WHEB Commentary

Ted Franks

Coronavirus Contagion: a Lockdown on Leverage?


A crisis puts everything in a new light. Over the last six weeks we’ve worked hard to review our strategy and all of our stocks. We’re looking at them from fresh angles, and with different eyes. And so with investors everywhere, no doubt.

Most important is to understand whether the pandemic challenges or boosts business models. Will it impact the sustainability issues that drive our companies? Will it enhance them, or create new challenges?

This analysis can be complex and will only really prove out over time. We gave a webinar with the skeleton of our current views on 7 April. You can watch a replay here.

The second key area of concern for us is much easier to frame. The issue is indebtedness, and liquidity. We can see that there will be a sharp recession, if not depression, beginning right now. A lot of companies, including some of ours, are facing stunning falls in demand. Like an airliner hitting an air pocket, for many it will be stomach-churning.

When their operations switch from a source to a use of cash, can our companies survive? We may feel confident about their prospects over the next six years. How about the next six months? All eyes turn to the balance sheet, to debt levels and cash management.

The truism is that a crisis always comes at a bad time. But you can easily make the case for corporate debt levels in 2020. After the financial crisis of 2008-2009, we’ve had more than a decade of loose monetary policy.  The debt markets have responded.  Total indebtedness by US corporates has run back up to nearly 50% of GDP, above where it was before that crisis[1].

As the economy shuts down, many of those excessive borrowers won’t meet their repayments. The risk is of a contagious spread into the banks, and from there back out to healthier companies.

A core part of WHEB’s investment process aims to identify higher quality companies.  And for us higher ‘quality’ generally means companies that are sustainable in every sense of the word, with good sound management, stronger cashflow and robust capital structures.  We hope and expect that such companies will be in a stronger position to weather the current storms than most.

As a result, our portfolio is generally a bit less levered than the broader market.  At the moment, our net debt to earnings before interest, tax, depreciation and amortisation (“EBITDA”) ratio is about 1.1x, while the market is 1.3x[2].

A handful of our companies are more comfortable with a bit more leverage. That’s fine. We invest with good management teams in highly impactful companies. We take time to understand the situation, and if we then invest, it is because we have faith in their ability.  It is hard to argue with the track record of the team at Thermo Fisher, for example.  But in the eight years we’ve owned them, only one has ended with their net debt below 2x EBITDA[3].

But we’re not complacent. In the last few weeks we’ve been in touch with the few that might give even slight cause for concern. So far their responses are assured.  They are controlling costs, husbanding operating cash flow, cancelling dividends, and speaking to their bankers.

Through the course of the month, governments have responded with financial guarantees and monetary stimulus. In a way, and without wishing misfortune on anyone, we might prefer it if they hadn’t.  There’s a moral hazard to governments continually bailing out imprudent borrowers.

But this isn’t our focus. We want to deliver outperformance from investing in sustainability, as purely as we can. It’s a long-term mission, and we keep our disciplined approach to risk along the way.  This should stand us in good stead if we do hit more turbulence now.

[1] Deloitte: https://www2.deloitte.com/us/en/insights/economy/issues-by-the-numbers/rising-corporate-debt-levels.html

[2] Source: WHEB, MSCI, Bloomberg, as at 31 March 2020.

[3] Factset

Recent posts

  • Noisy signals at the end of the Age of Oil
  • The first quarter of 2020 is now assured a place in financial markets history
  • What does Covid-19 mean for sustainability?
  • Coronavirus Contagion: a Lockdown on Leverage?
  • From No 10 to BP – it’s all moving very fast
  • This year’s new killer
  • Seeing the bigger picture – Cooper Companies and myopia
  • What does 2020 hold for sustainable investing?
  • Politics playing catch-up on climate change
  • The great smog; London’s dirty air
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