When just in time becomes just in case – The Property Chronicle
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When just in time becomes just in case

The Fund Manager

Balance sheets show the trade-off between resilience and optimisation 

% of companies with net cash

Source: CLSA, Factset as at 21 April 2020

As we highlighted last month, coronavirus is especially dangerous for patients with pre-existing conditions. This is true as much in the corporate world as it is for human beings. The unprecedented and unorthodox nature of the shock should not be allowed to disguise the fact it has revealed a shocking level of fragility amongst public and private companies across the globe.

This month’s chart demonstrates one proxy for fragility, the percentage of companies with net cash balance sheets. Debt magnifies the impact of outcomes, cash on hand dampens them. If you came into this with cash, the probability of your business needing life support is reduced.

Unbeknownst to many shareholders, corporate management have been engaged in a previously implicit, but now very explicit, trade-off between optimisation and resilience.

The story of boardrooms for the last couple of decades has been one of globalisation, financial engineering and shareholder value.

Companies have strived for, and investors have encouraged, operating leaner, faster, more efficiently. From complicated global supply chains to the relentless shedding of ‘non-core’ assets or the outsourcing boom.

Management have been highly incentivised to ride this gravy train with incentive plans tied to return on equity and earnings per share. What an easy win – pay out all your cash, borrow cheap, buyback shares. Stock markets loved it. What could possibly go wrong?

COVID-19 revealed all the flaws. To use the major US airlines as an example, they have spent $43bn on buybacks in the last six years whilst increasing their total debt. The four CEOs pocketed $430m between them[1]. The industry just needed a US government bailout of $25bn and is raising equity.

Corporates, particularly in the US, have become highly evolved to operate in a globalised, stable economy. But the opposite of efficiency is not inefficiency: it is robustness. Highly evolved for one environment, means less adaptable to another: cockroaches outlived dinosaurs.

In the future robustness will be prioritised. That means holding more cash and inventory on hand. It means shorter, local supply chains, diversified suppliers and re-shoring manufacturing; de-globalisation. Companies will care more about other stakeholders, running with less debt and lower shareholder payouts. In a sentence, as Margaret Heffernan put it: ‘just in case over just in time’.

So what does that mean for investors? All of these things are bad for corporate profit margins, but good for ensuring the business can survive another crisis.

The Fund Manager

About Duncan MacInnes

Duncan MacInnes

Duncan joined Ruffer in 2012. He graduated from Glasgow University School of Law in 2007 and spent four years working at Barclays Wealth and Barclays Capital in Glasgow, London and Singapore. Duncan is a CFA charterholder. He is co–manager of Ruffer Investment Company.

Articles by Duncan MacInnes

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