Do Covid-19 subsidies threaten shareholder value?
New era of stakeholder capitalism
As more companies tap government stimulus funds, more questions are being asked about how the use of taxpayer money may affect shareholders.
To answer these questions, investors must assess how corporate behaviour and stakeholder engagement will shape a company's long-term outlook.
Government stimulus is an essential ingredient to combat the recessionary drag of the pandemic. For many companies, stimulus funds provide a cash lifeline that can make the difference between survival and extinction in today's tough environment.
Complex questions for investors
Yet the provision of public grants or loans also creates questions for investors. Should companies be allowed to draw on taxpayer funds if they didn't manage their capital responsibly before the crisis?
Will shareholders get hurt if a company cancels dividends to accept public funds?
And with dividends and buybacks being scaled back, how should investors evaluate company spending on employee engagement and community outreach during the pandemic?
These questions reflect the first test of the new era of stakeholder capitalism. In 2019, 181 US CEOs signed a declaration stating that their businesses would fully consider all stakeholders, not just shareholders.
In the Business Roundtable statement, corporate leaders pledged to support the environmental and social health of communities in which they operate and to embrace sustainable practices.
Now, companies face tough capital management decisions to balance business dynamics and shareholder interests with public health considerations and other social issues.
Dividends and buybacks are getting cut
Shareholder rewards are already under pressure. Dividends paid globally dropped to $1.05trn in June on an annualised basis, a 12% decline from their peak in February.
In the US, companies slashed $42.bn in dividends during the second quarter of 2020, the biggest cuts since the first quarter of 2009, according to S&P Dow Jones Indices.
Buybacks are also being reconsidered. In the US, S&P 500 companies that contributed to 27% of share repurchases in 2019 have already suspended buyback programmes.
After the Federal Reserve issued guidance in June for large banks to halt buybacks, share repurchases are expected to drop by more than 50% in the second half.
Many companies will face restrictions on dividends and buybacks if they access public funds.
Under the CARES Act, US companies that take PPP loans may not pay dividends or buy back shares in the next 12 months or until there are no outstanding loan guarantees.
The European Central Bank has ordered EU banks to halt dividend payments and buybacks at least until October 2020.
And the Bank of England asked large UK lenders to suspend dividends and cash bonuses for senior executives, saying other stakeholders' interests should come before those of shareholders and management to support the economy.
Evaluating debt levels amid relief funds
So how should investors evaluate debt levels versus shareholder rewards? We think the following three issues take on added importance today:
• Default risk - do solvency concerns and default risk outweigh expected returns? If the answer is yes—with or without access to stimulus—the investment thesis is compromised.
• Reinvestment rate - is the company investing enough for business growth? Reinvestment is always key to forecasting future return potential, especially today when many companies face a cash crunch that constrains their ability to invest for the future.
• Shareholder rewards - are dividend and buyback levels reasonable in light of the company's default risk and reinvestment rates? Getting the balance right is tricky in the best of times. Today, public funds add more variables to consider.
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