Is The Adrenaline Enough?

Last year, we predicted that the pandemic would exacerbate pre-existing weaknesses in the financial health of both public and private companies across industries. Among 24 out of 30 industry categories, there was an average six-point drop in core health from YE ‘19 to YE ‘20. This type of fundamental deterioration of US corporates is significant.

But while the prediction has generally played out—with average core health scores dropping across the board [Figure 1]—we’re now in a season of optimism: markets are riding high, liquidity is plentiful, and pent-up demand among consumer spending and travel has returned to resuscitate and adrenalize the global economy.

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These signs are good and should be celebrated, but they also need to be examined and evaluated over time—as current trendlines are exhibiting a wide range of rebounds, standstills, and even continued declines.

Begging the question: have we reached an era of recovery or are we still wading through an era of continued, compounding, and potentially lasting, pandemic uncertainty?

In 2020, public and private companies across industries borrowed more, extended maturities and gained short-term liquidity. Cheap and easy access to capital provided an incredible boon to companies—emboldening the strong and giving a band aid to the weak. The big question is whether these weak companies can improve from pandemic-induced trauma with this cash or whether it will run out prior to their return to health (and when they need to pay the piper and refinance their increased borrowing).

Overall, financial health ratings and core health scores have been improving since reaching their 2020 low points, now that sales have kicked back into gear and cash is up.

But along with these improvements come fundamental changes to both public and private businesses that need to be evaluated over time.

Many companies are now more highly levered; they’re flush with cash; extending out their short-term liabilities and kicking that debt-can down the road.

These companies—that are both highly-levered and cash-rich—may look well-positioned in the short term, but current liquidity levels are potentially masking financial health weakness that wouldn’t be apparent on the surface—like in their stock price. [Figure 2]

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Within this vein, an industry that may be a harbinger for others, is Autos.

In general, autos, and their suppliers have begun to burn down excess liquidity and reduce cash so far this year. During 2020, Autos increased Cash to Current Liabilities by 57%, but that’s now off 17% this year.

As automakers are at the center of some of the most complex supply chains in the world, and given all of the challenges they’ve faced (viz. chipmakers, border closures, shipping delays and other quarantine measures), they’ll continue to be a bellwether to watch.

But people need to watch all industries, and the companies within them—carefully—to observe whether the “new” liquidity gained over the past four to five quarters can sustain companies or just prop them up for a while longer.

In other words, is the wound under the band aid healing?

Another bellwether industry, Retail, saw a decrease in short-term debt (-16.44%) and an increase in long-term debt (16.04%), combined with one of the highest changes of cash to current liabilities (56.11%) overall by year’s end 2020.

Now at the midpoint of 2021, we are certainly seeing a mix of data showing hints of rebounds—but the jury is still out. Current conditions are still murky enough and it’s more important than ever to monitor the underlying fundamentals of the companies boomeranging into a state of perceived recovery.

We may not be out of the thick of it yet.

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