The Covid-19 Recession
Link Group has categorised UK plc’s sectors according to their vulnerability. The red list contains critically, directly affected sectors banned from trading or otherwise on the front line. The amber group contains those likely to suffer the second-round effects of the economic hit; they will be affected by falling demand and by supply constraints (including the supply of labour). Those least likely to be affected are on the green list – some of these may even benefit. Each group made up almost exactly one third of UK plc profits over the last year.
The exact impact is exceptionally unclear, but it will be enormous. As a guide, Link Group has looked first at the 2008-9 recession and secondly at the impact of the last collapse in oil and commodity prices. Finally, the team has folded in Covid-19-specific factors such as the hit to retail, travel and leisure. The results of this exercise lead Link Group to pencil in a 75% decline in UK company profits by the autumn this year, before a bounce-back occurs into 2021. This is a hit of £170bn over 18 months, equivalent to a whole year’s worth of profits lost.
Susan Ring, CEO of Global Corporate Markets, authors of the Link Group UK Dividend Monitor said: “The pandemic has huge social and economic consequences. Firm evidence of how companies are faring will take time to emerge; even profit warnings will only be of marginal use given the rapidly moving situation. This is why the stock market is showing such unprecedented volatility. It is impossible to value companies accurately until investors can nail down with greater certainty the severity and duration of the disruption, and work out how effective the policy response will be from governments and central banks. Share prices are blown from pillar to post as a result.
“Lower profits mean lower share prices are justified. But most of the value of a share derives from its ability to deliver profits over the next 15-20 years, not just from the next year or so. If the damage from the crisis is short-term, and if profits start to rebound later this year, then the elimination of almost £800bn of value from UK stocks during the crash is a clear overreaction to the loss of perhaps £170bn of profits. The gap is the value of uncertainty. Covid-19 will cause a huge amount of economic damage, but does it justify value destruction on this scale?
“All this does not mean the market cannot continue to fall for now. Moreover, if we are set to endure a protracted slump, then our estimates for profits are likely too sanguine. But the recovery will come.”
On dividends, she added: “Dividends are a vital anchor in stormy seas. Even in harsh times, companies try to protect the dividend, especially if they think the hit to their profits is temporary. We saw this clearly in the last recession when UK profits fell by two thirds, but dividends only dropped by around 15% peak-to-trough. At the worst point in the financial crisis as the stock market crashed, the yield on UK shares rose to 4.9%. The decline in this recession will be greater. We have seen many dividends delayed or cancelled already as companies look to preserve cash in order to protect themselves against a cessation in business, and there will be much more. If the Covid19 crisis is short and sharp, we may look back on this moment as a historic buying opportunity.”
