The detail in this report highlights the uncertainty faced by companies across most sectors as a result of COVID-19. Generally, the global economic environment deteriorated much faster than expected as COVID-19 spread beyond China. Into late February, the prevalent belief was that COVID-19 would remain contained within China and not have a widespread global impact. However, as the virus' economic impact spread globally, many companies scrambled to increase liquidity in order to weather the expected downturn. With the depth of the downturn and the timing and pace of a recovery uncertain, companies across sectors chose to withdraw guidance. Expectations are that FY20 (and second quarter 2020 in particular) will show significant year-over-year declines. Many companies are thinking about a U-shaped recovery, as Goldman Sachs said on its earnings call "it's still going to feel like you are operating in a recession."
As the COVID-19 crisis swiftly impacted Quarter 1 2020, S&P 500 earnings finished the quarter -17% on a year-over-year basis after a solid start to the year and following positive growth in Quarter 4 2019 (+1.3%). First quarter 2020 results were also well below consensus estimates, with earnings coming in below estimates that expected a change of -9%. While the percentage of positive surprises relative to consensus was 67% vs negative surprises of 28%, consensus estimates highlighted the difficulty in pinpointing the impact of the crisis as declines in certain sectors far outweighed the average. Only 223 companies reported higher year-over-year earnings vs 334 on average for the previous four quarters, while 220 reported negative year-over-year trends.
Similarly, the continued impact of COVID-19 is expected to negatively affect FY20 results with the most acute impact to the second quarter. The earnings estimates for FY20 have moved from an expected 9% growth year-over-year as of 31 December 2019 to current expectations of -22% year-over-year. Specifically, FY20 earnings in the Consumer Discretionary and Industrials sectors are now estimated to be down over 50% year-over-year. Additionally, the steep decline in oil prices has resulted in Energy sector earnings expected to be down more than 100% year-over-year. As a result, the S&P is currently trading at 20.4x LTM P/E and 23.5x next 12 months P/E.
Globally, the results were similar in Quarter 1 2020. Using the MSCI Developed World Index (MXWO), earnings in Quarter 1 2020 were down 38%. While earnings within this index are expected to recover over the course of the year, FY20 estimated earnings are still projected to be -14% year-over-year. Currently, the MXWO is trading at 19.7x LTM P/E and 21.1x based on expected earnings over the next 12 months.
Sector results relative to expectations – Aegon Asset Management's thoughts from a fixed income perspective
|Negative||Modest negative||Neutral/mixed||Modest positive||Positive|
Source: Aegon AM US.
Liquidity: Given the swift deterioration of the macro economy globally and an uncertain recovery, many companies have focused on maximizing liquidity. In order to do so, companies have focused on a combination of actions including raising cash through the capital markets, cutting operational expenses, reducing capital expenditures, eliminating share repurchases and in some cases reducing or eliminating dividends. As AES Corp stated on its earnings call, "In times of uncertainty, we recognize that cash is king."
Near term cash burn has necessitated that some sectors more aggressively cut expenses. The airline and other travel related industries have been the hardest hit by the crisis. As revenues have deteriorated to near zero, companies in this sector have been forced to adjust quickly. In response, they have significantly reduced expenses including dramatic numbers of terminated and voluntarily furloughed workers. While airlines likely represent the most aggressive sector in reducing expenses, most of the impacted sectors have been similarly focused.
In addition to expense reduction, companies have focused on reducing their fiscal year capital expenditure plans. Given the uncertainty of the environment, many companies have been prudent about eliminating discretionary expenditures.
The opening of the capital markets has provided companies with significant availability of capital that was closed off at the outset of the crisis. Initially, management teams that were most concerned with liquidity, drew down on available credit facilities. Additional available financing was generally confined to secured financings or at significant pricing discounts. As the environment has improved, management teams have had greater access to bonds markets, as well as equity and convertible markets, and on more favorable terms. Further, government programs (like the CARES ACT in the US) provided targeted liquidity to particularly stressed industries (like airlines). These combinations of funding sources have significantly improved the prospects of most companies' ability to weather the crisis.
Some relevant quotes:
- VF Corp (Consumer): "These are uncertain times, but in this moment of turmoil, we demonstrated both our willingness and our ability to tangibly build excess liquidity to weather the disruption caused by COVID-19 for a prolonged period."
- Marriott International (Lodging): "We know the recovery could take a while, but we're confident we have the liquidity we need to manage through this situation, including paying back near-term debt maturities. We've made solid progress in mitigating the impact of COVID-19 on our business and are prepared for the wide range of scenarios that could play out."
- Zimmer Biomet (Healthcare): "Related to liquidity, our capital allocation priorities remain consistent with what we outlined earlier this year. But in the near term, we will focus our energy on navigating the challenges of the pandemic while strategically prepared to meet demand as end markets recover."
- Iron Mountain (REIT): "One of the stress tests we ran was based on service activity being down about 65% year-on-year and persisting at that level through 2021. Even in that scenario, we do not foresee an issue with liquidity or leverage through 2021."
Recession/Recovery: The potential for a recession was a very common topic on the Quarter 1 2020 earnings calls. There was almost a unanimous view that the economy was heading into a recessionary period, however, there was much less agreement on how long it would last. When assessing the potential impact on the business environment, companies attempted to compare the current situation to the Recession of 2008/2009. However, it was often pointed out that this recession would be very different in nature because it is being driven by a health crisis. Still, in contrast to 2008, the financial industry is in much better shape and in a position to support the economy through this crisis. As such, the COVID-19 crisis is expected to impact various sectors of the economy very differently.
While there was no clear view on what the path of a recovery will look like, those providing thoughts seemed fairly optimistic that the recent fiscal and monetary actions by governments would result in either a V shaped or U shaped recovery path as lock-downs were lifted. Some did have concerns about the potential for a second wave of COVID-19. For the economy to return to normal, management teams acknowledged that individuals would have to feel safe which means vaccines and testing need to be developed and rolled out. Given the potentially longer time frame of returning to normal, many companies highlighted that there were just too many variables to make a reasonable assessment on the recovery path, and as a result pulled their 2020 guidance.
Some relevant quotes:
- United Parcel Service (Transportation): "Most economists are currently predicting a recession, but there is broad disagreement on the length and shape of the recovery. The main economic indicators, US industrial production, US retail, global industrial production and global exports are all forecasted to decline significantly. Due to the uncertainties ahead, we are unable to predict the business impact of the pandemic or reasonably estimate our financial performance in future quarters."
- KeyCorp (Banking): "If you look at the economic forecasts that have come out in early April, they probably are a little bit more negative, more about the recovery rate as opposed to the depth of the actual recession. And so more going toward a U-shaped scenario as opposed to a V-shapes."
- Citizens Financial (Banking): "We've assumed a deep recession in Q2, followed by a V-shaped recovery in our forecast, which if true, would take us back to more normal provision levels over the balance of 2020. If the recovery is more U-shaped, provisions will be higher. Safe to say, there's a great deal of uncertainty over the economic outlook."
- Whirlpool (Consumer): "The financial institutions are in a much stronger shape than they were in 2008. I think it's a different macroeconomic context where the coronavirus happened. But again, that's right now our most likely assumption, I think time will tell. Is it a U? Is it an L? We believe it's a U, but not an immediate recovery before Q4."
- Goldman Sachs (Banking): "If you're giving someone advice about how to position their business, even though technically we wouldn't be in a recession as you got to the end of the year and early 2021, we would not have recovered the output that had declined and so certainly if you're operating a lot of these businesses, it's still going to feel like you're operating in recession."
Corporate Real Estate Footprint: As COVID-19 moved across the globe, management teams quickly shifted office employees from centralized locations (Company-managed properties) to remote work-from-home (WfH) environments. Numerous companies moved all non-essential office staff to remote platforms, with the majority of management teams reporting little to no disruption in productivity. Ironically, several management teams spoke of increased productivity.
Based on little to no business disruption, many management teams are now reassessing their ability to offer more WfH opportunities. An increase in WfH employees would allow for a smaller real estate footprint, increases in work-life balance, plus provide the ability to hire talent anywhere in the world. In some cases, management is calling for real estate cost savings to offset a portion of the near-term earnings impact caused by COVID-19.
After reviewing transcripts across industries, the remote workforce trend was most prevalent in office workforces (e.g., customer service populations, software companies, R&D focused businesses, back-office operations), but nearly non-existent in certain industries where hands on work is required (i.e., manufacturing, healthcare). Square recently announced the option for all its employees to continue to work-from-home permanently. Twitter has been working on decentralization with the thought of being able to hire great software engineers anywhere around the world. While not moving to a permanent work from home situation, Visa's CEO recently announced that he expects a majority of its workforce to continue working from home for the remainder of the year.
If this trend gains momentum, it could negatively impact the demand for commercial office space over the medium to long term. However, over the near-term employers may also need to provide more space per employee to accommodate social distancing restrictions.
Some relevant quotes:
- Progressive (Insurance): "Before the COVID-19 happened, we probably had maybe about 10,000 of our 43,000 employees, working from home, now we have 95%. As we think about returning, there could be an advantage for real estate because many of those people will be very efficient and effective working from home."
- The AES Corporation (Utilities): "Investments we have made over the past few years have made it possible for most of our staff to work remotely including many positions on the operational side. We expect some degree of remote work and the associated benefits to continue even in the post-pandemic world."
- Fidelity National (Consumer Finance): "Re-evaluating our real estate as a part of COVID-19 as a backdrop, we're so successful at working from home. We're going to really take a hard look at that. So there's just a lot more levers we'll continue to pull that will drive benefits into the future."
- Duke Energy (Utilities): "We're trying to get our hands around quantification of that as we look at remote work policies and as we look at our real estate footprint and you can expect to hear more about that as we think about 2021 and beyond."
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