Maybe it’s all the unkept hair around these days, but the 1980s song ‘Money’s too tight to mention’ came to mind recently, as I thought about how companies and households are managing their cashflows in light of the current lockdown.
Some of you may know it as the pop song by Simply Red. Actually, it was first released as a blues song in the US in 1982 in the midst of a biting world recession. The song by the Valentine Brothers1 from Ohio is about a worker who has lost their job and is going through some tough times financially. He is asking, but not getting, help from friends, family, or the bank.
I’ve listened to the song again recently, and found it captures the dilemmas facing some unfortunate companies and households at the moment. I think it speaks to how investors could change their thinking to successfully invest in these tough times.
Over a month ago, we published that we thought dividends would be cut by more than a third and later that banks would halve their dividends from last year2. We think these are prudent moves and it is important to understand why they are happening and why high levels of capital raisings will continue for the rest of the financial year.
So I went to the bank to see what they could do/They said son looks like bad luck got a hold on you
It’s been another busy week for ECM bankers with over $14.5bn raised in the market so far in 2020. Some companies are looking to fortify in the face of uncertainty, and raisings from some others are for a number of reasons such as working capital, debt pay down, funding acquisitions and to prevent covenant breaches3.
Companies are also looking for money, asking suppliers for better payment terms, asking banks for more facilities and even asking shareholders for equity top ups. With markets valuations somewhat below levels of recent years, this is currently an expensive option for companies, and often a very good deal for investors where stock is often sold at a meaningful discount. In our view, retail investors who hold individual stocks could do some research into these raisings, as we are finding some good investments in some of these raising opportunities.
Dividend cuts have spread too, as low revenues mean working capital is scarce until lockdowns are eased. We predict that ASX 200 dividends could be cut by at a third or more over the next 12 months, which would be a larger cut to aggregate dividends than we saw in the Global Financial Crisis (GFC). In our view, it is only reasonable that dividends are crimped to preserve cash too, particularly as debt costs for non-investment grade companies spike.
It’s best to think of these dividend cuts like a landlord might, where you perhaps take a temporary drop in rent to keep a good tenant. We believe that when activity bounces back, so too will dividends. Investors can consider picking and investing in the companies that have the best leverage to the recovery and are in a robust position to trade through the disruption.
For companies, our current economic slump is pitting many traditional company stakeholders against each other. Companies are having to decide on using cash and debt facilities to pay invoices, dividends, wages or spend capital expenditure for future growth.
In our view, working capital preservation is key during these times. When revenues are under pressure, companies move to preserve cash by temporarily standing down workers, negotiating rental abatements with landlords and reducing outgoings. We have seen shareholders receiving reduced dividends, some job losses and government waivers and support programs. In our view, wages and enterprise agreements will need to get more flexible too in order to facilitate a recovery and keep jobs. So far, there has been good co-operation in this crisis.
Counterparty risk between companies is also important to watch more closely. Unpaid invoices, once a sign of a good and growing business, are now a cautiously optimistic thing. For the first time in over a decade, broader consideration needs to be given to the creditworthiness of counterparties. The same extends to companies whose business is lending, such as lending to small businesses or consumer lending for, say, cars or individual consumption. Some companies in this shock may not come out the other side and there are risks to recoveries of money outstanding from debtors.
They're passing all kinds of bills/From up there on Capitol Hill
The government has done a great job in containing the virus outbreak with Australia being one of the leading examples of how to contain the spread with the $130bn Jobkeeper stimulus designed to keep businesses and employment intact through the lockdown. However, the next phase of the coronavirus crisis has the potential to be far more divisive because of higher unemployment, reduced income, increased debt, closure of businesses, restrictions on movement and social interactions. We believe it is a good time to start to reform the Australian economy and if executed properly increase the speed at which we bounce from this slowdown.
What are we going to do when the economy has got a crush on me and you?
Debt makes us rigid to changes in business and wage conditions, as some sectors won’t come out of lockdown as strong as they went in4. We worry about high levels of mortgages for some households, particularly those who overuse negative gearing, as this is the weak underbelly of our economy which will be exposed as the lockdown extends. In our opinion, as a country we need to jump start the economy as fast as is safely possible to protect jobs, businesses and households, so less damage is done to the economy.
Longer term, it is important to remember that this period is transitory and the crisis will pass. In our view, profits and dividends will bounce back with some good opportunities right now. Shareholders could consider valuing companies on a mid-cycle three-year basis so they can calmly look through the short-term pause to find companies that can grow their dividends in normal times.
While everyone was listening to the title track in 1982, by mid-1983 “Karma Chameleon” by Culture Club played on the radio. The times changed and a new cycle was born, and Australia boomed for much of the rest of the 1980s. So keep the chin up, and focus on where business conditions are going rather than where they are now. The world will get through this and those that will gain will have looked through the noise.
Subscribe to SMSF News below to receive my latest articlesDermot Ryan, Co-Portfolio Manager (Income)
1 All lyrics quoted by John and Billy Valentine
3 Data references: Factset
Other sources: https://www.afr.com/chanticleer/why-the-asx-blitzes-the-world-in-equity-raisings-20200420-p54ldy
4 Data references: Factset
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