The Dash for Cash: This story is the third of a three-part series examining the changing shape of company balance sheets in the wake of the coronavirus pandemic.
Don't rely on companies to drag the U.S. economy out of its coronavirus-induced slump.
After U.S. companies built up their cash buffers to multiyear highs to guard against pandemic-related uncertainty, capital expenditure — the second-largest chunk of the U.S. economy after consumer spending — is predicted to suffer, acting as a drag on the recovery.
Cash ratios — a measure of liquidity calculated by dividing total cash or cash equivalents by current liabilities — among S&P 500 members jumped to 17.1% in the first quarter from 13.8% at the end of last year as companies increased their cash holdings by $250 billion to a record $1.8 trillion, according to calculations by S&P Global Market Intelligence and S&P Dow Jones Indices.
U.S. companies have been carrying more cash ever since the global financial crisis of 2008 as CFOs remained wary of future shocks. Now, analysts are pondering the long-term effects on company balance sheets of this unprecedented economic trauma.
"[Cash ratios] will stay like this for some time particularly while the virus is still out there and the threat of an extended first wave or second wave are very much a risk," Toby Gibb, head of investment directing, equities at Fidelity International, said in an interview. "Until there is a vaccine, the risk is very much there that we could go back to lockdowns and that cash flow could be switched off."
There is evidence that the shift has already started, compounded by a slump in demand and disruptions to supply chains.
Demand for core durable goods — a key indicator of capital expenditure in the manufacturing sector that excludes fluctuating goods such as aircraft — slumped in April, with new orders down 6.5% month on month from $65.61 billion to $61.34 billion, a three-year low and the sharpest month-on-month decline since April 2010.
Shipments fell 6.2% from $65.3 billion to $61.25 billion in April, the sharpest decline since January 2009.
There was a rebound of sorts in May with orders and shipments increasing by 2.3% and 1.8%, respectively, but levels remain well below the pre-pandemic normal.
By pumping trillions of dollars into financial markets, the Federal Reserve and U.S. Treasury have effectively supported liquidity, allowing companies access to cheap credit. However, there are doubts as to how long that support will be there and whether borrowing will become more expensive.
Lawmakers are sparring over what measures to include in a second stimulus package and the Federal Reserve's $600 billion Main Street lending program is yet to disburse any payments.
"Main street program interest rates are too high," Simon MacAdam, senior global economist at Capital Economics, said in an interview. "There has been poor take up in some government schemes so there are some question marks of access to funds if cash ratios do fall."
Rather than rely on government largess, companies have been hitting debt markets like never before to buff up their balance sheets.
Investment grade companies borrowed a record $1.129 trillion in the bond market in the first six months of 2020 while their speculative-grade peers raised an all-time high $210.6 billion, according to LCD, an offering of S&P Global Market Intelligence.
"In the short term it's still liquidity that is the concern," MacAdam said. "[The] medium-term concern is whether that holds back the recovery because, rather than funding capex, they're just concerned about multiple waves."
While there are estimated to be around 100 vaccines in development with a number in human trials, the earliest that one is likely to be widely available is in 2021, according to Dr. Anthony Fauci, director of the U.S. National Institute of Allergy and Infectious Diseases.
The danger for the economy is that the decision to hoard cash and not invest becomes self-fulling, said Neil Richardson, investment director at Aberdeen Standard.
"If corporate confidence is low and they don't invest then it will produce low growth, which will make them think they were correct not to invest," he said in an interview.
U.S. companies have been investing less for decades, in many cases juicing valuations with dividends and buybacks instead. Capex as a percentage of GDP was 21% in 2018, down from over 25% in the mid-1980s, according to the World Bank.
However, the pandemic may change that equation as companies shift priorities in the new reality, according to Fidelity's Gibb.
"We've been in a period for a long period of time where companies haven't been investing, they've been using their cash flow either to pay dividends or buyback their own shares," Gibb said. "At the least maintenance capex and a degree of growth capex will remain. I think some companies see this as an opportunity to reset the bar from a dividends perspective."