Coronavirus: Inventory short, cash long

Only 2 days ago we ventured the following opinion that then looked far-fetched. It may soon become mainstream. Stop the virus means stop China which means stop the planet:

“To combat the coronavirus mark II, China is using the big guns afforded by a dictatorship: its population may not move, i.e. individuals’ freedom to travel is curtailed to the benefits of the nation and most likely to the benefits of the rest of the planet. The Western world may say thanks.

In macro terms (not our territory), this may quickly translate into negative GDP growth assuming that the spread and plateauing of contamination is a 6-month process. If China is busy containing the spread i.e. stays home, its manufacturing capacity is likely to be missing for the rest of the planet too.

Then fear scenarios about the resilience of the financial system will multiply. It is easy for the PBoC to open the credit taps but it is less clear how a weak life insurance industry may be hurt by fast rising mortality and the corollary dumping of financial assets to face obligations.”

Like in Greek tragedy the outcome is highly predictable: transport stops, manufacturing stops, finance crashes. A mighty mess if this virus does not disappear by itself.

This brings us back to an observation that we have been steadily updating since 2016: European corporates have been hoarding phenomenal and rising quantities of gross cash, c. €900bn by now or 40% of their gross debt. (As a reminder net debt/gearing ratios are steadily up).

Gross cash (AlphaValue Universe ex Financials)

We repeatedly ventured that excess cash is the ultimate insurance policy in a world which has contracted its working capital, i.e. inventories, to the point that any hiccup in the supply chain may become a massive issue. The reasoning then is that banks are unlikely to help in such juncture. A big pile of (gross) cash amounts to saying “prepare for the worst, hope for the best”.

The above idea may be tested sorely as the Chinese stay home and inventories are fast depleted. Whatever transport capacity is left will go to the supply of food, water and drugs first. The rest will have to wait. How much the cash pile will help pay for short term disruptions is the next question. Obviously gearing will jump as a result.

It sadly remains extremely difficult to measure how far this depletion of safety belts across all industries has gone as we only look at listed corporates and their scope of consolidation is changing fast, making it difficult to spot trends. Below is a chart tracing the changes in the WCR/Sales ratio. This is built on non-Financials by essentially taking out Deep Cyclicals and sectors where suppliers are meant to fund the business (negative WCR). The picture is hard to establish.

Obviously, we shall keep an eye as the “too-small-for-comfort-inventories” theory is likely to be tested now.

Changes to WCR/Sales ratio

Coming to sectors and stocks, this is likely to encompass the obvious (Adidas, Seb, Puma, Logitech, Next, H&M, Philips, Electrolux) but one would have to think that all Autos, all Semiconductors/IT Hardware are concerned. Less well known is the dependence of MedTech companies on Chinese manufacturing. The likes of GN Store/Sonova/Demant do rely on Chinese components as do Smith & Nephew, Getinge and others.

As most corporates were not making a priority to communicate on their manufacturing set-ups, expect surprises.