Beyond the Covid-19 Shock: Revisiting Capital Allocation
By Shoaib Yaqub, Global Head of Standard Chartered’s Financing Solutions and Advisory (FS&A) Team
As the challenge of surviving Covid-19 gives way to the potential for growth, how can CFOs and treasurers make sure they’re ready for any opportunities that lie ahead?
For corporates, the next phase of the Covid-19 challenge is beginning. After a conversation dominated by the tragic human cost of the pandemic and, from a business perspective, liquidity and survival, the focus is shifting to how companies will come out of the crisis.
Will there be a ‘new normal’ with respect to capital structure? And what’s the optimal way to manage both the challenges and opportunities presented by the post-lockdown world? At Standard Chartered, we have developed a framework to help corporates reassess their capital allocation – and we hope it will be useful to all treasurers as they prepare for recovery and beyond.
Focus on the long term
First, we must start with the end in mind. In other words, any new capital allocation structure needs to focus on the longer-term strategic objectives of the business. Yet with uncertainties around the economic recovery, as well as concerns about a second wave of the pandemic, financial agility must remain paramount.
Second, getting to where any corporate needs to be requires an assessment of where they are now. Specifically, how has the sector evolved since the previous crisis and, indeed, since before the 2007-08 financial collapse? And are these changes sustainable?
To help answer these questions, we have analysed capital allocation and indebtedness trends across large corporates over the past 15 years1, and observed two key trends:
- For a variety of sectors, the relationship between shareholders and corporates – with respect to how returns are achieved and valued – has changed.
- Investor attitudes towards corporate debt levels have also evolved and now support an increase in leverage across the board.
With respect to shareholder returns, the sector differences are stark. They also clearly reflect how the market perceives – or is beginning to perceive – changes in the overall structure of some of these industries. For instance, the Oil & Gas sector had the second-best average dividend returns over the past 15 years, after Utilities. Yet it suffers on a total-return basis due to the past decade’s underlying volatility and the emergence of environmental concerns.
Meanwhile, other sectors have been able to rely on steadily increasing stock market valuations to provide investor returns. Least surprising in this respect is the Tech sector, although the Non-Food Retail and the Fast-Moving Consumer Goods (FMCG – or ‘consumer products’) sectors also show strong value. Tech – as well as Aerospace & Defence and Hotels & Leisure – has offered incremental shareholder value via share buy-backs.
Taking all these attributes together, FMCG comes out on top over the 15-year period. Meanwhile, Oil & Gas, Utilities and some other more established sectors remain reliant on cash dividends to maintain investor loyalty.
Why is this important for the capital structure? Because, in each case, the investor base has some clear expectations that will permeate the thinking of any corporate treasurer when allocating capital – particularly when it comes to debt.