Corporates brace for up to 20% earnings decline as dismal second quarter comes to an end

• Cash and leverage remain in spotlight as companies borrow more and stockpile cash 

Sri Lanka’s listed corporates are expected to report between 15 percent to 20 percent decline in their earnings, as they prepare to close books on one of the worst quarters on record. Analysts are parsing data to understand each company’s operating leverage as most businesses remained either completely or partially shut for nearly two months. 

The operating leverage gives an understanding of the level of fixed costs in a business. Higher the fixed cost, higher the operating leverage and thereby, the business risk. In a downturn such as the present one, where the top line gets impaired, it could heavily weigh on the bottom line, if the company has a higher operating leverage. So is the upside for earnings for a company with a higher operating leverage in an economic upturn. 

As businesses cut costs by way of salary cuts and curtailment of other overheads, to ride the tough spell wrought by the coronavirus, analysts are measuring to what extent those cuts in the fixed costs could have an impact on their bottom lines, as sales were disrupted significantly during the nearly two-month long lockdowns. 

“Our initial workings suggest that on average, the listed entity earnings could take a hit by between 15 to 20 percent. However, there could be some outliers with much steeper implications, depending on the industry they belong to and the financial health of the company before the pandemic, which may have worsened due to the business disruptions,” said a lead equities researcher in a Colombo-based stockbroker firm on condition of anonymity, as the final numbers are still being worked out. 

While earnings are going to be the obvious casualty, the pandemic brought cash and leverage of companies to spotlight. The businesses battered by the coronavirus-induced lockdowns are borrowing more and stockpiling cash to bolster their resilience until they feel safe to spend, when the rebound sets in. 

From larger corporates to small companies have applied for moratoriums up to six months, effectively suspending cash outflows for some time and they also lodged applications for loans under the Rs.150 billion Central Bank liquidity support scheme.

Some drew down their credit lines, which they already had with their banks as precaution, the stock market disclosures made since the end of April by companies on the impact of the virus on their respective businesses showed.  

Meanwhile, market interest rates have also come down to single-digit levels for businesses, as a result of the back-to-back cut in key policy rates. Market liquidity is at a very comfortable level, providing a fresh impetus for companies to take on more debt. 

The credit guarantee scheme, which will come into effect from tomorrow (July 1), will also expedite such loan disbursements to companies, as the Central Bank guarantees such debt up to 80 percent, depending on the size of the loan. 

A number of companies have deferred their capital investments to preserve cash, as cash becomes the king in time of crisis. 

Companies stockpile cash in a crisis as it provides them with flexibility and safeguard them from any asset price volatility and the resulting losses. It also acts as ready fuel, once the sustainable growth resumes and new investments make sense.