(Apr 13): Four times a year, investors assess the performance of companies worldwide with a fairly standard toolkit: revenue growth, net income, gross margin, free cash flow, debt – all weighed in comparison to analysts’ predictions and what rivals report.
This earnings season, with the coronavirus pandemic claiming lives and sowing chaos across the globe, those yardsticks are mostly meaningless, leaving the investment community lost in a fog at a time market volatility has hit historic levels.
In March, as governments ordered lockdowns to stop the spread of the virus, the global economy slipped into contraction for the first time since the financial crisis. Expecting the fallout will get worse, ratings agency Fitch said we’re headed toward a “deep global recession.”
Or maybe not, given the unpredictability of the crisis. With little ability to accurately forecast anything from consumer spending to new-home construction, investment pros can’t build reliable financial models.
“Analysts are at a total loss,” said Jean-Louis Sempe, an auto industry analyst with Invest Securities SA in Paris, who – like almost everyone else in finance – has been sequestered at home for weeks, with little idea when he might be able to return to the office. “No one ever imagined this could happen, and we just don’t know how it will end.”
That sense of the unreal has spurred analysts to tear up estimates for the quarter ended March 31, which companies begin reporting this week. In one measure of their futility, the average spread between the lowest and highest earnings-per-share estimates for US stocks is at a record high, according to Bank of America.
Armchair Epidemiologists
A fundamental problem is that managers have scant insight into what the coming months might bring. “I don’t think companies know what’s going on,” said Mike Stritch, chief investment officer for BMO Wealth Management. “No one knows.”
Last week, Chip Bergh, chief executive officer of apparel-maker Levi Strauss & Co., pulled annual guidance, took a 50% pay cut, furloughed workers, and then began his earnings call by saying: “The biggest challenge we’re all dealing with right now is uncertainty. How long will this continue? How deep an economic crisis does the pandemic create? How will the consumer respond when the crisis abates?”
Terence Tsang, CEO of Chinese sportswear maker Li Ning Co., last month told reporters, “No one knows when and how big the rebound is if it happens. So it will be meaningless to give top-line guidance.”
That’s left investors and analysts seeking novel ways to assess the financial health of companies. Many are becoming amateur epidemiologists, building new models that include contagion rates, tests administered, and geographic spread. Cowen & Co. publishes an almost daily note on the virus that delves into topics such as infection fatality rates and the under-counting of COVID-19 deaths.
New Corporate-Speak
Paul Markham, global equity portfolio manager at Newton Investment Management, which oversees US$66 billion, says liquidity is crucial in a period when earnings are so artificially depressed. He points to free cash-flow yield, a measure of money coming into a company’s bank account, as a good way to assess whether management can keep meeting obligations like debt payments.
“Much more important to us is to understand the debt dynamics of a company, how much outstanding leverage it has on its balance sheet, and directly related to that is the free cash-flow yield,” Markham said.
Corporate quarterly reports and conference calls typically focus on acquisitions, store openings, new products, and other measures that might augur faster growth. Now, a key element of corporate-speak is “balance-sheet health” – proving you have enough money to ride out the pandemic.
That means cost cutting will be front and centre, but not just reductions in capital expenditures, dividends, share buybacks, and payroll. In the past, most companies would seek to downplay reports that they’re violating lease agreements or not paying rent, because such moves can mean insolvency is near. These days, once-proud companies are trumpeting it.
No Rent
Dallas-based restaurant chain Dave & Buster’s Entertainment Inc., which has temporarily closed all locations, said April 2 that to reduce its “shutdown period expense burn rate” – an obvious candidate for one of this era’s new metrics – it had notified landlords that it didn’t plan to make April rent and didn’t say if it would ever pay it.
With so much of the market flying blind, those who get creative on data gathering and analysis can reap outsize rewards. Since long before most people thought of corona as anything other than beer, sophisticated investors have sought out alternative data points: They might examine satellite images of parking lots to track shopping-mall visits or use artificial intelligence to parse social media for clues about increased interest in a product.
Sam Poser, a footwear analyst for Susquehanna Financial Group, makes the case that how much companies share the pain during the pandemic should matter to investors. He pointed out in a research note that executives at Under Armour Inc. took a 25% pay cut, and those at Caleres Inc. did 20%. Though the salary reductions sound like a lot, both companies furloughed thousands of workers. Meanwhile, executives at some competitors have taken deeper pay cuts or are going without salaries altogether.
Under Armour and Caleres will likely experience a mass exodus of talent during the crisis as employees look for other opportunities, according to Poser. That means after the virus fades they’ll need to go on a hiring binge – at great cost.
“Honestly, I don’t think what people say about current trends is that important,” Poser said. “The real story is who in this crisis is enhancing their brands. Treating people right and doing stuff to support the cause is a winning situation.”
