As Q1 earnings come to a close, investors will shift their focus on Q2 earnings that will shed light into the deep disruptions experienced by European companies.
Most of the impact for Q1 earnings came from the sudden closure over the course of March 2020. Effectively, the impact was on one-third of the period. Invariably, the impact on earnings varies across various sectors and industries. As observed during Q1 earnings, companies may be especially exposed to specific months of the year.
Indeed, companies may have a seasonal distribution to their earnings, and companies that were mostly sensitive to March have registered the largest negative impact. The quarter-on-quarter growth during Q1 2020 was negative for the overall market with sales shrinking by c. 6.50 per cent and earnings sinking by c. 25 per cent. The higher costs associated to reconfigure their operations, adjustments for social distancing measures and other necessary measures for business continuity (where possible) meant that margins were eroded.
The hardest hit from the pandemic during Q1 2020 were mostly cyclically related companies that provide non-essential products which saw their sales plummet during March. Industrials, basic materials and consumer goods all saw c. 10 per cent declines in their top line. The shock protruded through the OPEC+ decision to substantially increase supply, hit energy companies the worst as they experienced significant falls in their revenues with a fall of around 14 per cent and earnings contracting by 38 per cent.
A surprise drop in total revenue came from the utilities sector. The notoriously defensive sector did not provide the sufficient downside protection as utility companies were exposed to the slowdown in business activity. This meant that there was lower demand for utility services following the outbreak of COVID-19. On a positive note, utility companies were among the few set of companies that recorded a quarter on quarter earnings growth at 23 per cent. This came on the back of an optimised cost management process adopted by utility companies. Both healthcare and technology companies were the only two sectors that registered both top and bottom line growth.
The greatest disruption in economic history saw its apex reached during the first part of Q2 in the real economy. Indeed, during the month of April, the US registered around 22 million people that have lost their job. This came in view of the total closure of operations for businesses during that period. Most of the people that lost their job are expected to be temporary rather than permanent. As a result, investors are expecting the worst for Q2 and an improvement from thereon as lockdown measures continue; assuming that the second wave is averted by economies around the globe.
Expectations for Q2 2020 are that sales for the largest 250 companies in the eurozone will fall by circa 24 per cent from Q1 and a fall of circa 28 per cent compared to the same quarter of 2019. Net Debt to EBITDA is also expected to increase from 4.38 to 5.77 as income from operations fall whilst Net debt increase as companies seek liquidity funding and other longer term financing assistance to survive during this period. Compared to Q2 2019 operating income; Q2 2020 is expected to fall by 23 per cent and earnings are expected to fall by around seven per cent.
Expectations mostly hinge on the evolution of the pandemic over the course of the next few weeks. The dreaded second wave may be a game changer for economies and businesses. Tracking the R-factor (which captures the ratio of how many people, on average, will be infected for every person that has the disease) will be the tool of reference for investors to try and delineate the future economic path around the world.
Disclaimer: This article was issued by Jesmar Halliday, CFA, investment manager at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.