are growing at over 20% (also categorized as high-growth software companies) are trading at an average of 18.6x revenue, which is a record high (see above graph). For reference, they were trading at 12.8x in March of 2019 (the previous peak). The fundamentals (e.g. growth, margins, etc.) haven’t improved by that much, leaving the increase in multiples to drive most of the stock appreciation. It looks like we’re due for somewhat of a downward correction from these highs (at least with technology companies).
So You’re Betting on Travel…What Are You Buying?
- 70% Cruise Lines (Norwegian Cruise Lines, Royal Caribbean, Carnival): These are roughly 30% EBITDA margin, 0% Levered FCF businesses, and have more variable expenses (fuel, etc.) than fixed expenses. They were relatively good businesses before the crash, and a lot of them have been able to secure funding (e.g. Saudi Investment fund) and still have the means to secure funding in the future. They are also pretty essential to tourism in countries across the globe, so it remains to be seen if governments will let them go under. The downside is that they’re not really domiciled in the US, so they’ll unlikely get bailout money from the US, and it remains to be seen how quickly people will hop back on cruise ships after this is all said and done. On top of that, they’ll likely have to increase fixed expenses afterward due to increased marketing spend to get travelers on board (their marketing efficiency ratios will probably decline too). The upside here is higher than airlines given how much their stocks have dropped.
- 20% Airlines (United, Delta, American): These are roughly 15% EBITDA margin, slightly worse cash flow businesses than cruise lines. I think they’ll likely get some bailout money here, which should provide them a cushion in the near-term. Given this bailout point and the fact that they are more of an “essential service”, there seems to be a higher likelihood here of a recovery. It should also be noted that some of these airlines have been flying cargo in lieu of flying passengers, which is relatively profitable.
- 5% Hotels (Marriott): I think hotels will go the way of the airlines, with less upside. I would focus on investing in the big hotel brands here with stronger balance sheets.
- 5% Boeing: Boeing is likely to get a bailout because it’s a national security risk if it doesn’t get bailed out (it makes planes for the government). I feel like it’s unlikely that Boeing disappears and this becomes a one-player industry with Airbus taking the market share.
These thoughts are my own and do not reflect those of my employer.