1、Global Research24 March 2020Fundamental AnalyticsYour guide to identify which companies have the resilience to weather the COVID-19 crisisOur analysis started with gauging what stocks are pricing-inOn March 16th we published our note Pricing-in the impact of COVID-19. This note used a fundamental mu

2、ltiple model, driven by returns, growth and risk to back out what investors believe the market is pricing into stock prices. This note and its associated model should continue to be useful to investors into perpetuity. But it is not enough in isolation.How do we identify companies with financial res

3、ilience?It is 12 years since the global financial crisis. Some of us have seen these global downturns before (but this one is unprecedented in many ways), while others have not had this experience. Analysts and investors in equities have benefited from working through one of the longest bull runs in

4、 history. As Andrew Grove (former Intel CEO) said, only the paranoid survive. It is at times like this that we must fully consider the downside tail risks and break down the big question into smaller testable hypotheses. Analysing and financial resilience can be time consuming; to aide analytical ef

5、ficiencies we have built an interactive model which calculates a quality score based on balance sheet strength and sustainability of earnings across more than 1,800 companies for you to triage your targets.Unpacking the big questionWe unpack the big question that asks who can weather the current cli

6、mate, into an assessment that focusses on cash flow generation, flexibility and access. We then take this view to examine the full commitment spectrum facing companies. Not just debt commitments. We view any commitment where the company needs to pay cash out as a financial obligation its not just ab

7、out debt now. These other obligations can cause critical cash flow issues for o small testable hypotheses to uncover risks missed in standard analysis. In the note we analyse sources, restrictions and uses of liquidity, cash burn rates and runaways and defensive interval ratios. We look

8、 at operating leverage assessments, cost mixes, debt compositions, maturity structures, subordination and debt covenants. We focus on the analysis of hidden guarantees, off-balance sheet commitments and contingency probability reassessment.EquitiesGlobalValuation, Modelling & AccountingGeoff Robinso

9、n, CFM, FCAAnalyst HYPERLINK mailto:geoff.robinson geoff.robinson+44-20-7567 1706Yiding Lu, CFAAnalyst HYPERLINK mailto:yiding.lu yiding.lu+44-20-7568 9091Courtney Cook, CFAAnalyst HYPERLINK mailto:courtney.cook courtney.cook+44-20-7567 4871Renier Swanepoel, ACA,CA(SA),CMAAnalyst HYPERLINK mailto:re

10、nier.swanepoel renier.swanepoel+44-20-7568 9025Paul WinterAnalyst HYPERLINK mailto:paul-j.winter paul-j.winter+61-2-9324 2080 HYPERLINK /investmentresearch /investmentresearchThis report has been prepared by UBS AG London Branch. ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 64. UBS d

11、oes and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment

12、 decision.Contents HYPERLINK l _TOC_250027 Your guide to identify which companies have the resilience to weather the COVID-19 crisis 3 HYPERLINK l _TOC_250026 What is the big question? 3 HYPERLINK l _TOC_250025 Financial resilience 4 HYPERLINK l _TOC_250024 Unpacking the unknowable from the knowable

13、? 5 HYPERLINK l _TOC_250023 Our two-step methodology 8 HYPERLINK l _TOC_250022 Quant-driven assessment 9 HYPERLINK l _TOC_250021 Interactive model to screen companies 11 HYPERLINK l _TOC_250020 Fundamental cash-driven assessment 16 HYPERLINK l _TOC_250019 The big picture 16Cash flow resilience analy

14、sis 17Cash flow generation 17 HYPERLINK l _TOC_250018 Asset quality 19 HYPERLINK l _TOC_250017 Available free cash flow 22 HYPERLINK l _TOC_250016 No fans of EBITDA (during times of stress) 27 HYPERLINK l _TOC_250015 Cash flow flexibility 28 HYPERLINK l _TOC_250014 Analyse all obligations: NOT just

15、debt 32 HYPERLINK l _TOC_250013 Financial obligations in a stressed scenario: debt obligations 33 HYPERLINK l _TOC_250012 Getting to the on-balance-sheet debt number 33 HYPERLINK l _TOC_250011 The composition of the debt getting inside the debt numbers 34 HYPERLINK l _TOC_250010 Debt maturity and re

16、financing risk 36 HYPERLINK l _TOC_250009 Assess committed versus uncommitted facilities 37 HYPERLINK l _TOC_250008 Enhanced (net) debt definitions for financial stress analysis 39 HYPERLINK l _TOC_250007 The importance of getting an insight into debt covenants 44 HYPERLINK l _TOC_250006 The importa

17、nce of modelling scenarios and sensitivities 45 HYPERLINK l _TOC_250005 A extract from Build Better Models Setting up a scenario manager 45 HYPERLINK l _TOC_250004 Sensitivity analysis 49 HYPERLINK l _TOC_250003 Appendix 56 HYPERLINK l _TOC_250002 The proliferation of bias when without a base rate 5

18、6 HYPERLINK l _TOC_250001 Identifying statistical outliers in analysis 57 HYPERLINK l _TOC_250000 Anomaly identification using modified Z scores 60Geoff Robinson, CFM, FCAAnalyst HYPERLINK mailto:geoff.robinson geoff.robinson+44-20-7567 1706Yiding Lu, CFAAnalyst HYPERLINK mailto:yiding.lu yiding.lu+

19、44-20-7568 9091Courtney Cook, CFAAnalyst HYPERLINK mailto:courtney.cook courtney.cook+44-20-7567 4871Renier Swanepoel, ACA,CA(SA),CMAAnalyst HYPERLINK mailto:renier.swanepoel renier.swanepoel+44-20-7568 9025Paul WinterAnalyst HYPERLINK mailto:paul-j.winter paul-j.winter+61-2-9324 2080Your guide to i

20、dentify which companies have the resilience to weather the COVID-19 crisisWhat is the big question?How do we identify the companies most (or least) resilient tothe crisis brought on by COVID-19?The five takeaways:Unpack your big questions into smaller ones and build hypotheses you can test. Stress-t

21、est the analysis with sensitivities and scenarios.Focus on cash metrics and ratios that provide a better understanding of the ability to convert earnings into cash flow. Cash is generally cleaner, though it can still be managed, and metrics can be manipulated.Broaden your view: Do not think of finan

22、cial obligations as just debt. Anything that the company must pay, which is on- or off-balance-sheet, is a financial obligation.Assess: Do not assess liquidity purely on cash and cash-equivalent metrics. Assess the companys total accessible liquidity and adjust for liquidity restrictions.Dig deep: G

23、et an insight on debt covenants and the pathway to breach.Financial resilienceWe consider financial resilience to be:a condition where an entity can generate sufficient cash flow to meetits full financial obligations givenits sources of available liquidity that allows it to sustain and operate as a

24、going concernThe structure of this definition is important: it is a lack of cash flow that drives the risk implications for obligations. The obligations sit, (as we shall see through this note) in part, on the balance sheet. The business models balance sheet (and their associated quality) that drive

25、 the cash flows, but these cash flows are financed by capital (which forms part of the companys obligations). There is an element of circularity here that highlights when financial resilience is called into question, the downward spiral can be quick and it can be severe.Cash callObligationsOperating

26、 Cash flowAssetsCash residual or burnCapitalReinvested cashFigure 1: The circularity of the assessment financial resilienceSource: UBSAnalytical errors and narrow lenses often lead to the late identification resilience issuesThe early identification of financial resilience issues is critical if an i

27、nvestor is trying to position his or her portfolio. Analytical errors can be made and lenses can be too narrow.Analysts and investors may:have too narrow a definition of the real obligations facing a business model;continue to use metrics and form views based on an “established normality” mind-set;

28、cash flow, liquidity and obligation definitions need to be broadened to consider widening downside tail risk;look to find comfort in cognitive “quick fixes” in times of uncertainty and complexity; andoften not think enough about the credit perspective equity investors must think like credit investor

29、s in a stressed scenario.Equity investors need to think more like credit investors and analysis;only the paranoid surviveThe COVID-19 outbreak is a case of event-driven financial stress. Some business models can close down almost instantly, either due to the nature of their business models or due to

30、 regulatory imposition (the UK on 23Rd March 2020 being one of many examples in recent weeks). Others will gradually be starved from a lack of cash flow. There will be some models that actually benefit from the circumstances that the business finds itself in.In scenarios of event-driven financial st

31、ress, the urgency and depth of the threat must be assessed relative to a the full spectrum and scope of the obligations (and dont just think financial here) found on the balance sheet and what can be hidden off it We will analyse cash flow through a variety of lenses:Underlying cash flowCash flow su

32、stainabilityLiquidity accessWe will also approach the analysis of a companys commitments through the broadest of lensesMore: HYPERLINK l _bookmark30 The proliferation of bias when without a base rateUnpacking the unknowable from the knowable?How do we identify the companies most (or least) resilient

33、 tothe crisis brought on by COVID-19: This is a BIG questionWe need to unpack our questions into more focused, manageable and testable hypotheses. We very much fall back onto Fermi-style questions1 . By using this1 Enrico Fermi, winner of the 1938 Nobel Prize in physics and creator of the worlds fir

34、st nuclear reactor, was famous for his ability to produce reasonable estimates based only on educated guesses of base rates the ultimate “back-of-the envelope calculation”, as it were.A typical example of a “Fermi Problem” would be: “How many piano tuners are there in Chicago?” when the only availab

35、le information is the size of the population of Chicago. Fermi would approach this problem with educated guesses about base rates for factors like the typical family size in Chicago, the percentage of families likely to possess a piano, and how many pianos a piano tuner could reasonably service in o

36、ne year.questioning technique and by unpacking the bigger questions into smaller questions, we should be better able to identify the potentially knowable from the unknowable. This allows us to bring our areas of ignorance to the surface.Knowing what it is that we dont know helps us better identify t

37、he potential flaws in our hypothesis.BIG questions need to be unpacked into small, more testable hypotheses to separate the knowable from the unknowableA few summary tips to unpack the BIG question:Triage and focus on the questions that matter;Unpack the questions into smaller, testable hypotheses;K

38、now when new evidence suggests you are wrong and recalibrate your beliefs;Force yourself to consider the arguments from the other side; andUse probabilities and drop vague verbiageWe cover these unpacking tips in more detail in our note Pricing-in the impact of COVID-19.Download: Pricing-in the impa

39、ct of COVID-19: Why are multiples where they are & where could they be?In the figure below, we attempt to unpack the questions we should be considering when trying to identify companies with financial resilience. These considerations are wide-ranging. Some of these questions can be asked at scale. T

40、he answer to many of these questions requires detailed analytical effort. In this note, we suggest a pragmatic methodology to meet in the middle of these two demands on our time.In an equity analysis context, Fermis approach can be extremely useful for reverse- engineering revenue forecasts as part

41、of a “Whats priced in?” estimation. The trick is to break price-implied aggregate revenue projections up into lower-level components for which we feel more confident making informed or even common-sense judgments regarding the plausibility of the implied base rates.Accessible cashUndrawn linesMarket

42、able securitesThe liquidity positionCash and equivalentsDistribution restrictionsRestrictions to accessNon- convertible curenciesMinimum cash balancesObligationsCommit- mentsOff-balance sheetDebt obligationsOn-balance sheetJV debtCross debt guaranteesDebt compositionDebt instrumentsHybridsHedgingUn-

43、 committedSub- ordinationMaturity structuresDebt covenantsCommit- mentsPensionsCapital commitmentGuaranteesReassessed contingencyFinancing failureAsset retirementRefinancing / Capital raiseCash flow flexibilityAsset portfolio flexibilityValue chain analysisPESTELFinancial resiliencePorters5 forcesSW

44、OTPost- retirementAsset retirementM&A earnoutsDeferred compDelever operationsFactoringDividend cutsCapex deferralWCap mgmtUndrawn liquidityCash restricted in a subsidiaryAsset diversityFinancial diversityOperational diversityFigure 2: Unpacking the COVID-19 financial resilience question:Cash flow fo

45、rmat Cash conversion rates Cash burn ratesCash runway Cash coverage DOLsMargin mixes Debt coverage Fixed coverage Gross debt metricsReturns disaggregation Impairment lookbacks True cost fixed baseCash flow analysisQuant assessmentCritical failings of EBITDAImpairments are cashCash generationAvailabl

46、e free cash flowAsset qualityA distaste for EBITDAWhich companies could be most resilient to the COVID-19 crisis?Working capital volatilitySource: UBSOur two-step methodologyA quant-driven approach allows us to triage our company identification,at scale, so we can narrow the focus of our in-depth fu

47、ndamental analysisWe have adopted a two-stage methodology to maximise the benefit of scale and analytical efficiency. We use the quant model triage a wider universe of companies to identify analytical targets with financial resilience issues or opportunities. We outline our methodology in the follow

48、ing section.1,800+stock coverageFigure 3: Our two-step methodologyQuant assessmentQuality factorsFull obligations analysisCash flow analysisFilterFundamental assessmentCash generationDebt obligationsAccessible liquidityFull commitmentCash flow flexibilitySource: UBSMore: HYPERLINK l _bookmark0 Quant

49、-driven assessmentInvestors should use our Quant model to select which companies to focus on in their deeper-dive fundamental analysis (Interactive quant factor model). The fundamental analysis is credit orientated and focused on an assessment of cash generation, liquidity access and full-spectrum c

50、ommitment analysis.More: HYPERLINK l _bookmark9 Fundamental cash-driven assessmentThe fundamental analysis requires us tobreak the spine of the annual report and dig deeper. Cognitive quick fixes will lead to the missing of issuesQuant-driven assessmentOur quant-driven screening of companies is base

51、d on previous work published by our Global Quants team. Our screening focuses on various quality factors to assess the strength of the companys balance sheet and the sustainability of its earnings. A company with stronger balance sheet and more sustainable earnings is in a better position to weather

52、 this crisis, and vice versa.More: Investing in QualityThese quality factors are also based on reported numbers obtainable from data providers such as FactSet, which allows us to scale the analysis on a large number of companies. We can then identify those companies with lower quality scores to perf

53、orm a deep-dive analysis in our 2nd stage.The quality factors used shown in HYPERLINK l _bookmark1 Figure 4.Figure 4: Quality factors used in screeningQuality factorDefinitionRationaleAccruals (Sloan definition) 1. The phrase “cash is king” never rings truer in the current market. A larger accrual m

54、eans that a higher proportion of earnings is non-cash, which could be written down if the debtors default, especially in the current environment. We scale accruals by the average total asset to mitigate the size difference between companies.Gross debt to EBITDA 2Gross debt to EDITDA measures how lon

55、g it will take the company to repay its debt. This is also often one of the metrics in debt covenants, where exceeding a certain debt/EBITDA ratio will cause the credit line to be pulled immediately.Interest coverage ratio Interest coverage ratio measures how easily a company can pay interest on its

56、 outstanding debt. A higher interest coverage ratio indicates the company is more likely to weather the current crisis given that their past earnings could easily cover interest on debt.Gearing ratio looks at how levered the company is. A higher gearing ratio indicates that the companys capital stru

57、cture is mainly debt-driven. In the current market environment, this is more risky as the company might not generate sufficient returns to meet its debt obligations. Gearing ratioCurrent ratio Current ratio measures the amount of liquid assets that are available to meet short-term liabilities. A hig

58、h current ratio would allow the company to better weather the current uncertain environment.Gross profitability . Gross profitability looks at the return on assets using gross profit, which is usually a cleaner number than EBIT or net income. A higher gross profitability means that the company might

59、 have competitive advantage, which would allow it to fare better in an economic downturn.Cash flow relative to assets (CFRA) . CFRA is an alternative calculation of return on assets by using operating cash flow instead of net income. It measures how well the company is able to generate cash relative

60、 to its size.Cash flow variabilityStandard deviation of past 10 years operating cash flowCash flow variability looks at how much operating cash flow changes in the past 10 years. A smaller variability indicates that the company is more resilient towards economic upturns and downturns, which would al