#financialarmageddon

Coronavirus will end up killing way more jobs than the people in them

GDANSK, POLAND - SEPTEMBER 3, 2018: Norwegian Air Shuttle airlines offers cheap flights. Airplane Boeing 737-800 takes off on from the International Lech Walesa Airport in Gdansk.; Shutterstock ID 1176630295; Purchase Order: -

None of this should be a surprise. 7,300 (out of 11,000) workers at Norwegian Air have been temporarily laid off as 85% of flights are cancelled.

This follows on from Scandinavian Airline Systems (SAS) which has temporarily suspended 10,000 workers and cut 90% of flights to combat coronavirus.

In short, Coronavirus will likely kill way more jobs than the people in them. Sadly, there isn’t a robust economic cycle to be able to weather this storm.

Note that Boeing shares fell 20% overnight as markets finally come to grips with what we mentioned yesterday. Boeing was also put on credit watch negative by Fitch. GE is back at $6.

And Trump’s S&P500 index reading was 2,264 when he took office. It is at 2,474 or 9.3% above that. We always said what he proudly attributed to his leadership on the way up could end up making him hoisted by his own petard on the way down.

Buy Gold, not toilet paper.

Boeing’s negative equity & prospect of zombie lending

We should have seen this earlier. One sign of trouble in industrial businesses can be seen through the lens of the cash conversion cycle (CCC). A CCC that is positive essentially means that payables are being executed way before receivables are being banked. Rising CCC is never a good thing. Amazon is at the other end of the spectrum with negative CCC which means they receive payment before delivery.

Note Boeing has seen its CCC blow out from around 124 days in Dec-2010 quarter to 344 days in Dec-2019. Effectively Boeing is sucking up a year of net receivables before collecting them. What escaped us is that the company is trading in negative equity at present and it will be a hard balancing act to let such CCC get much larger to a group that is so under the fiscal pump.

We recall the difficulties the supply chain had under the delayed 787 program in the early 2000s. Parts suppliers were bleeding because they’d invested and prepared for an expected ramp-up that ended up arriving 3.5yrs later than anticipated. All that high fixed capital formation and inventory that needed to be paid for by a client that couldn’t take delivery. Boeing tried to muddle through but was ultimately forced to rescue suppliers to keep them alive after some faced the brink. Boeing bought some suppliers in house.

One imagines the 737MAX delays will exacerbate the CCC again although Boeing contends it is in cash conservation mode. Coronavirus can only add to the misery of airlines reluctant to add to fleets where capacity is being slashed aggressively. Just look at the self-isolation bans being put in place in recent days. Who wants to holiday abroad if told they’ll spend two weeks in their hotel room feasting on room service? Airlines get the efficiency of new aircraft helping operating performance but at the same time running any planes at 20% capacity won’t help.

This is only going to get worse. For all of the pain of a much higher unit volume plane yet to be approved for flight, Boeing cash flows are being tortured. It is incredible that the shares had held on so well during the MAX crisis.

It is interesting to note that Boeing is trading in a state of negative equity. Liabilities are greater than assets. Where is the press on reporting this? It is hardly trivial for a business that hasn’t even faced the worst of its struggles.

Just like we wrote two years ago about GE, Boeing went straight down the line of monster share buybacks. $43bn to be exact since 2013. Over half of the buyback has been conducted at share prices above the current level. The goodwill and intangibles on Boeing’s balance sheet total $11.398bn. Equity at minus $8.3bn. So negative $20bn.

bA

We did the following infographic some 3 years ago but the trend has deteriorated further. As we can see AAA-rated (top) stocks in the US have dwindled while BBB+ and below has surged. It is estimated that over 50% of US corporates have a rating below BBB. That is the result of artificially low-interest rates which have lured companies to borrow big and splurge on buybacks. Our biggest worry is if the market starts to reprice corporate debt accordingly, such as what happened to Ford when it was dropped to junk.

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So the question remains how does Boeing manage to get out of this pickle? Even if MAX gets certified, airline cash flow is being crippled. How big will discounts need to be in order for airlines to take on new planes? At the moment one imagines many airlines are deferring deliveries (787, 777 etc) until they get a clearer picture.

Boeing has delivered 30 aircraft in the first two months of 2020. At the same time last year, Boeing had delivered 95 planes. A lot of MAX impact but we imagine March will be even worse.

Airbus delivered 86 aircraft so far in 2020. At the same time last year, Airbus delivered 88 planes.

Think of the major gateway that is Hong Kong International Airport. It’s passenger flow for February 2020 – minus 68%! 6 months of this type of crippling volume would be catastrophic for airlines. 9-11 was a watershed moment for the aviation industry where the confidence to get back on a plane turned quickly after the terror attacks. Now we have a situation where passengers would be more than willing to fly again but governments simply aren’t letting them. The problem is whether they will be in the same financial position to fly if the virus isn’t contained rapidly

One sweet spot for Boeing is that it is a major defence contractor which means that government bailouts are a given. Sadly, shareholders shouldn’t think this current share price collapse has finished. Boeing feels a lot like mimicking GE when it sunk to $6 from over $30.

It is probably worth referencing AerCap Holdings which owns International Lease Finance Corporation (ILFC) one of the big two commercial aircraft leasing companies. Its share price has cratered from a high of $64.79 to $24.50. Moody’s affirmed the “Baa3” ILFC this month.


AerCap

The company has 3.1x leverage. $36bn of property (mostly planes) on its books. The shares are trading at 0.35x tangible book value presumably because the market is forecasting the value of the tin is going to fall through the floor if leased planes return from airlines that have been forced to cut costs or go bankrupt.

The only crux is the future appetite of investors to support AerCap in the debt markets. It has $17.5bn in unsecured notes and $9.8bn in secured debt with a further $2.3bn in subordinated, mostly via a 2079 maturity bond issue. The maturity profile is still comfortably beyond 2028. No problems just yet but times are only just starting to get challenging.

Of note, AerCap is paying $1.295bn in interest charges on $29.5bn of debt. Leasing rents from its airline customers total $4.281bn. It all comes down to the assumption that its multiple airline customers can keep honouring those payments or whether the leasing companies are forced to renegotiate their deals in order to keep the customer alive. The last thing a leasing company needs is a flood of aircraft to return because customers go belly up. Fingers crossed there is no zombie lending to avoid having to mark-to-market the value of the fleet (assets) which would flip the ratings and refinancing prospects considerably. The balance sheet would be slammed.

With so many financial excesses built into the global economy, a prolonged spell of coronavirus containment will come at the expense of a crippling economic armageddon which will undo so much of the disastrous can-kicking we’ve become accustomed to. You can’t quarantine the world for 6 months and expect a tiny ripple.

CLies IT

It is not the disease we need to worry about per se. It is government and central bank incompetence over the last 20 years which has created a situation where we are out of ammunition to rescue the situation because expediency is so much easier for voters – comforting lies are easier to take than inconvenient truths.

Be sure to reference our thoughts on

Aussie banks,

Aussie government debt,

central banks and the

pension crisis ahead.

Chapter 11 bankruptcy filing trends in the US surging

Chap 11.png

The Chapter 11 bankruptcy trends in the US have been picking up in the last 4 years. While well off the highs of the months and years of the GFC and years following it, the absolute numbers of filings has exceeded the levels leading up to the crisis in 2007/8.

Chap 11 by year.png

Here we put 2006/7/8 alongside 2016/17/18. The average monthly bankruptcy filings were around 355 in 2006 moving to 429 in 2007 and then 718 in 2008. If we looked at the data in the 12 months prior to the quarter leading into Lehman’s collapse, bankruptcies averaged 463/month. The ultimate carnage peaked out at 1,049 in 2009 (1,377 in Apr 2009). For 2016, 2017 and 2018 (annualized) we get 454, 480 and 521 respectively.

Chap 11 Comp.png

Bankruptcy filings tend to be seasonal and often show peaks in April when tax season coincides with businesses.

However the %-age spike in bankruptcies in 2008 ahead of Lehman’s downfall was 46%. In the latest recorded month from the American Bankruptcy Institute (ABI) was 81%. This March 2018 spike is the second highest since the GFC hit. April figures will be interesting if we get another lift on that figure. Not even seasonality can explain away the differences. The trends seem clear.

Thinking logically, we are at the end of the generous credit cycle. Interest rates are heading north thanks to a less accommodating Fed. Naturally ‘weaker’ companies will have more trouble in refinancing under such environments. The lowering of corporate taxes would seem to be a boon, but with loss making businesses it becomes harder to exercise tax loss carry forwards.

We’ve already started to see GFC levels of credit card delinquency at the sub-prime end of town. Sub-prime auto loan makers seeking bankruptcy protection have surged too.

Fitch, which rates auto-loan ABS said the 60+ day delinquency rate of subprime auto loans has now risen to 5.8%, up from 5.2% a year ago, and up from 3.8% in February 2014 to the highest rate since Oct 1996, exceeding even GFC levels.

growing number of car loans in the US are being pushed further down the repayment line as much as 84 months. In the new car market the percentage of 73-84-month loans is 33.8%, triple the level of 2009. Even 10% of 2010 model year bangers are being bought on 84 month term loans. The US ended 2016 with c.$1.2 trillion in outstanding auto loan debt, up 9%YoY and 13% above the pre-crisis peak in 2005.

The irony here is that sub-prime auto loan makers expanded lending because new technology allowed these companies to to remotely shut down and repossess vehicles of owners who were late on payments. That game only lasts so long before it forms its own Ponzi scheme.

Throw skittish financial markets, geopolitical instability and the mother of all refinancings coming the US Treasury’s way it is not to hard to see bankruptcies pick up from here.

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