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Balance Sheets Flag Risky Companies Amid Virus Outbreak

March 30, 2020, 8:45 AM

Investors used to focusing on earnings and top-line revenue growth are back to studying balance sheets, trying to pick which companies will outlast the coronavirus outbreak or end up battered and in bankruptcy court.

Analysts and corporate executives alike are struggling to understand what the new economic normal will be, how long business disruptions will last, and how consumer behavior might shift as a result of the pandemic. That makes balance sheets a critical and timely snapshot of corporate finances, detailing assets like cash on hand and goodwill and offsetting expenses like rent, credit lines and pension obligations.

“We’ve seen a tremendous increase in investors asking about balance sheet quality, leverage metrics, pensions, leases. All those things that really matter when they matter,” said Ron Graziano, accounting & tax research analyst at Credit Suisse LLC. “And they matter a lot right now.”

The most recent filings available, however, capture conditions at the end of December—before the virus hit. And companies may take advantage of extended SEC filing deadlines, delaying when investors would have access to fresher information.

Debt

Jennifer Rowland, senior analyst for Edward Jones Equity Research, said she’s looking at the short-term debt owed by oil and gas companies. An all-out production war between Saudi Arabia and Russia caused the price of crude oil to plunge in March just as the coronavirus pandemic caused demand to plunge.

Stock prices for oil and gas companies with significant debt have fallen 80 to 90 percent. In comparison, Chevron Corp., with a healthy balance sheet, has seen its stock price drop 50 percent, she said.

Companies with heavy debt loads may not be able to refinance, or find interested buyers. Even private equity funding may not be an option.

“When you have these periods of stress and significantly low prices, you want to have a balance sheet that you can lean on to get you through it,” she said.

Debt takes on many forms. Companies are also on the hook for billions worth of lease expenses for everything from corporate headquarters to warehouses to airplanes and medical equipment—obligations that companies began reporting on the balance sheet for the first time in 2019.

Armed with a full year of leasing information, investors are updating their models to factor in those lease liabilities, Graziano said.

Debt taken on to acquire brands or intellectual property or other intangible assets is another potential sign of trouble. Companies may be able to write off the value of those acquisitions through impairments, but the debt will remain on the books, he said.

Liquidity

Cash may be king, but the ability of companies to borrow or tap other lines of credit to shore up its capital is just as important.

Consumer goods, apparel, automotive and transportation services industries face some of the highest liquidity risks amid the coronavirus outbreak, according to Moody’s Investor Services.

Companies also need cash-on-hand to pay off debt and roughly $469 billion of debt is coming due through 2021. Technology, oil and gas, and consumer products are among the sectors on the hook for the most debt in the next two years, the ratings agency said.

As access to credit tightens, companies will have a harder time meeting liquidity needs and making those debt payments, Moody’s said.

Liquidity always plays an important part in the credit rating agency’s analysis. But in a crisis, it takes on an even greater importance. Industries with the greatest exposure to outbreak disruptions with the weakest access to cash and credit will be most at risk, said Brian Oak, managing director of corporate finance for Moody’s.

Cash Management

The pandemic couldn’t have come at a worse time for an already-struggling sector like retail. Once more, balance sheets may be the guide to picking survivors.

Gap Inc., for instance, has $1.3 billion in debt due next spring. The company has suspended its stock buyback program and may need to reduce its shareholder dividend “to preserve cash and fortify the balance sheet,” said Morgan Stanley analyst Kimberly Greenberger in a March 19 note.

To strengthen its balance sheet and preserve cash, Gap announced Thursday that it would draw down a $500 million revolving credit line, cut capital expenses by $300 million and suspend dividend payments for all but the first quarter.

In comparison, Jefferies analysts in a March 23 note described Home Depot Inc. as having a “fortress” balance sheet. The company benefits from a strong credit rating, $2.1 billion in cash and no short-term debt coming due.

“Companies with strong balance sheets and sustainable cash flows will be best positioned to weather the storm. Those approaching low cash positions or near-term maturities may present near-term risk,” Jefferies said.

Retailers were struggling long before the outbreak began, but temporary store closures will pressure some brands more than others, especially if two-week shutdowns stretch into several months, said Poonam Goyal, a senior U.S. retail analyst with Bloomberg Intelligence. She provided her own balance sheet assessment in a March 26 outlook.

She’s focusing on current assets—including cash-on-hand—plus access to credit lines like revolvers that companies can tap to keep paying employees and rent. Companies have some flexibility to preserve cash including reducing marketing and advertising and scaling back capital expenditures, Goyal said.

“Timing is key here. It’s not just do you have a strong balance sheet today, but for how long can your balance sheet withstand this pandemic,” Goyal said.

To contact the reporter on this story: Amanda Iacone in Washington at aiacone@bloombergtax.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Bernie Kohn at bkohn@bloomberglaw.com

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