BY NEIL UNMACK

The pandemic has saddled companies in most of the world with debts. Big enterprises with reserves and access to capital now look like they can ride it out. Smaller outfits are at much greater risk of default.

Looking at the bond market, the coronavirus crisis was a short-lived affair. Lockdowns caused company revenue to collapse and debt levels to shoot up. The average leverage of U.S. junk-rated companies in the leisure sector, for example, doubled to around 12 times EBITDA in the six months to June, according to ING. Around that same time Moody’s Investors Service reckoned default rates globally could, in a pessimistic scenario, hit 16% in the coming year.

Some defaults came, including U.S. retailers Neiman Marcus and J.C. Penney. CreditSights analysts put the U.S. 12-month default rate in November at just over 7%. But the crunch eased thanks to bailouts, reopening economies, and companies raising fresh debt and equity. Federal Reserve Chair Jerome Powell and other central bankers slashed rates to zero and snapped up bonds, forcing investors to pile into riskier debt just to earn a return above inflation. The year 2020 has seen the second-biggest flow of funds into junk debt on record, Deutsche Bank analysts reckon. Their peers at Citigroup expect the U.S. high-yield default rate to fall back to just 3.4% in 2021, below 2019’s roughly 4% level, according to Moody’s.

Away from big-ticket capital markets, things are less rosy. Smaller companies typically have less diverse revenue and rely on banks for finance rather than bond investors. Even as high-yield borrowers pay less in interest, the proportion of U.S. banks tightening credit standards is near its highest level since 2009, according to the Federal Reserve Senior Loan Officer survey. Around a tenth of small and medium-sized companies across Europe may collapse in the next six months, McKinsey said in a November report.

Governments have helped by granting companies tax relief and guaranteeing debt. But in the UK, for instance, as much as 23 billion pounds of a potential 74 billion pounds of state-backed debt may be unsustainable, according to a report by CityUK.

The small-company crisis matters. Bigger, more financially robust groups may simply crowd out struggling competitors. Starbucks, for example, is among other moves raising wages, potentially making life even tougher for rival local coffee shops. To avoid continuing attrition, governments may need to extend cheap debt programs for longer or even forgive loans. Another option might be offering tax breaks to spur investment. With government debt also ballooning, that may require tough fiscal choices in 2021 and beyond.

First published December 2020

BY ED CROPLEY

Africa Rising may fast become Africa Uprising. After a decade of debt-fuelled growth, the poorest continent always risked a difficult moment of reckoning. Depressed commodity prices and more circumspect foreign lenders will mean tighter budgets and unhappier citizens from Angola to Zimbabwe in the coming year. That’s a recipe for political instability, conflict and migration.

Even before Covid-19, warning lights were flashing. In 2019, Sudanese telecoms tycoon Mo Ibrahim’s eponymous Index of African Governance turned negative for the first time in its 10-year history. South Africa, the most developed economy south of the Sahara, kicked off 2020 by slipping into recession. When the pandemic struck, social, economic and political cracks papered over by years of cheap credit and bountiful mining receipts were torn open: soldiers seized power in Mali, Zambia defaulted on its obligations, and ethnic civil war broke out in Ethiopia.

With global banks like Morgan Stanley predicting only marginal increases in world oil prices, to around $55 by next December, there’s little external respite in store for crude producers like Nigeria and Angola, which rely on hydrocarbons for three-quarters or more of government revenue. Nor can struggling citizens expect much sympathy from the state. Dozens of Nigerians were killed in October in a crackdown on protests against police brutality.

Finance, too, will be harder to come by. Even though rock-bottom rich-country interest rates should bolster debt sales by high-yielding frontier sovereigns, Zambia’s default will have made many investors reassess the continent’s credit metrics. They’re not reassuring.

From 2011 to 2019, sub-Saharan Africa’s outstanding debt nearly doubled to $625 billion, according to the World Bank, going from 23% of the region’s GDP to 38%. Meanwhile China, which has lent an estimated $150 billion since 2000, will temper its largesse as it shifts from Belt and Road-based lending. Countries like Ethiopia, Angola and Kenya running into repayment difficulties will only accelerate Beijing’s pivot.

Even the sticking plaster of charity will be in short supply. Britain is cutting its generous overseas aid budget to save money on the home front. And developed nations bulk-buying Covid-19 vaccine for their own citizens means 1.2 billion Africans will be relegated to the back of the inoculation queue. Suddenly, Africa Rising looks a very long way off.

First published December 2020

BY AIMEE DONNELLAN

Sprucing up a run-down property is a quick way to add value. That’s what landlords are banking on in 2021, as Amazon.com buys defunct malls and offices become flats. It could boost valuations in the $33 trillion global commercial property market. Even so, assets will still be worth less than five years ago.

Demand for office space has plummeted to a record low, according to London’s Great Portland Estates. The landlord’s stock declined 25% since the beginning of 2020 as companies from Twitter to BP and PwC embrace a future where working from home is the norm. Shopping malls are in a worse predicament. Retail titans like Arcadia, owner of Britain’s Topshop, and J.C. Penney in the United States have collapsed amid the pandemic. The e-commerce boom that has eviscerated the high street is only likely to intensify – Moody’s reckons the proportion of online sales will leap to 25% by 2025 from around 15%.

Luckily, Amazon is crying out for warehouse space. The $1.6 trillion retail giant could aim for 50% of U.S. online sales in 2021, according to investment bank Needham. Refurbishment costs are minimal as shopping malls have enough headspace to accommodate delivery trucks.

Landlords will still get burned, though. Five years ago, the typical yield on UK shopping malls was 4%. Asset value slumps in 2020 mean this is now more like 7%, according to estate agent Savills. For a building with 1 million pounds of annual rent this sort of yield shift is the difference between a property being worth 25 million pounds and 14 million pounds – a 44% drop. Prevailing yields on warehouses are 6.5% – not enough to get values back where they were.

Repurposing offices is also tricky. Turning BP’s recently flogged headquarters in central London into posh apartments is an obvious move. But a shortage of affordable housing means councils may not grant planning permission for luxury flat conversions. Cheap apartments may attract as little as 2 pounds a square foot in rent, according to Knight Frank – a far cry from the 100 pounds a square foot level for top-tier offices. Real estate kings should prepare for lasting scars.

First published December 2020

BY ANNA SZYMANSKI

Latin America’s luck will change. Pandemic lockdowns caused more regional corporations to default between early May and June. But yield-starved investors will ignore some of these risks.

There’s a lot of bad news to ignore. The International Monetary Fund expects Latin American and Caribbean economies to contract by more than 8% in 2020, the most of any region, with only a 3.6% improvement in 2021. And non-financial companies with foreign debt have seen revenue dented by a combined $200 billion due to the pandemic, Fitch Ratings estimates. The credit ratings company expects sales to rebound by less than half that amount in 2021.

But there are green shoots. The largest economies regained some lost ground in the third quarter. U.S. appetite for manufactured products helped Mexico report seasonally adjusted quarter-on-quarter growth of 12%, and local stimulus contributed to record-breaking expansion of almost 8% in Brazil, led by President Jair Bolsonaro.

More fiscal stimulus in developed countries, especially spending on infrastructure, could further boost commodity prices. That would be good for some of the region’s largest companies by revenue, including Petrobras, Pemex and Vale. Meanwhile, regional companies’ cash piles have grown to around 2.4 times short-term debt in 2020 from less than 2 times in 2019, Moody’s Investors Service calculates. And with a few exceptions, most companies no longer have significant mismatches between dollar debt and dollar revenues.

Country-specific risks remain. For example, Chile is getting a new constitution, and Peru saw two presidents leave office within a week in November. Also, around half of the region’s countries are on Fitch Ratings’ negative watch list for credit ratings downgrades. That will weigh on corporates with close links to states, like Colombia’s Ecopetrol.

But the returns on offer in the region may be too alluring for investors to pass up given low U.S. and European yields. The yield gap between Latin American corporate bonds and U.S. government debt has fallen by almost three-fifths since March, to around 370 basis points by mid-December, according to an ICE Bank of America index. Even so, average spreads remain among the widest in emerging markets. That sort of reward may be enough for investors to take on the risks.

First published December 2020

BY PETE SWEENEY

China’s speedy recovery from the pandemic will get harder for the world to take in 2021. Rapid containment of Covid-19 after it emerged in Wuhan let President Xi Jinping restart factories quickly, helping companies seize record export market share. With the renminbi strong, a resurgence of overseas M&A will come next. Struggling governments, especially in the developing world, will find China’s cash difficult to resist.

It’s unsurprising that China has outperformed. First into recession, draconian measures helped the country leap out first too. But even as it sealed off the viral epicentre in Hubei, flights from China kept landing in overseas airports, helping to set off a pandemic that will have shrunk the global economy by 5% in 2020.

That’s why Europeans and Americans may find China’s recent trade performance galling. By July, China’s share of global exports reached a record 14%, a share not enjoyed by any country since the United States in 1981. Exports by value expanded 3% year-on-year that month to $158 billion, even as rich-country exports shrank 7%. In short, overseas demand did far more to support China’s recovery than the other way around.

The deficit spike is due in part to China’s dominance of medical equipment, and frozen offshore tourism, both of which will revert. Even so, Chinese manufacturers are exploiting the discombobulation of foreign rivals. Zoomlion, a rival to Caterpillar, boasted in its first-half earnings report that it finally managed to break the “long-term monopoly” of Western competitors in Malaysia.

There might be another irritant in the offing. The yuan rallied over 6% against the dollar in 2020, positioning China Inc to restart overseas dealmaking, which dropped after foreign governments began blocking transactions and Beijing grew concerned about overstretched balance sheets.

The currency’s newfound strength has Beijing encouraging outward investment to offset speculative inflows. While diplomatic tensions may keep barriers up in Western markets, poorer nations like Turkey, where the yuan had appreciated 29% against the lira by mid-December, may be happy to let Chinese buyers save struggling local employers. State-owned giants are already snapping up assets in Latin America.

For politicians who were trying to contain China before Covid-19 wrecked their economies, watching it snap up distressed assets may be a bitter pill to swallow. They might have to choke it down anyway.

First published December 2020

BY SHARON LAM

Online education is about to get an economics lesson. Covid-19 lockdowns rang the bell worldwide for virtual-school financiers, who ploughed money into the burgeoning business from the United States to China. Stragglers should start getting weeded out in 2021.

Kids crammed into video-powered classrooms and supplementary instruction sessions as the pandemic shuttered schools for long stretches. That roused fresh interest in the technological side of education, which in 2019 accounted for only about 2.5% of the $6 trillion invested by schools worldwide, according to Citigroup research. All the fresh interest should help that figure more than double to about $360 billion by 2024.

The math is working for established companies. Pearson, for example, experienced 14% year-on-year growth in its online division in the first nine months of 2020. Koolearn Technology said K-12 enrollments increased by nearly 225% to about 1.9 million for the financial year ended in May. Tutoring apps also attracted fresh funding that quickly inflated valuations. Capital injections put Byju’s in India at about $12 billion and China’s Yuanfudao at $16 billion, according to media reports.

Enthusiasm for educational technology has been so strong, in fact, that stocks such as GSX Techedu’s have overcome short-selling attacks alleging fraud. The exuberance is bound to wane, however, as students suffer screen fatigue and return to school in person. Investors and parents are also likely to be more discerning, intensifying competition. Chinese online teaching companies robustly grew revenue a few years ago while scaling back their sales and marketing expenses, according to CLSA analysts. The price of growth is now quickly on the rise, even if operating profit margins should eventually outpace offline peers saddled with rent and other fixed costs.

The sector’s sprawl also should lead to some consolidation straight out of the financial textbook. Deep-pocketed Alibaba might use its DingTalk app as the basis for expansion. Dutch technology titan Prosus also is emphasising education. Alphabet’s Google, whose operating system runs on many students’ Chromebook laptops, could graduate to other parts of the online teaching market. There can be little doubt that virtual education is here to stay in some capacity, but 2021 will determine which providers are best in class.

First published December 2020