Whatever happens, there will always be winners….
What will the world look like a year from today? As we start a new year, I’d like to step back and think about which companies are ideally placed to prosper in the aftermath of Covid over the coming year and beyond.
First, let’s consider the economic backdrop. In all my years investing in the markets (possibly with the exception of those two scary ‘end of the financial system’ October weeks in the 2008 financial crisis), I don’t think I can remember a time with such an uncertain economic picture. The bull case rests on the positive economic implications of the end of Covid thanks to the rollout of the vaccine, further boosted by unprecedented levels of monetary stimulus. Investors are growing hopeful that this will result in an enormous ‘roaring 20’s’ type economic boom – similar in magnitude to that which followed the Spanish flu in the 1920’s – as pent-up demand and easy money turbo-charge the post-Covid economic recovery. There is a pretty large consensus on this, with the implication that inflation and pricing power finally return to boost corporate profits in virtually every sector. Jobs and profits become so easy to come by that as investors, we can buy the most bombed-out and out of favour sectors and still make disproportionate returns. In terms of valuations, bulls argue that PE multiple expansion has really only been focused on a few stocks and sectors so wider market valuations are generally not that high, especially in the context of such a low-interest rate world, where equities remain the only game in town in terms of real inflation-adjusted returns.
At the other end of the spectrum, you have the bear case which centres on the third wave of Covid leading to successive shutdowns, with the vaccine’s slow rollout process unable to prevent this from happening. Under this extremely bearish scenario, we face a deep and prolonged recession, no matter the size of any monetary stimulus package and this downturn is exacerbated by the lack of pricing power and wage growth in most areas of the economy as powerful deflationary megatrends (ageing populations, automation, robotics etc) continue to take effect. Against this backdrop, most market sectors would struggle, and the sky-high asset valuations and ballooning government debt piles would add to the potential risks…
Big picture, the fact that uncertainties exist is very normal. In fact, markets typically climb ‘a wall of worry’ even in the biggest bull markets. Study after study highlights how staying invested over the long term through the market gyrations is actually your best bet to achieving attractive returns, especially for people with decades left to retirement. Furthermore, there are always winners however negative or uncertain the economic situation as a whole and it’s usually possible to find these outliers through detailed research and fundamental analysis.
I’ve been wracking my brain who wins from the aftermath of Covid. Typically much of my portfolio focuses on companies which are less economically sensitive as their growth is more based on exposure to some powerful theme or megatrend. Although these companies do not, therefore, benefit as much from a roaring economy scenario, I believe in most situations this lack of economic sensitivity is a plus and gives them an ‘all-weather’ chance of achieving their plans. In terms of finding who stands to win now, it has proved hard to find actual beneficiaries of the Covid-induced economic downturn, where there are really positive business implications and where the stock is still under the radar in valuations terms. Overall, I feel most confident that the three stocks I am going to tell you about over the next few posts will prosper in this post-Covid year ahead. Today, I’d like to tell you about why I believe Burford Capital is well-positioned in the year ahead:
Date: January 7, 2021
Burford Capital, a large-cap UK /US listed market leader in litigation funding likely to benefit from all the corporate disputes generated by Covid business disruption
Burford Capital, founded in 2009, is the market leader in offering financing to lawyers and clients engaged in litigation and arbitration, asset recovery and other legal finance and advisory activities. This is a niche funding area that continues to have enormous growth potential as companies increasingly choose not to have their hard-earned capital tied up in this way. By having a strong market position and being very selective in taking on corporate cases, Burford has achieved a spectacular long term track record in IRR terms.
Past performance is not a true indicator of future results.
I believe Burford is one of the very few companies that benefit from the exact situation we find ourselves in following the Covid-induced downturn. I am very bullish on their prospects next year following a recent investor call.
The CEO explained in some detail on the call why he expects a big boost to new business this year for Burford with reference to what happened in the aftermath of 2008 (ie a one-off event that was in a lot of ways like Covid, bigger and more sudden than a normal economic downturn). In addition, it is clear that historically recession boosts corporate disputes/litigation business anyway, but these one-off shocks are even more of a boost. One example of how Covid boosts corporate liability disputes: a ship full of bananas arrives at a port which is closed due to Covid. Bananas rot, who should pay?
Overall, I believe there are excellent prospects for a whole new raft of Covid-related disputes which companies do not want to tie their capital up with – on top of the boost we could expect looking historically at what happened in a normal downturn. Interestingly, the CEO pointed out that in 2008 you didn’t see the skyrocket in litigation business in the ‘eye of the storm’ of 2008 as companies were understandably firefighting. These took place in 2009 when the dust started to settle. The hope is the same positive boost to business will emerge for Burford this year.
Recent US dual listing: corporate litigation funding is far better understood and therefore more highly valued by US investors. Burford’s recent US dual listing is in my opinion very likely to lead to multiple expansion as the US shareholder base increases from 30% to more like an expected 50%. This is especially true as the business is currently valued on a paltry 7x PE.
Some courts have been closed / jury trials put on hold due to Covid, delaying awards to the business. Burford’s recent results were amazing nonetheless but this backlog of court cases is a positive as it adds a layer of pretty certain recovery prospects in the business (unlike a restaurant, where business lost this week is business lost forever, no one will walk away from a £100m litigation claim because of Covid delays).
Burford throws off a lot of cash and is in an excellent position to pay large dividends going forward. Like a lot of UK businesses, Burford chose to ‘delay’ its dividend pending a review of the business impact of Covid. As the normal business of the courts resumes, the resumption of the dividend is another valuation upside catalyst.
Thanks to the aftermath of the short-selling Muddy Waters debacle, we can still buy the shares 30% cheaper than a year ago despite a material uplift in earnings and the order book announced in the recent results. I think the low valuation, excellent business prospects, the likely multiple expansion from US listing and most importantly the scarcity value of a business which actively benefits from Covid means it’s not unrealistic to expect a doubling of the share price over the next two years.
Past performance is not a true indicator of future results.
- The risks to the business model centre on the lumpiness and uncertainty of winning cases (though the growth in the number of cases helps to smooth returns)
- Risk of sourcing enough attractive cases as competition heats up, depressing returns on future cases versus the IRR’s generated in the past (though they are the market leader so are better positioned than new entrants)
- The risk that Covid stays rampant and that courts remain shut (delaying the resolution of cases further)
- My biggest worry with Burford is the fact that they have one case on their books worth a whopping $800m – the value is underscored by the sale a few years back of 20% of this case to a third party for $200m - I think this transaction was designed to show investors its true value. This one case is called the Peterson case, (basically, it’s with the Argentine government on the other side), and up to very recently, has dwarfed their other claims in terms of size so made the valuation outlook more uncertain as so much hinged on the outcome of this one case. But now we’ve seen that 2020 results showed very good growth on 2019 despite no new developments on Peterson and the excellent prospects highlighted above have nothing to do with earning a penny from Petersen. I think as the business demonstrates it’s not all been about getting lucky on something massive like Peterson, investors will attach a higher valuation to the shares. However, the risk remains that any negative Petersen newsflow will hit the share price.
- The negative report and ongoing short-selling campaign last year from short-seller specialist Muddy Waters decimated the Burford share price, as they basically claimed Burford’s returns were too good to be true. While Burford didn’t manage to prove to the SEC/FCA that Muddy Waters and their associates had put in place short positions and acted in concert ahead of their research note, other seasoned investors gave point by point counterarguments to MW’s claims
- Interestingly, the CEO pointed out that he has now willingly subjected himself and the whole company to a stringent SEC dual listing due diligence review and any glaring shortcomings surely would have been revealed by this. I feel this recent regulatory due diligence lowers the risk of a new short selling attack and will over time go some way to restoring investor confidence. However, a similar short selling attack cannot be ruled out.
Now it’s your turn:
Which other companies are ideally placed to prosper in the aftermath of Covid over the coming year and beyond?
Why are they well-positioned to prosper in the aftermath of Covid over the coming year and beyond?
What are the risks associated with your companies of choice?
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