Sales will bounce back, but will profits?
As the lockdown ends, everyday life will resume – just don’t expect business as usual, says Matthew Lynn.
Investors are betting that once the economy opens up again sales and profits will bounce back. After all, governments and central banks are pumping money into the economy so the demand should be there. There might be a bad drop for six months or so, but that will just be a blip. But will it? Perhaps not. Sales might return eventually. But profits? That is far from clear.
There are already troubling signs that even some of the world’s most successful businesses are going to struggle to make money in a world in which Covid-19 is being kept under control, but not yet eliminated. Amazon’s sales are booming, but in its latest results it warned that rising costs meant it wouldn’t make a lot of money on all that extra revenue. Tesco has already said it is suffering significant extra costs and, although its sales are up, its profits may not be. That is just a taster. It is only going to get worse as companies reopen and start reporting their post-virus results. Why? There are three reasons.
Change costs money
First, all the changes to the way businesses will have to operate to limit the spread of the virus are going to cost money. We have already started seeing one-way systems in supermarkets. That limits the chance of infection, but it costs money to install and it means customers have less time to browse, and that may mean less spending. Factories will have to reconfigure their floor space so that workers are not too close to each other. Face masks, hand sanitiser and screen wipes will have to be provided for office staff and a lot more cleaning will be needed. All this increases costs and that reduces profits.
Next, productivity is going to be a lot lower. An office with a rota will be less productive than one where everyone is working together at the same time and if commutes have to be staggered, journeys will take longer and people will spend less time at their desk. A restaurant with half the tables, because they have to be kept apart, will still have the same rent as when it was packed out and it will still need chefs and waiters – it is just revenues that will be lower. A clothes shop with no changing rooms is going to sell less stuff because it will be harder to engage customers. So will a bookshop that doesn’t allow browsing (as some of them have suggested for re-opening). The list goes on and on. Output per person will drop dramatically and, unless wages are slashed as well – and that seems very unlikely – that will make it a lot harder to make any money.
Finally, supply chains will inevitably be disrupted. A clothes chain might not be able to source supplies from a low-cost manufacturer in the Far East anymore, and even if it can there might be sudden interruptions. A manufacturer might need a lot more warehousing because it can’t rely on parts being delivered every day as they used to be. Quarantine restrictions will hold up the flow of goods as well as people and of course services companies won’t be able to send people from place to place to see clients. In countless different ways, that will add to costs, but not to revenues.
The struggle for profits
The result? Whether it is because of changes to operations, lower productivity, or costlier supplies, there will be a relentless squeeze on margins. With demand inevitably lower, despite the stimulus the government will throw at the economy, it is not going to be possible to raise prices. Indeed, in a brutally competitive market you might even have to reduce them. Taken together, it means profits are going to be lower and often substantially so.
That matters and it matters most of all to investors. After all, a flow of future profits is fundamentally what they are buying when they buy an equity. The real challenge over the next few months will not be to find companies that can come back from lockdown, restart their operations and start serving their customers again. Most of them are going to be able to do that. It will be to find the companies that can work out how to come back profitably – because making profits is about to get a lot harder.