In a recent report Goldman Sachs Group, Inc. (NYSE:GS) noted that tighter liquidity may spell more headwinds for certain listed companies. Although short-term liquidity conditions have eased somewhat from the extreme conditions in 2H June, they expect 2H13 liquidity to tighten vs 1H due to political leaders’ higher tolerance for lower growth and desire to control risks. Against this backdrop, they believe listed sectors/firms facing potential funding shortfall or strain on working capital may be less well positioned than those with stronger balance sheets.
Industrials, Materials and Utilities More Vulnerable To Liquidity
They analyzed the 1Q13 financials of 2000+ A-share companies and found industrials, materials and utilities have the most at-risk balance sheet characteristics, and are currently more vulnerable to tighter liquidity conditions in the coming quarters. Goldman Sachs analysis is based on following metrics:
1) Ability to meet interest and short-term debt payments
Goldman Sachs Group, Inc. (NYSE:GS) look at EBITDA interest cover to indicate interest repayment risk and cash plus free cash flow divided by short term debt for debt payment capability before refinancing in the coming few quarters. They found that utilities, materials, property and industrial are the riskiest sectors from this perspective . Software and consumer staples are relatively strong in debt repayment capabilities near-term.
2) Return vs financing cost
They calculated EBITDA return on assets and compared this with estimated financing cost (interest expense divided by interest bearing debt). A higher spread means the sector could be more resilient in a macro muddle through environment where returns could be challenged and financing costs may rise. They found materials, utilities, tech hardware and capital goods are more vulnerable given their return on asset were only slightly higher than current financing cost. Energy, staples and telecom are well positioned given relatively high return on assets.
3) Working capital positioning
They calculated sectoral account receivable days, inventory turnover days and current ratios based on 1Q13 financial statements, and rank all sectors based on both their absolute level and on their z-score toward historical average. Construction, capital goods, IT and steel are the worst positioned industries in terms of working capital; and consumer sectors have better working capital structures .
Goldman Sachs Group, Inc. (NYSE:GS) also tested for financial strength on Goldman Sachs covered Chinese companies (both onshore and offshore). In addition to balance sheet checks, they calculated earnings sensitivity to potential higher financing cost (2013E) and extended the investigation to 2013E based on Goldman Sachs estimates. They observed similar results to that in the entire A-share listed universe – with materials, utilities and industrials at higher risk in the near term from tighter liquidity and /or increase in financing costs.
Although these industries are historically highly leveraged, their greater sensitivity to liquidity conditions could be particularly punitive in the current environment. Alternative energy is an especially high risk area in their view, especially as many players are not SOEs. Energy and telecom balance sheets have been deteriorating in recent years as well, but their associated funding risks should be lower given their largely central SOE status.