For decades, business schools did a brisk trade promoting courses on capital efficiency. This meant striking the right balance between equity and debt at the lowest possible cost of overall capital.
But suddenly this no longer seems so important. The mantra going forward is liquidity and raw survival, even if this comes at a cost.
Those without access to cash will be the first to stumble.
Over the last two months, virtual boardrooms around the country have spoken about little else. Whether to borrow now and face the day of reckoning later, or tough it out for another few weeks. There is no easy answer.
Among the companies filing for business rescue in recent months are Comair, South African Airways, Edcon and Phumelela Gaming. There will surely be more. Business rescue and liquidation teams can look forwards to years of prosperity as the economic downturn unfolds.
A quick analysis of the cash holdings of the 350-odd companies on the JSE shows a combined cash pile of more than R1 trillion at the end of 2019, a near 70% increase on the figure in 2015.
Corporate cash pile
Research in 2017 by the University of Johannesburg’s Centre for Competition, Regulation and Economic Development put the corporate cash pile at R1.4 trillion, not counting a further R1.6 trillion in reserves from JSE-based multinationals with little actual presence in SA.
Reasons given for the hoarding of cash were shrinking domestic demand, the Zuma legacy and a lack of suitable investment opportunities.
That cash pile, fat as it is, will be winnowed out over the coming months as companies stretch their balance sheets as far as they can to survive the collapse of the economy, with hopefully enough gas in the tank to catch the expected recovery later this year.
Transaction Capital CEO David Hurwitz, presenting the group’s mid-term results to March 2020 last week, offered a taste of what’s to come for corporate SA. The group’s headline earnings were up 19% to R402 million for the six-month period – an achievement that is the envy of the JSE, but it’s clear the real pain of the economic downturn will come in the second half of the year. The group made a non-cash R126 million impairment provision on its taxi loan book, and wrote down its non-performing loan book by R65 million.
To ensure it has enough cash to tide it over the coming months, it has undeployed capital of R800 million, of which R300 million is immediately available. Taxi drive time is down by about half during the lockdown, and that impacts the ability of taxi owners to service their loans. On the plus side, taxis will be among the first to benefit from an easing in the lockdown. The loan collections business has seen a drop in promises to pay, and this may take longer to recover.
“Most businesses go bust because they don’t have enough liquidity,” says Hurwitz. “We have a very conservative capital structure. We have R800 million in excess capital on our balance sheet, with an average cost of funding of 10% to 11%. That’s high, and people said we could reduce this.
“We raised money offshore which, converted into rands, cost 12% to 13% in interest. But we opted for diversity of debt funding, and you have to pay for that, but we consider this worth paying for.”
It also helps to have solid, long-standing relationships with funders, and to negotiate repayment holidays where needed. Companies are going to have to staff up their debt collections departments, and even that’s no guarantee of success.
Nicolaas van Wyk, CEO of the SA Institute of Business Accountants, says the lockdown has made capital efficiency one of the most talked-about topics in corporate boardroom.
“Companies are likely to reconsider their capital structure while carefully evaluating their short-term liquidity. However, postponing repayment of debt to secure liquidity does have risks. Rolling debt forward increases the total amount to be repaid at a future point in time. It may be better to take a hard look at the capital on [the] balance sheet and [seeing] if this is still fit-for-purpose, while exploring other sources of liquidity such as salary cuts, unpaid leave and temporary unemployment measures, particularly for companies that do not have cash in reserve. Debt-to-equity and total debt-to-total assets is likely to occupy the minds of boards across the country.”
Van Wyk says an early lift of the lockdown will also assist in improving liquidity.
Companies are likely to reduce margins to generate increased revenue and improve liquidity. This may be a preferred option to deferring loan commitments.
The issue of balance sheet efficiency will not go away entirely. Product lines will be simplified and streamlined, and those products yielding marginal returns prior to the lockdown could disappear. Surplus and marginal assets will be up for sale in cases where companies face a debt crunch. Though debt is cheap right now, the quest for sustainability may drive a prolonged period of deleveraging. Debt at any price is considered a risk too foul for many businesses.
“Companies are also unlikely to open at full capacity; their focus will be on past orders and backlogs,” says Van Wyk.
“Customers can expect a lot less choice and longer waiting periods.”
There’s no question that many companies will not open their doors again, Edcon being the most notable example of an already-struggling enterprise euthanised by Covid-19.
But for tens of thousands of small businesses with little in the way of cash reserves, these may be the leanest times in living memory. Lauren du Plooy, a director of digital accounting firm Rae & Associates, says the message she is promoting to her clients is to build cash reserves for the future.
“Even before the lockdown, we were advising clients to set aside reserves so they could survive two to three months of no income. We did not know at the time that the lockdown was coming, but this is just prudent financial management. Going forward, I think just about every company in SA is going to be thinking this way.”
It may be some time before company shareholders see dividend flows again. The focus now is on surviving the next few months and having enough cash in the bank. It’s all about raw survival.