Earnings Season Update: Communicating COVID-19 Impacts
Halfway through the current earnings season, companies are beginning to dip their toes in the water of communicating current and upcoming impacts of COVID-19 on financial performance. More than fifty companies from our Automotive, Retail, Recreational Products and A&D and Industrial monitoring lists have reported current quarter earnings and as seen in the table below, outside of COVID-19-related impacts, many are focusing on expectations for the next quarter and reiterating the strength of their long-term strategies.
In addition to these themes experienced across sectors, each industry is seeing other impacts directly associated with the environment to which they are operating.
Significant unknowns remain for the automotive sector as the COVID-19 pandemic continues to wreak havoc. Already facing a tough production environment that was exacerbated by China early in the quarter, nearly all companies in the space announced production suspensions in Europe and the Americas by March, and are just now beginning to resume production. As the dust settles, these companies are taking a hard look at all operations, flexing cost structures to ensure their ability to maintain performance until a clearer picture regarding global demand and related industry production can be identified.
As earnings kicked off in earnest for the automotive sector this week, several key themes have surfaced:
- The impact was broad and deep. Nearly half of companies Clermont monitors have quantified a COVID-19-related impact to this quarter’s results, largely quantified in terms of either sales or profitability. Across the board, expectations are being set for a significant negative impact in the near-term. For those that specify a discrete impact from COVID-19 to financial results, the pandemic was frequently cited as a major driver to a year-over-year decrease for nearly every metric. Roughly one third of this set provided insight on expectations for the subsequent quarter’s results, with the entirety of this commentary being given qualitatively.
- Backing away from guidance. Nearly all of the companies monitored chose to withdraw full year 2020 guidance, while those who chose to provide guidance either drastically reduced forecasts, or provided qualitative information regarding expectations for the year, reflecting the common theme of mass uncertainty across the industry. For those that did provide guidance in some form, expectations are uniform that industry production will be significantly diminished in the coming quarter, and likely to extend through the remainder of the year, resulting in negative year-over-year comparisons to 2019.
- Taking near-term steps to maintain the long-term strategy.Over three-fourths of the companies monitored took the opportunity on their earnings calls to both reiterate their long-term strategy plans, and emphasize that cost-cutting measures being taken to mitigate the impact from COVID-19 in the near-term still allowed for execution on the aforementioned business strategy. A small number of these companies pointed to performance during 2008-2009 as an indicator of ability to successfully navigate global economic downturns and challenging operating environments.
- Addressing financial position, liquidity and solvency.Nearly all companies highlighted cash balance and availability on credit facilities to paint a picture of ample liquidity in the near-term, with a small group laying out cash burn rates and the Company’s ability to “keep the lights on” for a duration of significantly impacted (or zero) revenues. Some highly levered companies in this set also pointed to renegotiations on established loan covenants held in the prior weeks to address concerns of breaching covenants due to deteriorating operating results.
Retailers have faced – and will continue to face – tremendous hardship due to COVID-19. While some essential retailers have experienced an uptick in sales since the outbreak began, the vast majority have had to close their doors and rely on e-commerce channels to make up for lost in-store sales. Several retailers have reported their quarterly earnings, citing COVID-19 as detrimental to this quarter’s results and likely future quarters’ as well.
It is still early in retail’s reporting season, but trends have begun to appear in earnings releases, as well as in earnings conference calls. Here are this quarter’s most notable themes, so far:
- Quarterly financials are seeing an impact. Of the companies Clermont monitors who have released quarterly earnings, 100% of them have cited a COVID-19 impact to their financials. While some experienced strong sales in the first half of the quarter, they saw a steep drop-off in the last two weeks of March and into April.
- COVID-19’s effect will be felt in quarters to come. 67% of companies expect to see an impact in the second quarter and likely beyond. As Crocs noted, “We expect a larger decline in revenues in the second quarter of 2020, as the majority of our retail and partner stores may be closed for the whole period.” The notion that second quarter results will be worse than first quarter’s was not uncommon.
- Strong balance sheets, solid long-term strategies will prevail. 100% of companies believe that strong financials, coupled with well-thought out strategies, will result in successful navigation of the current crisis. While it will not be easy, retailers believe they can come out of this performing better than before.
- Guidance cannot be relied upon. 83% of companies have either withdrawn or modified their guidance given the uncertainty surrounding COVID-19. We expect this number to increase dramatically as more companies report earnings. We would also like to note that guidance withdrawal has been popular across all industries, not just retail.
- Cost-cutting measures have proven to be beneficial. 100% of companies have taken precautionary financial measures to try and offset the financial impact of COVID-19. These have included actions such as executive compensation reductions, reducing capital expenditures, furloughing/laying off employees, and drawing down or increasing on credit facilities, among other liquidity and cash conservation activities.
- Companies are thankful for their employees, frontline, and health care workers. All companies who have released earnings this quarter noted appreciation for the work being done by their employees and others during this unprecedented time.
With all this extra time on our hands due to school closures and shelter-in-place orders, recreational products companies might seem somewhat insulated from some of the market devastation. Although, consumer sentiment plays a big role in the demand for boats, RVs, motorcycles and the like.
As recreational products companies have started to report earnings this past week, several themes have emerged:
- Sales were strong until the last two weeks of the quarter. Recreational products companies in our monitoring group that have reported earnings have emphasized strong sales well above prior year until mid-March when the bottom dropped out and, in many cases, reversed the positive year-over-year comp.
- Hope is on the horizon. Production was shut down for most companies beginning the last two weeks of March and continued through April. However, several companies cite early- to mid-May re-start dates.
- The impacts of COVID-19 were not quantified. None of the companies in our monitoring group gave any quantification of the impacts of COVID-19 on the reporting quarter or future quarters.
- Cash flow and recovery expected.One third of companies qualitatively guided to generating positive free cash flow next quarter and the majority of companies expect a U shape economic recovery with significant disruption in the second quarter followed by sequential improvement through the back half of 2020.
A&D and Industrials
In A&D, Commercial Aerospace OEMs, like Boeing and Airbus, have largely experienced performance hits as a result of slowed passenger traffic and delayed customer orders, while Defense players, such as Lockheed Martin, are holding strong with support from the U.S. government. Then, in general Industrials, companies continue to grapple with closed facilities, along with associated costs, and declining customer demand in the near-term.
A little under half of the companies Clermont monitors have reported, while the remaining half will be coming out of the gate in the upcoming weeks. Here is what we are hearing so far:
- Performance was largely in line prior to the March drop off. The majority of monitored companies in these segments, with the exception of those more exposed to defense, experienced some impact to financial results in this most recent quarter as a result of the spread of COVID-19. Majority of A&D companies experienced steep declines in Commercial Aerospace segments, while Defense segments generally maintained expected growth.
- Companies are reserving capital spending including, in many cases, suspensions of dividends and share repurchases, and maintaining strong liquidity. A majority of the companies reiterated previously issued business updates prior to their quarterly earnings reports, which outlined cost reduction actions being taken to mitigate the incoming hit to financial performance. Additionally, many companies aimed to calm the Street by outlining strong balance sheets and liquidity positions that would provide near-term support while facing further headwinds a result of COVID-19.
- Those that are looking ahead are seeing extreme downward pressure on the next earnings period. Many companies, more so Industrials, that have reported are already signaling further negative impacts on next quarter’s performance and some have already started to set quantitative expectations. GE provided a standard example of qualitative insight: “The second quarter will be the first full quarter with pressure from COVID-19, and GE expects that its financial results will decline sequentially.”
- Navigating an uncertain environment means a pullback or full withdrawal on guidance for most. The majority of the 23 companies monitored maintained their previously withdrawn or suspended FY 2020 guidance for the foreseeable future as they synthesize the full impact of COVID-19 on business operations and performance, while four companies updated their guidance to be reflective of how they currently view the remainder of their reporting year. Those that maintained issuing guidance largely had exposure to defense markets that are known to perform well in in downturns.
- Most are remaining steadfast in their long-term strategies. Regardless of the current market sentiment, almost all monitored companies felt confident in their company’s long-term strategy and believed their vision would remain in play when coming out on the other end. More so, several flagged the strength and experience of their management team, who have weathered past downturns, would successfully navigate them through this unprecedented environment.