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Listed Equity Bulletin 27 March 2020

We have compiled this bulletin with the aim of providing an overview of Market developments over the last week and highlighting some of the implications for, and reactions of, listed companies. The document is intended for clients of h2glenfern, but in light of the unique and fast-moving circumstances we find ourselves in, we are making it more widely available and please feel free to share it. If you have any questions, please contact us (details below). Furthermore, if you send us a list of the peer group companies you are interested in, we would be delighted to use our proprietary analytics to keep you updated on sector developments.

Market Developments

It’s worth noting that so far there has been little, if any, concrete guidance on the true impact to corporate earnings of Covid-19. As we head into the US quarterly reporting season, we may start to see some greater clarity as to the true extent of the global economic and earnings slowdowns. All signs would suggest that earnings are going to be revised down substantially across the board which makes effective valuation virtually impossible and leaves investors flying blind.

This week’s stock market rally is as much a response to aggressive and unprecedented global fiscal stimulus packages as a clear sign that there is a slowdown in the global pandemic. In the absence of a much clearer outlook on economic growth and corporate earnings, markets are likely to remain extremely volatile. It is hard to predict whether the decline is too much, too little, or just right in expectation of the downturn companies are facing right now.

Market risk and investor sentiment

The VIX index is the 30-day volatility index for US stocks and acts as a very useful proxy for global investor sentiment and fear levels. The index currently sits at 64, down from 83 on the 16^th March but well above the recent long-term average of 15. A high reading implies investors remain extremely cautious in the near term.

Another useful benchmark to follow is the CNN Fear and Greed Index. Measured on a scale of 1 (extreme fear) to 100 (extreme greed). This index currently stands at 22 borderline extreme fear but is 20 points higher than the lowest ever reading of 2 which was hit last week.

https://money.cnn.com/data/fear-and-greed/

Shares traded per day

It’s interesting to note that the recent sharp moves are categorised by extremely high activity levels in all major markets and indices and some signs of bottom fishing in the most oversold highly exposed industry sectors. Volumes during the recent sell offs have been remarkably consistent and almost double the average daily volumes we have seen over the past 6 months.

Key sector moves

[James Blackburn is a partner at h2glenfern and was previously Head of Equity Sales and Trading for Merrill Lynch in New York].

Results Reporting

Last weekend the FCA requested listed companies to observe a moratorium of at least 2 weeks on the publication of preliminary results. For those that have reported this week (e.g. Bellway, 25^th March) historic performance was discussed in the usual way but outlook statements followed a similar pattern to that outlined below, with commentary limited to liquidity and re-emphasis of the longer-term proposition that the business represents.

Dividend Developments

Numerous statements have been released relating to dividends (both declared and undeclared). From a sample of 50 company statements across the FTSE All Share, we made the following observations:

• Over 80% of companies announced that they are cancelling the next dividend.
• SSE dividend payment remains but may change. Coca-Cola HBC and Aberdeen Smaller Cos Trust still intending to pay.
• Persimmon announced that it is “postponing” the dividend (to be reviewed later in the year) and Balfour Beatty also postponing.
• British Land announced that it is “temporarily suspending future dividend payments” (implying potentially more than one dividend).
• Ocean Wilson is reducing its dividend (by 57%).
• Capital & Regional is to pay its final dividend but is also offering a scrip alternative which major shareholders and management, representing 65% of issued equity, will take up. Flutter is also paying a dividend in shares.

Trading Updates

RNS releases on current trading and the shorter-term outlook have focussed on:

• The lack of visibility and therefore the inability to provide guidance (Polypipe, Howdens, Royal Mail).
• Liquidity and covenant headroom (St. Modwen, Dalata)
• Cancellation of share buybacks and return of surplus capital (SIG, Persimmon, Cairn Homes)
• Senior executive remuneration (Hammerson, Rolls Royce, Rentokil, James Fisher).
• Social issues (Unite not charging students for summer term accommodation and MJ Gleeson prioritising sales to front line staff and key workers).
• Operational constraints such as recruitment and non-essential capex (Barratt Developments).
• AGMs. A number of companies have also referenced the logistics of AGMs, with several moving to a digital/proxy approach (Hammerson, Clarkson and Taylor Wimpey).
• The first reference to pensions came from Wincanton (Tuesday 24^th March) in relation to “pension recovery payments”.
• And despite such volatility, the markets remain open with City Pub Group completing a placing to raise £22m at a 10% discount.

NB. A very good example of a comprehensive Covid-19 trading update was produced by National Express Group on the 19^th March.

Balance Sheets and Banking Arrangements

The majority of companies who have posted a Covid-19-related update to the Market this week have referenced the balance sheet and banking arrangements in their statement. Many have emphasised the positive features of their banking arrangements, such as long maturity periods and existing headroom. Interestingly, a significant number of companies have announced that they have now fully drawn-down all their banking lines to bolster their balance sheets for what might be a long and drawn-out crisis.

it is clearly hard for companies to predict the likely effect of the current circumstances on their cashflows and balance sheets but quoting banking ratios that were tested even as recently as the end of the last calendar year, which some announcements have done, is unlikely to provide much insight to balance sheet strength and liquidity. The more information that can provide, will allow followers to perform their own analysis and make their own judgements. In an exemplary approach, NewRiver REIT provided the Market with their internally generated sensitivity analysis on future cashflows and its effect on their balance sheet, both in the short and medium-term. Essentra referenced scenario testing for liquidity and in a more abbreviated approach to sensitivity St Modwen stated that its portfolio could withstand a 40% fall in value before reaching its closest LTV covenant.

Some companies have already flagged that they may breach banking covenants and are in discussion with their lenders. Whitbread, for example, whose businesses have been impacted by the closure of the hospitality sector, admitted this week that it might trigger a ‘technical event of default’. It is likely that many companies will need to have discussions with their banks, or indeed raise additional capital. As with Whitbread, some may have to seek a waiver for what will be, in effect, a technical breach, whereas for others it will much more existential and helping the Market to differentiate between these two types of events is important.

Addressing the ‘Social’ in ESG

At the onset of this crisis there were a number of comments suggesting that ESG objectives might be shelved as management teams struggle to preserve their businesses. So far things are playing out quite differently, but with the ‘S’ taking star billing. With environmental issues less of a concern (at least temporarily), how companies deal with their staff, customers and other vulnerable stakeholders will live long in the memory. Decisions made quickly deliver deep insight into corporate culture, both good and bad.

Who will forget LVMH immediately shutting down perfume production lines to manufacture hand sanitizer to be provided free to the French health service? Likewise, few will forget other high-profile companies who have seemed to exploit the circumstances through increased prices or by treating staff with disrespect. Future funding can also be put into the ‘S’ category. Banking facilities are fine if everyone doesn’t access them at once. A number of firms are rushing to build capital buffers for a rainy day, but if that capital deprives others who are more needy then judgement over time will be harsh.

The ‘S’ in ESG has always been the poor and misunderstood relation of the ‘E’ and the ‘G’. If nothing else, this crisis will highlight its importance to long-term corporate success.

Executive Remuneration as a Governance Issue

Board remuneration is a high priority issue in these circumstances due to its cost and the message which decisions on senior team pay send to other stakeholders on how a company is being run and its approach to governance.

Many companies, including Intercontinental Hotels Group, Dunelm, Rentokil, Dalata Hotel Group, Hammerson, James Fisher, Rolls Royce, Coats Group, Mattioli Woods, John Menzies and Applegreen, have already announced significant and decisive action. The most common step being reducing salaries and fees by varying amounts. James Fisher, Coats and John Menzies stated the reduction was 20%. Mattioli Woods’s CEO chose to reduce his salary to zero until 30^th June 2020 with other board directors agreeing to reductions of up to 50%.

Other steps taken include the cancellation of bonus schemes (Rentokil), partial or full deferral of bonuses (Rolls Royce and Applegreen) and the postponement of long-term incentive awards (Rentokil and Hammerson). Separately, the FT has reported pay reductions of 20% at Kier and IAG and of 50% at Ryanair.

[Michael Ansell is a partner at h2glenfern and runs the Remuneration Advisory team].

From the Fund Manager’s Desk

Fund managers are currently grateful for any bit of guidance a company can give them on likely fall in sales, duration and fixed versus variable costs. They will run them through their existing models, and as usual put together a base, bull and bear case, but probably on liquidity timelines rather than the usual earnings forecasts. The gap between bull and bear they can then use as a proxy for risk given all their risk models have been rendered temporarily useless. This is the information that will help them consider potential changes in the size of their holdings.

The other thing they’ll be doing is trying to figure out how and when to have conversations with management. They have plenty of questions but recognise that executive teams are under severe pressure trying to keep their businesses turning over and addressing new issues such as employee funding legislation. But ongoing communication is important when time allows.

[John Pickard is a partner at h2glenfern and was previously CIO of Martin Currie and European Head of Equities at UBS Asset Management].

Contact Details

Tim Huddart (timht@h2glenfern.com) 07775 822711

Clive Anderson (clive@h2glenfern.com) 07775 822737

John Pickard (john@h2glenfern.com) 07552 461451

James Blackburn (james@h2glenfern.com 07887 844864

Michael Ansell (Michael.ansell@h2glenfern.com) 07540 836873

Tom Chetwood (tom@h2glenfern.com) 07921 455820

Michael Wills (michael@h2glenfern.com) 07885 406087

Chris Birks (chris@h2glenfern.com) 07909 975889

Deirdre Bellingan (Deirdre@h2glenfern.com) 07824 171098

Natalie Crisp (natalie@h2glenfern.com) 07415203194

Remy Dumoulin (Remy@h2glenfern.com) +33621061018

Julia Kavvadias (julia@h2glenfern.com) +491726874918