Written by Hudson Adviser Phillip McGann
The health emergency brought on by the Covid-19 pandemic has had far reaching consequences across the whole of society.
Impacts financially have been felt in most households, company boardrooms, government coffers and - dramatically - on the worlds share markets.
The local Australian market was down 33% into mid March and has since recovered somewhat to be actually up about 17% from those lower levels. Is this the start of a new bull market or a "traditional bear market rally"?
We will know more in coming weeks and months
At the individual company level the basic operating environment has been turned upside down. Many specialty retailers have seen their physical stores forced to close and are trying to make do with online sales. Whilst those in food retailing, other hospitality, events, sports and tourism have seen a near collapse in income and are literally fighting for their financial lives.
Once restrictions are finally lifted and the economy gradually opens up again a lot of these companies will need to find a different way to operate in a post-Covid world.
Many smaller privately held companies will collapse whilst their publicly traded competitors are now making plans to tap their shareholders for more capital to shore up their balance sheets
A company without sustained sales turnover is headed for financial oblivion unless its fixed expenses can be met by borrowings or capital reserves. Additional debt is often not possible or practical and capital reserves need to be replenished.
Shareholders are often asked to stump up more capital to wade out the bad times the company is going through. Shareholders need to decide if they are prepared to give more capital to the company and thereby increase their own exposure to the companies' fortunes.
This is economics 101 and this is what is occurring now.
Scores of companies are tapping the market for much needed capital. Mostly at large discounts to already collapsed share prices.
Is this a good deal for share holders?
As always the answer is "It Depends"
When considering any individual offer from a company for more capital a shareholder needs to consider:
- What is the offer and is it worthwhile in consideration of the prospects of the company going forward. Just because a company is offering you a 20% discount to the current depressed share price does NOT of it itself necessarily mean the offer is a good one.
- Is the current economic impact a temporary dislocation or is something more fundamental occurring that will endanger the company (and your now larger share holding) going forward?
- Will you have too much exposure to this one company in your portfolio by taking up the offer?
- How will you fund the investment? Are you borrowing funds? Or are you buying the additional shares in a SMSF where you will have too much exposure to this one investment. Will this impact your investment mandate?
- Are there better opportunities out in the general market places for your capital?
The other way companies can / will and are addressing their capital needs during this crisis is to retain profits and thereby cash by cutting dividends.
Again scores of companies have made announcements over the past few weeks that they will cancel, defer, suspend or cut their upcoming interim dividends usually payable in the April / May period.
This will impact individual shareholders to varying degrees. If you are solely reliant on dividends and the attached franking credits for a large part of your income this is very problematic for you. But all shareholders will see an impact
There is really not much you can do about this in the short run as the company has no obligation to pay profits out as dividends. You could sell some shares to fund the cash shortfall but this is NOT recommended at all.
Some would argue that it is actually prudent for companies to retain the profits so as not to be forced to issue additional shares at greatly reduced prices thereby diluting the shareholdings of existing shareholders who cannot or choose not to take up the offer. The companies can then deploy this capital with greater impact than individual shareholders in a recovering economy.
Even the large banks are now entering this scenario with the regulator APRA coming out in early April directing financial institutions to seriously consider the prudence of paying out dividends in these uncertain times.
When your regulator tells you to cut dividends this is a direction you must adhere to.
National Australian Bank responded this week by slashing its dividend by 60%. However at the same time it raised capital by issuing shares – a very contradictory capital management strategy. Management when questioned about this said they did not want to see a mass exodus of small share holders.
If this was true why not offer retail shareholders a more favourable portion of the capital raising as they did for the institutions?
Where to from here?
We live in interesting times. The current movements in the local and international share markets are not for the feint hearted but they are offering opportunities for further investing at lower prices
Current volatility is likely and we may well yet retrace our recent rebounds from the March lows.
As always the best course of action is the one that is best for your financial strategy in the longer term. Do not panic but stay the course of your longer term strategy.
Carefully consider any additional share offers in light of your personal financial situation and the future prospects of the company you are currently a shareholder of.
Dividend payments will return when it is in the best interests of the company to pay them.
If you wish to discuss any of the above with your personal Hudson Adviser please call 1800 804 296 to book a call