Calm before the storm? While three quarters of a year fundamentally affected by the global pandemic have passed, what interim conclusion on market reaction can be made? Q3 2020 in Switzerland was associated with a relatively stable and low number of new infected cases, which was also reflected in a recovering economic and business environment.
However, while a second wave is coming with an unprecedented speed and scale, the extent of future market detraction also depending on government’s decisions about strict measures and lockdowns remains volatile and is almost impossible to predict.
In this blog edition we present the key highlights of the most actual market developments as of Q3 2020 published in our quarterly 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
While in Q1 2020, a strong decline in trading EBITDA multiples was observed driven by the crash in the stock market, followed by a moderate increase in Q2 2020 for some of the industries, a sharp upward turn in trading EBITDA multiples can be observed for four out of six industries in Q3 2020, even boosting multiples to the record levels.
Although the LTM financials as of June 2020 considering first impacts from COVID-19 are now available and negative performance might lead to investors correcting their expectations downwards, this seems not to be the case. Instead, share prices of most of the companies have improved since Q2 2020, which can be explained by investors’ optimistic expectations of improving market conditions and financial performance after recovery. These growing expectations of companies’ improving future performance result in a higher proportion of future growth value as part of the enterprise value of a company, while the current operations value, which is mainly impacted by the pandemic, seems to be a less valued component of a company’s total value.
Chemicals, construction and materials
Driven by the decline in LTM EBITDA figures as of June 2020 and increased market capitalizations as of September 2020, the median EBITDA multiple of this industry has increased from 9.1x in Q2 2020 to 13.4x in Q3 2020, reaching the highest median multiple observed since Q1 2018 for this industry. Although the sharp increase in median multiple in Q3 2020 looks extraordinary as compared to Q2 2020, it cannot be directly compared given that in the previous quarter, multiples were based on financials as of December 2019, which did not consider any impacts from the pandemic. The multiples of prior quarters are usually presented based on the most recent financials, which were publicly available as of that respective valuation date and are not recalculated when updated figures become available.
In light of COVID-19, chemical manufacturing companies are facing slower global economic growth, supply chain disruptions and deteriorating end market demand in key industries such as automotive and construction. The general fall in demand coupled with oversupply in commodity chemicals has resulted in weaker pricing which has negatively impacted the profitability of the chemicals companies.
Industrial goods and services
Driven by the overall trend of reduced earnings and increased share prices for 65% of the companies, the median EBITDA multiple of the industry increased from 9.6x in Q2 2020 to 12.9x in Q3 2020, reaching a record level observed since Q1 2018. The negative impact of the pandemic has been profound for the industry given that not only the OEM’s faced manufacturing disruptions and breakdowns, but also their suppliers and customers faced similar issues even after lockdowns were lifted, which resulted in interruptions for the entire supply chain.
As the “new normal” is dominated by restricted site access, limitations on employee collaboration due to social distancing and other safety regulations, which clearly burdens operating performance, a lot of companies are now looking to focus on divesting non-core or under-performing business units to strengthen their balance sheets.
Retail and consumer products
Also, for the retail and consumer products, the median EBITDA multiple increased from 7.8x in Q2 2020 to 10.4x in Q3 2020 following the same trend and reaching the pre-COVID level as of Q4 2019. Although, at-home consumption of retail and consumer products has seen an uptick, discretionary spending and out-of-home consumption, which is usually associated with higher margins, has witnessed large scale downturn, resulting in lower earnings. Similarly, consumer spending at traditional stores nosedived which was partially offset by increase in online sales. The overhang of this momentous change has led to lower industry wide EBITDA margins.
Media, technology and telecommunication
The median EBITDA multiple of the industry increased from 8.5x in Q2 2020 to 9.8x in Q3 2020, also driven by lower financials. The profitability of the media industry was negatively impacted as high margin advertising revenues started to dry-up due to cancellation of sports and live events which have high footfalls. On the other hand, some technology and telecom companies were positively impacted by higher demand due to remote working and reliance on technology to conduct business and operations.
Healthcare
Opposed to trends witnessed across other industries, healthcare industry’s median EBITDA multiple has declined from 17.2x in Q2 2020 to 15.1x in Q3 2020, which was not driven economically but rather by 3 companies, whose increased multiples were considered outliers.
Energy and utilities
The median EBITDA multiple for the energy and utilities industry remained stable during the current quarter, while the LTM EBITDA figures as of June 2020 increased for 2 and decreased for the remaining companies. While demand for energy and utilities decreased on commercial, industrial and manufacturing side, however, this was largely offset by expanded demand across residential formats, comparably resulting in a certain robustness of the industry to the current crisis.
Unlevered beta
Since beginning of the year, the median unlevered betas across all industries are following an upward trend given an increased volatility in the stock market. As a component of cost of capital, increased betas lead to increased cost of capital providing an indication of higher levels of systematic risk and therefore lowering valuations (all else held equal).
Debt to total capital ratio
In Q3 2020, the median debt to total capital ratio continued the declining trend for 4 of the 6 industries, mainly driven by a positive development of market capitalizations for the majority of SMI companies. However, the underlying debt level is still based on pre-COVID 2019 financials and does not yet consider any new debt resulting from government survival packages.
Credit Spread
The European credit spreads (Barclays Europe Aggregate) continued their downward trajectory during Q3 2020 after breaching record highs in March 2020, which can be attributed to expected recovery across Continental Europe as economies lifted lockdowns and economic freeze-outs and business activity picked up again reducing risks of default.
GDP growth
Driven by industrial activity that picked-up during the past three months, GDP growth expectations were slightly corrected upwards in Q3 2020 as compared to projections in the previous quarter. However, the GDP projections for 2020 remain as before negative for Switzerland, Germany, USA, emerging markets and globally in average. For Switzerland the short-term projected GDP growth for 2020 was slightly adjusted upwards from -6.4% as of Q2 to -4.6% as of Q3 2020, while the 10-year average (geometric mean) remained almost unchanged at 2.2% due to a recovery expected in the following years.
Banking and Insurance Sector
Banking and Insurance industry witnessed contrary valuation trends during Q3 2020. While the median P/TB multiple for insurance companies increased from 0.9x in Q2 2020 to 1.0x during Q3 2020, the median P/TB multiple for the global and private banks on the other hand, decreased from 1.1x to 0.9x during the same period. The decrease in banking sector multiples was mainly due to shrinking of their market capitalization values as the sector continues to suffer from the overhang of the COVID-19 crisis.
Summary
While Q3 2020 shows some signs of recovery, the uncertainty about the direction and speed, in which the markets will develop especially considering a second wave of the pandemic, remains of the biggest challenge. Corporate finance practices must be prepared for the 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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