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COVID-19 - Where to from here?

Sean O'Neill
Sean O'Neill
Managing Director
March 16, 2020
minute read

What a start to 2020! The current COVID-19 pandemic combined with the lasting impacts of the devastating bushfires has left Australia in the grips of a recession. The technical definition of a recession is “two quarters of negative growth”. There is zero chance that Australia does not contract in 2020 and there is the very real chance that from 1 March to 30 June the economy will contract by 25%!

Australia’s economy has been driven by 3 factors over the last decade:

  1. High commodity prices and exports to China.
  2. Rapid immigration and therefore population growth.
  3. A housing bubble driven by falling interest rates – thus creating a wealth effect throughout the country.

All 3 are now at risk.

Public sporting events are being cancelled, airports are quiet, offices are being closed. The share market is jumping 5% up or down in a single hour. Where to from here?

We anticipate a significant jump in unemployment: Unemployment rose from 5.1% to 5.3% in January. It is possible that unemployment will rise to exceed 8% in the coming months, driven by the downturn in Australia’s largest sectors:

  • Tourism – The sector is down 50% year on year as a result of bushfires, lack of Chinese visitors, and reduced travel due to COVID-19. Now the Government has effectively banned international travel and our national airlines have cut capacity by 90%.
  • Education – One of our largest sectors, the education sector has been driven by foreign students for the last decade. We expect a 10-20% reduction in the sector in 2020 due to COVID-19, and even greater falls should the schools across the country be closed for a prolonged period.
  • Food and hospitality – Falls of up to 30% should be expected across most venues, including restaurants, cafes, bars, or pubs. These losses will be compounded if a wholesale lockdown period is mandated.
  • Retail – This sector has been the hardest hit in the last 6 months, and this will continue as people restrict discretionary spending.
  • Finance - With falling asset values, the finance sectors’ own revenues will contract significantly. Net interest margins at banks have been shrinking for years. Expect mortgage delinquencies to rise quickly. Bonuses, which compromise 30-50% of employee income, will be non existent.
  • Mining – This sector accounts for 10% of the Australia economy. If China sneezes, what impact does that have on the Australian mining sector? It can’t be good.

Casual workers will be hit hardest, followed by those who must care for others who are sick and parents forced to stay at home to look after their children if schools close and grandparent childcare dries up.

Why does this matter?

Higher unemployment leads to lower spending, which induces additional unemployment. Delinquencies on credit card debt and mortgages will quickly rise. Australia’s growth over the last decade has been off the back of a housing market which followed an upward trajectory and created the “wealth effect” in the economy. When the unemployment rate increases, the housing market will correct substantially, further exacerbating pressure on consumer sentiment and purchases.

Companies will find their working capital stretched. Debtor days will be stretched across the country and that will be enough to bring some companies to insolvency. Most companies will be hit by a reduction in revenue, high staff costs due to sick leave, and cash inflows being restricted. Companies will need to ask landlords for concessions, and bank covenants will be broken. Those with personal guarantees on debts will risk their primary residences to keep their businesses afloat.

With Australia’s strict HR employment laws, businesses will have limited powers. Redundancies cost money, and upfront cash payments. Unpaid leave will no doubt rise, as will part time or forced annual leave.

What are we witnessing in the private markets?

We are actively monitoring the market and speaking to our contacts on a daily basis.

[th]Company Type[/th]
[th]Last 30 days of trading update[/th]
[th]Nash view on the business[/th]
[td]Online infant supplies company[/td]
[td]No apparent impact[/td]
[td]• Stable and well positioned in the long term[/td]
[td]Large logistics company[/td]
[td]No apparent impact[/td]
[td]• Likely will be impacted over the coming weeks[/td]
[td]Group of dental practices[/td]
[td]Trading is ~20% lower than usual[/td]
[td]• Appears that consumers are worried about either hygiene or their expenditure

• Moderate reduction in employment

[td]Food and hospitality group[/td]
[td]Dramatic reduction in customers and revenue[/td]
[td]• Considering closing most days of the week.

• Large reduction in revenue

• Large reduction in employment

[td]Large travel bus company[/td]
[td]30% year on year reduction in revenue in February[/td]
[td]• Large reduction in revenue

• Large reduction in employment

• If debt load is high will require concessions from lenders until market improves

[td]Aged care hardware[/td]
[td]Will not hit FY20 Budget due to capex delays[/td]
[td]• Minor impact to day to day, but less profitable[/td]
[td]Inbound Tourism Operators (largely overseas PAX)[/td]
[td]Forward bookings have fallen significantly, and cancellations increased[/td]
[td]• Large reduction in revenue

• Large reduction in employment

[td]Consulting business[/td]
[td]Increase in client anxiety. Shift to lower prices and less success-based outcomes[/td]
[td]• Business is expecting a 50% reduction in revenue over the next 6-12 months[/td]
[td]Conferences and events[/td]
[td]Complete shutdown of majority of events[/td]
[td]• Nightmare – will have some access to insurance but otherwise will have mass cancellations and lost monies on events and sunk costs[/td]

Are we being overly conservative in our views? We hope so! This situation will be bad for all Australians.

How bad will this get? Should I be selling or buying shares?

We don’t have a crystal ball and we are not financial advisors, but in our experience events such as these get much worse before they get better. This will prove to be the recession that “was always coming”. Even though equity market prices are down 30% from the peak, prices are still near 2016 levels which were elevated at that time. We anticipate:

·       Mass shutdowns of companies and venues across March and April. This will severely impact revenues and profits for most companies in Australia.

·       Unemployment will rise quickly.

·       Companies with a high debt load will need to seek concessions from their lenders.

·       Companies will be reluctant to quickly pay their creditors. This will lead to a lock up within the markets and huge illiquidity. This could lead to insolvencies.

·       Housing prices will fall (although low liquidity will make it difficult to see this trend for months) and consumers will feel less wealthy.

·       Companies servicing necessities such as healthcare and food (Coles and Woolworths) will do well, however there will be few other sectors that will outperform.

The buying opportunities will come over time, and there will be better opportunities to invest in private companies than public companies. The benefit of investing in a private company is that you can get full insight into the company before investing, and also have the ability to influence the company and its decisions.

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