Investors in the European stock market, on alert due to the increase in tension in the balance sheets

Investors in the European stock market, on alert due to the increase in tension in the balance sheets

Securities experts have a message for corporate CFOs, and it’s becoming more urgent: Strengthen your balance sheets before the recession hits.

After more than a decade of ultra-loose monetary policy, financing conditions are tightening, inflation is rising and the global economy looks poised to slide into its first recession since 2009.

Highly indebted companies could run into trouble as their interest payments rise and earnings growth slows, say fund managers, who are already ditching debt-laden companies.

S&P Global believes that global credit conditions are at a turning point and anticipates an increase in credit stress in late 2022 or early 2023.

According to S&P, rating downgrades are set to increase and global corporate defaults are expected to double by mid-2023 from current historically low levels. Europe, which is dealing with an energy crisis and a war on its borders, will suffer the biggest setback in credit quality.

“There seems to be a change in attitude about more indebted stocks,” said Gilles Guibout, head of European equity strategies at AXA Investment Managers in Paris.

“This is pushing investors towards companies that will not be affected by the rising cost of debt. And the pressure on executives (of indebted companies) is mounting,” he added.

Bank of America’s most recent survey of fund managers shows that 60% of investors want executives to use cash flow to improve balance sheets rather than increase investments or dividends, about the same percentage as during the COVID-19 crisis and the global financial crisis.

“The time has come to save something for the rainy days,” says Giuliano Gasparet, head of equities at Generali Insurance Asset Management in Milan. “I would not be surprised if, in future polls, this percentage increases even more.”

The importance of a strong balance sheet has been reflected this month in a series of wild swings in share prices.

SBB, for example, soared 46% in two days as falling bond yields offered the property company, the subject of numerous short or sell positions, some relief on refinancing.

The real estate market is the European sector that has performed the worst this year, with a drop of 40%. Investors fear the highly leveraged sector could suffer restructuring and dividend cuts. SBB shares have fallen almost 75% this year.

The thing does not end there. In Europe, Citi sees power and industrial companies at the center of the deal and estimates that rising financing costs could reduce net profits of non-financial companies by 2%. He estimates that 15% of the STOXX 600’s debt is at floating rates, nearly double that of the S&P 500.

Analysts and investors have cited companies such as IT consultancy ATOS, food company Delivery Hero, energy company Enel, auto parts maker Faurecia, pharmaceutical group Grifols, beverage maker Campari and telephone company Telefónica as companies who could face rising interest costs.

Debt-laden stocks have already lagged considerably on the stock market this year and fund managers, concerned about credit stress, have trimmed their exposure.

Citi’s basket of highly leveraged European equities is down 33% this year.

However, some companies may have been punished excessively, even though their cash flow and debt maturity profile give them enough room to pay what they owe.

Samuel Edwards
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