SINGAPORE (Apr 30): There is no question that the Covid19 pandemic and resulting restriction on movements will inflict significant economic pain on businesses on a global scale. Most government aid packages are currently focused on helping to tide small and medium-sized enterprises (SMEs) over the short-term liquidity crunch. And rightly so, since these businesses are the backbone of most economies — developed and developing — accounting for a significant percentage of GDP and employment.
Large and listed companies have better access to capital markets and traditional bank financing, such as overdraft and revolving credit facilities. But they too are vulnerable, particularly if the slowdown in sales drags on over the coming months. And, even if loans are available, credit costs are rising for all but the highest-quality borrowers.
The pace of restarting economic activities is heavily dependent on when countries can get the outbreak under control and whether widespread testing plus other measures to prevent a second wave of infection are effective. Intense research on vaccines is ongoing, but they are not expected to be available for at least another year or so.
Hence, even when full lockdown is lifted, social distancing measures will remain — for instance, limiting the number of seats inside restaurants and number of customers in stores at any one time. Factories will have new sets of protocol to contend with, such as enhanced safety measures and ensuring workers are kept apart at the minimum distance.
Many people would not immediately resume their pre-crisis routines, given the still-present risks. Holidays and overseas travel, for one, are likely to be postponed. Air travel demand could take years to fully recover.
In any case, borders could remain shut for months, as countries are not in sync in terms of their progress in containing the outbreak. This will also delay the recovery from disruptions to the global supply chain. Manufacturers are likely to suffer from subpar utilisation rates in the coming months — owing to both parts and material shortages as well as weaker demand for end-products.
Global demand for everything but essential goods has collapsed. Discretionary spending may stay weak for some time if unemployment does not rebound quickly. Faced with less secure job prospects, people will, more often than not, choose to save rather than spend. Similarly, businesses will focus on conserving cash, by cutting spending and delaying capex.
Given all of the above, we believe that expectations of a quick “V-shaped” recovery are now off the table. Sales could take months to recover to pre-crisis levels. If so, temporary liquidity problems — the shortfall in sales and cash flow to cover operating costs such as payroll and rent — could very easily morph into more serious solvency problems.
How many months of subpar sales could a company sustain before its ability to service borrowings and refinance maturing debts becomes permanently impaired?
Clearly, the answer to this question is of critical importance to investors. Even businesses with viable business models could be forced into bankruptcy — when maturing debt cannot be rolled over and/or when the debt burden becomes unsustainably high.
We simulated the degree of financial distress for all the companies (excluding financials and real estate investment trusts) listed on Bursa Malaysia and the Singapore Exchange, based on their actual sales and expenses in the trailing 12-month period and latest balance sheet figures. The split between fixed and operating costs are estimated based on a sampling of 394 of 857 companies on Bursa and 311 of 645 companies on SGX.
The magnitude of sales decline will vary for different sectors — for instance, consumer food staples will be less affected than hospitality. Also, the lockdown is more stringent in Malaysia whereas many factories in Singapore are still allowed to operate with precautionary measures. And the extent of the impact on individual companies will depend on their operating and financial leverages. Companies with low fixed overheads and those sitting on big cash reserves will weather the shortterm sales decline better.
Chart 1 shows the estimated average fixed overheads as a percentage of total operating costs for each sector based on our data sampling for Bursa. Chart 2 tallies the total number of companies that will face financial distress assuming a sustained percentage of sales decline for specific durations while Tables 1 to 3 segregate these companies by sectors. Table 4 shows the average indebtedness for each sector.
Charts 3 and 4 and Tables 5 to 8 show the simulation results for SGX-listed companies. Singapore-listed companies are, on average, more leveraged than their Malaysian peers. Of Bursa companies, 47% have net cash compared with 35% on SGX. And of those with net debt, the average gearing on Bursa is 54% while that on SGX is 50%.
The complete list of individual companies for both Bursa and SGX are exclusively available to AbsolutelyStocks subscribers at www.absolutelystocks.com.
The above analysis suggests that some companies could already be in distress, within one month of stringent restrictive measures (under Movement Control Order in Malaysia and circuit breaker in Singapore). Clearly, the number of companies facing insolvency risks will rise the larger the sales decline and the longer the lower sales are sustained.
Bear in mind that weakness in demand and sales will extend beyond the actual lifting of MCO or circuit breaker measures, for all the reasons explained above, though the magnitude of decline should lessen with time. For instance, factories and stores may be open for business, but sales would still be dependent on demand.
We are not saying any one company on the list is looking at imminent bankruptcy. The point is to show that the risk of running out of cash is real — and this will have spillover impact for banks — but there are still many ways companies can minimise the cash burn.
For instance, they can cut back on operating expenses — by reducing wages and laying off staff, renegotiating or stopping payment of rent and so on — and raise their cash buffer by running down inventories, securing additional lines of credit and issuing new equity capital.
Companies can also extend terms of payment for goods and services and restructure borrowings. They can dispose of non-core assets. Also, these simulations are based on historical numbers, before taking into account government aid such as salary subsidies and rental relief.
What the analysis does is underscore the unprecedented economic and financial impact of the pandemic — and the urgency in gradually reopening businesses before the damage to the country’s productive capacity becomes permanent. Borrowings raised now to sustain operations will need to be paid back. That would hamper future expansion and growth and returns to stakeholders in the long run. No country can sustain a prolonged lockdown.
The initial lockdown period is necessary to reduce the exponential spread of the virus and prevent public healthcare from being overwhelmed. Going forward, we may well see a renewed rise in the number of infected cases once economic activities resume.
The key is in managing this risk, by implementing measures such as widespread testing and quarantine, to keep the infection rate low and within the capacity of the healthcare system. Treatment will reduce the mortality rate and the availability of a vaccine will significantly cut the rate of infection and risks.
For investors, we believe the next 12 months will strongly favour alpha (over index) investing. Not all companies will be impacted equally and the pace of recovery will differ. Balance sheet matters, now more so than ever.
In fact, those with solid balance sheets are likely to emerge stronger from the crisis, by winning market share when weaker competitors falter. As will companies that can adapt to the new normal. The Covid-19 pandemic is a transient event that will nonetheless have long-term impact — on our psyche and behaviour, the economy and businesses. The opportunities ahead will be different from those in the past.
The Global Portfolio gained 0.6% for the week ended April 29. This lifted total portfolio returns back into positive territory. Shares of homebuilder Lennar and building materials companies BMC Stock and Builders FirstSource rebounded strongly during the week. On the other hand, technology stocks that have been outperforming in recent days saw mild profit-taking. Total portfolio returns now stand at 0.5% since inception. By comparison, the benchmark MSCI World Net Return Index is up by 0.6% over the same period.
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