How to deal with corporate valuation in times of uncertainty caused by COVID-19, while the global pandemic and related investor behavior and government stimulus continues to affect the key parameters used in valuations? After a first quarter in 2020 with a strong negative impact of COVID-19 on the markets, the second quarter presents itself in a slightly new light.
In this blog edition we shed light on the most actual developments of market data as of Q2 2020 presented in our quarterly publication Valuation – Market Essentials Switzerland. The publication covers market multiples and cost of capital components per industry for the SMI companies, as well as some relevant macro-economic data used in business valuations.
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Trading Multiples Switzerland
As compared to the strong decline in trading EBITDA and EBIT multiples in Q1 2020 driven by the crash on the stock market, an upward trend in trading multiples can be observed for the four of five industries in Q2 2020. The underlying driver of this development can, to a large extent, be explained by recovery in the market capitalizations for the majority of SMI companies, which goes along with the positive trend of the benchmark indexes such as the SPI, Dow Jones, DAX, observed since end of March 2020. However, the increase in trading multiples as of Q2 2020 does not consider any impact of the crisis on the underlying EBITDA figures since the multiples are still based on latest available pre-COVID, 2019 financials for most of the companies. An exceptional development can be observed in the energy and utilities sector with an increase in median multiples in Q1 2020, mainly driven by a stronger decline in financials of one of the five companies in the cluster.
While the impact of COVID-19 on transactions in Europe was not yet clear three months ago, a decline in overall number of the European transactions can be observed now since the beginning of the year, with 170 transactions in Q1 2020 and 109 in Q2 2020 as compared to more than 270 transactions over each quarter in 2019. Also, for the median transaction volume the tendency is rather declining as compared to the previous year.
Implied yields on government bonds
While the yields on EUR and CHF government bonds (10-year) remain negative, the yields on the USD bond declined to 0.6%, reaching the record lowest level over the past 10 years. As key components of cost of capital (represented in cost of equity and cost of debt), those substantially lower values, ceteris paribus, lead to lower cost of capital if other parameters are not adjusted accordingly.
While in Q1 2020 the European credit spreads jumped to record marks over the past five years with BBB credit spread (Barclays Europe Aggregate) hitting the 2.8% mark, in Q2 2020 the credit spreads moved downwards again, approaching the 2019 levels and providing an indication for recovery. This fluctuation shows how sensitive the market prices are on corporate bonds to macro-economic changes.
Debt to total capital ratio
As compared to the increase in debt to total capital ratios in Q1 2020 driven by the crash of the stock market, the declining ratios in Q2 2020 for all industries are explained by a short-term recovery of market capitalizations for the majority of the SMI companies observed since the end of March. However, the underlying debt level is still based on pre-COVID2019 financials and does not yet consider any new debt resulting from government survival packages.
The impact of the Covid-19 crisis is profoundly reflected in the GDP growths expectations. For Switzerland the short-term projected GDP growth for 2020 was adjusted downwards from -2.6% as of Q1 to -6.4% as of Q2 2020, while the 10-year average (geometric mean) remained almost unchanged at 2.1% due to a recovery expected in the following years.
Globally, the 10-year average GDP growth was adjusted downwards from 7.0% as of Q1 2020 to 6.5% as of Q2 2020, which is to a large extent driven by the reduced growth expectations for 2020. The strongest decline in GDP for 2020 is projected for the emerging markets with double digit negative figures. And for countries such as Russia, United States, Italy, Portugal, Japan, Greece and Brazil the GDP growth forecast for 2020 as of Q2 was adjusted downwards to negative figures between -5% and -12%.
Banking and insurance sector
Insurance was the most affected sector in financial services from the impact of COVID-19 with significantly declining P/TB ratios dropping and remaining below 1x for most Swiss market participants. The share prices of private and universal banks experienced some recovery in May and June, while regional and cantonal banks showed a stronger performance and could mostly recuperate to the level of HY2 2019.
COVID-19 certainly still leaves its traces in the second quarter of the year. Nevertheless, there are some signs of a recovery after the initial market shake-up, although still based on the pre-COVID financials of public comparable companies. What remains, however, is the uncertainty about the direction and speed in which the markets will develop. Corporate finance practices must be prepared for the potentially diverse (recovery) scenarios, multiple valuation methods or more advanced statistical modeling that may arise out of the volatile waters we are sailing through.
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