A longer road back for corporates
Global corporates are suffering under the Great Lockdown, much as people are suffering dramatic changes to their way of life, and in many cases, their employment status. Like people, many companies face the looming threat of insolvency. Thanks to swift and decisive central bank action, these companies do not have issues with liquidity – indeed with a considerable proportion of the investment grade corporate bond market being absorbed, and with national governments offering generous loan schemes and guarantees that also support companies without an investment grade rating, liquidity is, for the most part, looking good. But while market commentators with an eye on high profile, loss-making technology outliers like Snapchat and Spotify have frequently reminded us over the years that cash is king, by extension implying that mere access to cash will keep everything ticking, such thinking cannot be generalized to traditional service providers, whose business models are fundamentally threatened when the outlook for revenue and earnings is so poor. Coronavirus may be the killer, however this corporate crisis has been brought about by its containment measures, which are also preventing any true, corporate-boosting stimulus.
Although the technical aspects of the corporate bond market look attractive, and from a valuation perspective, European investment grade corporate spreads have rapidly recovered nearly half of the move wider that occurred in March, the recent tightening does not reflect a recovery of fundamentals. Quarantines, lockdowns and social distancing policies have decimated mobility-related sectors: travel, hospitality, entertainment, and tourism to name a few. As consumers scale back their expenditures through financial hardship or fear-driven prudence, the marginal propensity to spend has plummeted. These behavioral changes will have repercussions for some time. To give an example, aircraft lessor Avolon has had to cancel or defer over 40% of its Boeing and Airbus aircraft orders for the next 3 years to protect its credit profile, after customers making up 90% of its revenue requested payment deferrals or relief. Approximately €30bn of index eligible investment grade, euro-denominated corporate debt (around 1.3% of the market) has fallen into high yield so far this year – much more is likely to come as lockdowns drag on, leverage rises, and outlook guidance is revised. The picture is not all bleak though: areas of resilience do exist, providing something of a safe haven. Healthcare companies such as Becton Dickinson and Abbott Laboratories are well positioned to weather the storm with solid balance sheets and liquidity, and similarly robust companies can be found in the pharmaceuticals and utilities sectors, where rating downgrades have been notably rarer than in the harder hit transport and automotive sectors. All companies are, however, seeing some form of disruption – Becton Dickinson’s medical device business is coping with postponed elective procedures, while Abbott Laboratories has turned its attention to manufacturing coronavirus test kits.
Disruptions are, of course, not solely domestic in nature, nor are companies sitting still as the crisis unfolds. Corporate supply chains have broken down, and, with few exceptions, international demand for exports will remain subdued so long as international consumers lack confidence. Companies across all countries and sectors are looking to meet these challenges and maintain both their short-term financial stability and working capital levels. This can be achieved by hoarding liquidity from asset disposals (GE, Vivendi); by cutting or deferring capital expenditures (Airbus, Pernod Ricard); or by taking on increasing levels of debt (Pepsi, AB InBev). That being said, while such actions may keep more companies alive than would otherwise be the case, it also means that coming out the other side of the crisis, the corporate market will be carrying both higher leverage and a growth pipeline diminished by the reductions in investment.
In a nutshell, even after lockdown is over and the economy is back open for business, many of the companies that survive will emerge weakened, in both their current finances and in their outlook. Productivity will have been permanently lost, as workers’ skills deteriorate through lack of use, meaning thinner profit margins for their employers. Additional fiscal support on an unprecedented scale will be needed to help these companies get back on their feet – the President of the European Commission, Ursula von der Leyen, has called for a €1 trillion economic recovery plan, which gives some sense of the initiative required. It will be a longer journey back to the heights of February for corporates.