The CoronaCrisis: Australia’s Economic and Financial Health

By: Lucinda Chen, Victor Yan and Anton Mifsud

Contents:

1. A Global Overview

2. Impact on the Australian Economy

3. A Dissection of Business Characteristics

4. Conclusion

1. A Global Overview

The rapid spread of COVID-19 has developed into a crisis of enormous proportions, causing disruptions in financial markets and halting economic activity across the world. Beyond the humanitarian fallout of the pandemic, the economic damage is projected to be equally severe with strong expectations of a global recession. With economic contractions generally occurring gradually and thus providing policymakers with time to adjust accordingly, the coronavirus threat has effectively forced governments across the world to pause activity through lockdowns and social distancing measures. This has been clear through the effective shut-down of the global discretionary services industry, and disruptions to the manufactured goods supply chain.

The unprecedented shock of the pandemic has also generated high levels of financial stress in capital markets, triggering responses from central banks across the world. For instance, last month, the Reserve Bank of Australia made an emergency rate cut to a record low of 0.25 per cent and embarked on an “unlimited” bond buying programme alongside a range of other efforts to soften the blow of the pandemic’s impacts (read more on QE by Sam T. in our previous UNIT article, here). Following the first crash in the week ending February 28 that halted the longest-lasting equity bull market on record, markets across the world continue to display high volatility, which has been exacerbated by the Saudi Arabia – Russia oil conflict. Since February 20, the ASX has fallen more than 25%, down $450 billion, with other markets across the world experiencing similar downward trends. Markets continue to face the challenge of navigating the virus’ unknowns, and all eyes continue to be glued to the latest health-statistics and financial figures.

Source: Professor Aswath Damodaran, NYU Stern School of Business

2. Impact on the Australian Economy

When examining market turmoil, we isolate Australia as one of the worst performers among its global counterparts (as evident in the prior table). Thus, despite almost 30 years of uninterrupted growth, minutes from the Reserve Bank of Australia’s March 2020 meeting suggest a very material contraction in growth is likely for the Australian economy. Naturally, predictions regarding the depth and duration of this downturn are largely dependent on how long shutdown measures remain and policy response to the fallout of the virus.

In actuality, the Australian economy was slowing even prior to the recent bushfires and emergence of coronavirus. However, constraints on physical activity, along with the uncertainty both businesses and consumers face today, create major challenges ahead. The damage from efforts to contain the virus continues to pile, with industry shutdowns and store closures costing jobs across the nation and weighing down on growth prospects. With the impacts of coronavirus emerging from the beginning of the year, this highlights how major industries such as hospitality, retail and travel are dangerously exposed to limits on movement and social distancing. Conversely, the crisis also draws attention to the major supply-chain vulnerabilities the demand-risks of panic-buying has caused.

Looking more broadly, Australia’s largest trading partner China accounts for nearly a third of all exports, making Australia relatively more exposed to a slowdown in the Chinese economy. Education and tourism, until six weeks ago, were among Australia’s biggest export-earners after iron and coal. However, with tourists and students from China making up about 16% of visitors to Australia annually and bringing in $12 billion in spending, travel bans have heavily disrupted these industries.

The current economic outlook for Australia is relatively grim, with business confidence falling 9.1% to a record low of 95.1 in March, and consumer confidence dropping to its lowest level since Australia’s last recession in 1990/91. These falls in confidence, along with lower income due to unemployment, translates to lower investment and consumer spending across the board.

Source: Australian Bureau of Statistics

3. A Dissection of Business Characteristics

Distilling from a macroeconomic view of Australia to the individual business, it only takes a short walk out on the streets to witness the debilitating impacts on the firms that make up Australia’s economy – from closed signs to empty streets to long queues at the local Centrelink. The most recent ABS survey report suggests around 49% of Australian businesses to have been adversely impacts by the virus over the past 2 weeks, with an expected 86% of all businesses to be impacted in future months:

Source: Australian Bureau of Statistics

While the coronavirus hasn’t discriminated its journey across nations, further analysis reveals some business characteristics that can lead certain firms to be hit harder than others:

1. Travelling Links

With containment initiatives towards the spread of the silent killer, nation-wide travel bans have been declared in and out of Australia, as well as severe travel restrictions within the country’s borders. Combined with general cooperation by the public to stay indoors as a way to minimise infection-risk, it isn’t hard to see how businesses with revenue models leveraged on travelling-links face a particularly hard road ahead.

For example, those in the tourism industry are expected to have revenue decline by an average of 10.1% in 2019-2020 due to the virus impacts. Rubbing more salt into the wound, further travel restrictions are not out of the question depending on how the virus spreads over the coming months.

2. Discretionary Products

With consumers sheltering away from the global pandemic, we have seen an abundance of hysteria driven bulk-buying from local supermarkets, notably towards frozen food, hand sanitise and toilet paper. The common denominator here is that these items classify as staple “essential” products – providing short term revenue boosts to the Woolworths and Coles of the world.

Conversely, businesses selling “want but don’t need” discretionary products are negatively impacted by lower consumer sentiment during these pandemic times, as people uncertain of whether or not they can return to their pre-virus normalised income are likely to delay purchasing the next line of Gucci handbags and Supreme t-shirts.

3. Cash Flow Profiles

In this pandemic world, the adage that “cash is king” takes centre stage, as companies look to “bunker down” with enough cash flow to survive the storm. For young start-up businesses with a high degree of cash burn, lower investment sentiment within capital markets can strip these firms from the very monetary life blood needed to keep the shop alive and breathing.

4. People or Technology Intensive

With governmental instruction for social-distancing and quarantine practices, there comes a structural divide between businesses that are able to transition operations onto the online world and businesses that lack that flexibility.
This can be easily witnessed through the cancellation of all major sports leagues, as the entertainment spectacle of these high contact sports are unable to be substituted by technological alternatives. In contrast, operational cash flows are still able to be partially recouped by organisations such as Australian universities that have transitioned online towards a viable “work from home” business model.

5. Net Debt Load

Since the post-GFC crisis, business leveraging has grown to historically high proportions due to cheap available debt facilitated by low interest rate environments. While this has been a vehicle for fast business growth, firms exercising prudence towards a “Goldilocks-medium” in debt financing are seeing a brighter light at the end of the tunnel relative to their counterparts that have over-leveraged.

After all, cheap money does not mean free money, as businesses facing outstanding interest payments with reduced operational cash flows due to the depressed demand may struggle to meet their debt obligations and are vulnerable to higher distress risks. This situation is made all the more complex due to the tightening of credit markets, such that these businesses struggle to borrow future debt more to pay back their current debt. However, we have seen federal measures such as debt relief and moratorium on loan payments for small businesses in an effort to relieve these financial pressures.

6. High Fixed Costs

With low demand and less purchasing activity, most businesses are expected to see a hit towards their revenue line. However, depending on the businesses’ cost structure, those with higher fixed costs may find it more difficult to “scale down” costs in an effort to minimise bottom-line profitability damage.

One industry notorious for its high fixed costs is the airline industry. In addition to travel ban effects, airline companies are subject to a double whammy since around 2/3rds of their total costs are “fixed” (eg. purchase of aircraft, equipment and facilities). As seen from the news, such cost pressures inflicted have led to unfortunate cost-cutting measures such as Qantas’ laying off of 20,000 staff.

Source: Professor Aswath Damodaran, NYU Stern School of Business

4. Conclusion

The coronavirus brings a unique and threatening crisis, as economic contagion seems to be spreading as fast as the virus itself. While it is difficult to know when restrictions in place will be eased, the devastating impact on economies across the world and for Australia in particular – which now faces its first recession in 30 years – is already evident. Such effects are clear when looking closer at specific business structures, with some firms clearly more vulnerable to the fallout of the pandemic.

Given the even greater economic destruction an escalation in COVID-19 cases would have, it seems for now, the best thing we as individuals can do is sit and wait – abiding by social distancing measures in order to continue flattening the curve.

Sources

• https://www.abc.net.au/news/2020-03-19/qantas-to-stand-down-two-thirds-of-employees-due-to-coronavirus/12069876
• https://www.afr.com/policy/economy/how-to-defuse-the-virus-debt-bomb-20200406-p54he5
• https://www.afr.com/policy/economy/shutdown-could-slash-22pc-off-economic-growth-20200331-p54fhy
• https://www.afr.com/policy/economy/the-big-state-is-back-20200331-p54fkv
• https://aswathdamodaran.blogspot.com/2020/03/a-viral-market-meltdown-iii-pricing-or.html
• https://www.goldmansachs.com/insights/pages/roaring-into-recession.html
• https://hbr.org/2020/03/understanding-the-economic-shock-of-coronavirus
• http://www.roymorgan.com/findings/8340-anz-roy-morgan-consumer-confidence-march-24-2020-202003232236
• https://www.theguardian.com/world/2020/mar/13/australian-schools-and–universities-preparing-for-shutdowns-over-coronavirus

Disclaimer: The views expressed in this article are solely that of the author’s, and do not necessarily reflect the position of UNIT nor the University of Melbourne. Transacting off this information is done so at one’s own risk, and individuals are encouraged to consult a  professional before making investment decisions based off of this article.