May 27, 2020
The pandemic’s impact on companies has highlighted the uncertainty around a timeline for returning to business as usual. Based on Q1 earnings, analysts are now estimating:
Only two out of the 11 S&P sectors, Utilities and Information Technology, are expected to show Earnings Per Share (EPS) growth in 2020
Overall S&P 500 is expected to show approximately 21% decline in EPS growth rate
The situation in Europe is slightly worse, with Stoxx 600 estimates at an approximate 28% decline in EPS growth rate. This is primarily due to Europe having fewer high-growth sectors such as Information Technology. For companies that reported Q1 earnings so far, fewer than 5% guided an upward trajectory for EPS, and 75% either lowered or withdrew their estimates. This signals that firms expect the financial impact to continue in subsequent quarters.
The percentage of companies surpassing earnings estimates is at decade lows. Only around 67% of companies in S&P 500 that have reported earnings have beaten estimates. Europe is also experiencing this, with just 55% of Stoxx 600 companies exceeding estimates.
The disparity between analysts’ estimates and earnings reality is not surprising in this environment. In fact, relative disagreement between analysts has also climbed. At the peak of the S&P 500 analyst estimates varied, on average, 2% from the mean; but have since climbed to about 6%, demonstrating the drop in market visibility of the future.
To avoid missing earnings targets and potentially misleading investors, companies have been withdrawing quarterly or annual guidance since March, a trend that accelerated into earnings season. As of mid-May, 212 S&P firms have opted to remove guidance entirely, a decision driven by the pandemic’s heightened uncertainty.
The two sectors hit hardest by COVID-19, Consumer Discretionary and Industrials, have seen the most number of withdrawals, accounting for more than 40%. This isn’t surprising: companies in these sectors have taken many other defensive actions to preserve liquidity. For example, 62% of companies that withdrew guidance in the Consumer Discretionary sector have also either cut their dividend or suspended their buyback program.
Several executives have used the situation to revisit the argument against providing quarterly earnings guidance. In their view, it promotes short-term thinking by incentivizing management to make decisions that may be harmful to the company in the long-term, in favor of meeting near-term goals. As uncertainty about the full impact of COVID-19 remains, we are likely to continue to see continued guidance withdrawals take place.
Firms are dialing back on capital spending – particularly discretionary outflows such share repurchases and dividends – and preserving liquidity. This year alone, 120 S&P 1500 firms have suspended their share repurchase programs and 173 firms have either decreased or eliminated their dividend.
The total amount year-to-date (YTD) of share repurchase authorizations by S&P 1500 companies is in line with 2008 levels, and market reaction has been relatively muted. For example, 25 S&P 1500 companies announced new authorizations in March and the median one-day market reaction was +4%.
Also in March, Weekly Open-Market Repurchase (OMR) activity executed by J.P. Morgan rose as high as 2.0-2.5x the average OMR activity in the first two months of 2020. Consumer Discretionary and Industrial firms that announced authorizations, representing about 35% of the total amount announced since market peak, signaled strength and received largely positive market reactions.
The decision to reduce or eliminate a dividend sends a more negative signal to the market. Dividend payers must not only assess the overall affordability of these payments and weigh them against available liquidity, but they also must consider their shareholder base and its reaction to this decision.
Consistent with other points in time during late Q1 or Q2, many firms have chosen to maintain their current dividend – though not increase them. In fact, YTD, 20% fewer firms have increased their dividend versus the same period last year. Of the firms that increase their dividend, 75% of the announcements occurred in the first two months of the year and the median YTD percentage increase is ~7%, which is lower than a median 8% increase observed over the same period last year.
The uncertainty associated with a potential second wave of the virus could result in significantly more dividend decreases and eliminations, as well as fewer dividend increases, compared to 2008.
Although markets have improved since late March, short-term uncertainties about the virus remain. Issuers should take advantage of market windows to address debt maturities and bolster their liquidity profiles. Investors appear willing to price credit-risk across all sectors and ratings profiles.
The Investment-Grade (IG) market has seen a significant amount of issuance in 2020 despite short-term impact on corporate earnings:
YTD issuance reached $920 billion ($560 billion since spreads peaked on March 23)
This represents 84% of the $1.1 trillion issued in all of 2019; 73% of the 2017 full-year record of $1.25 trillion
J.P. Morgan Research now expects $1.6 trillion of issuance in 2020
Interestingly, approximately 50 issuers have accessed the market more than once this year, clearly taking advantage of opportunities and prioritizing liquidity to navigate the current environment.
March was difficult for the High Yield (HY) market: four weeks without a single issuance. But once the markets reopened, April saw $27.6 billion of net issuance, representing the second highest month of net issuance on record.
Over the past few years, market participants have been focused on the amount of BBB-rated debt, and the potential impact that “fallen” angels (issuers that are downgraded from Investment Grade to Non-Investment Grade) could have on the HY market. YTD there has been ~$160 billion of debt reclassified to HY from IG. This is the largest amount since 2009, when $140 billion of debt transitioned to HY. Despite the increase, the HY market has absorbed the paper, has shown an appetite for more and even allowed one of these “fallen” angels to issue 30 year paper in a market where maturity is typically limited to 10 years.
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