In: Finance
In the coronavirus pandemic, stock analysts have a new job:
credit analysis.
As the global economy grinds to a standstill amid mandatory
shutdowns, the survival of many businesses is suddenly in doubt,
especially those in vulnerable sectors such as airlines, hotels and
restaurants. Instead of asking how fast a company can grow,
ever-optimistic equity analysts now have to answer a grimmer
question: how long can it last if its revenue vanishes? This focus
on cold, hard cash means they have to do work that is more familiar
to credit analysts: analyzing available liquidity, looking at debt
covenants and repayment schedules and checking the extent to which
assets are unencumbered.
While the current economic freeze is unprecedented, making it hard
to prepare for, investors overlooked credit health in the bull
market. They were focused on growth -- never mind whether companies
were able to make money -- and often pie-in-the-sky projections of
potential market size. Now that balance sheets have taken center
stage, traditional metrics like net debt to earnings before
interest, taxes, depreciation and amortization or even tangible
book value are back in vogue.
Even for companies whose businesses aren't immediately at risk,
refinancing existing debts could pose big problems. The junk-bond
market has stalled in recent weeks, so investors need to understand
what alternative financing channels are available to companies:
credit lines from banks or assets that could be used to secure
loans. Even for those that can still borrow, the surging costs will
hurt their profits down the road. Average yield on
dollar-denominated, junk-rated corporate bonds stands at 12%, up
from below 6% just a month ago, according to data from S&P Dow
Jones Indices.
With everyone in cash-preservation mode, companies that used to pay
generous dividends are starting to cut back. Delta Air Lines,
Marriott International, Macy's and Ford Motor have all suspended
their payouts in recent days, and more will likely follow.
Analysts better acquainted with income statements need to pay
closer attention to companies' balance sheets right now.
Yes, it is true that the outcome of the coronavirus pandemic is that stock analysts and equity analysts have had to overhaul their evaluation method of a company. Earlier the analysts were only focused on the growth aspect of the company and hence equity analysts and stock analysts’ core focus area was the free cash flow of a company and its possible growth in future. These analysts, it can be said, failed to look deeper in the company and do basic and fundamental analysis of the company with regards to its liquidity situation and credit outlook. This was a big mistake on their part as the credit risk associated with a company was often overlooked and the analysts got away with this as the economy had been mostly on an upswing and stock markets had witnessed more or less a bullish trend in which what mattered at the end of the day was growth prospects of a company.
With the changing economic scenario and market scenario after the outbreak of the corona pandemic analysts have started taking a holistic approach towards looking at a company and determining what drives its valuation and what are the different risk factors associated with it. This approach is a better approach as it takes into consideration the entire spectrum of risks that can affect the valuation of a company and its stock.