Investors seem reconciled to the financial warnings in high-risk sectors.
Photo: timothy a. clary/Agence France-Presse/Getty ImagesInvestors should brace for a wave of ominous-sounding liquidity warnings in companies’ financial results. They may also learn to love them.
The scale of the current health crisis will make “going concern” notices—which detail the important uncertainties in a company’s future—a much more widespread feature of corporate reporting this year, according to regulators and accounting experts.
When preparing their numbers, companies need to believe, and satisfy auditors, that their business has the resources to operate for the next 12 months. If they have significant doubts, financial statements must include a warning.
Under normal circumstances, the directors of a solvent, successful company can make a simple case. Right now, however, there is a lot of guesswork. The often-unanswerable questions include: when will employees return; can facilities operate safely; will suppliers deliver; when will customers come back; and how likely are additional virus outbreaks or lockdowns. The situation is highly unusual and fast-changing, says Gilly Lord of accountants PwC.
This liquidity analysis is being rigorously applied during the current economic shutdowns. That contrasts sharply with some other requirements that regulators have relaxed. Loan holidays don’t need to count as a default event and annual bank stress tests have been canceled, for example.
Officials and auditors have allowed companies more time to do the work, though. Nearly 16% of U.S. public companies reporting in the first five months of the year had a going concern modification, according to data provider Audit Analytics. That was in line with the same period last year, but fewer companies reported—presumably those with fewer problems to grapple with. Experts expect the numbers to rise significantly.
Investors already seem reconciled to the warnings in high-risk sectors. When Cineworld, which owns U.S. movie theater chain Regal, included a going concern notice in its fourth-quarter results in March, its shares fell by 75% the following week. When its main U.S. competitor AMC put a warning in its first-quarter results last week, the stock fell less than 3%.
These warnings also can have business implications such as breaching a loan covenant or triggering a credit-rating downgrade. It helps, however, that many companies will be in the same situation. Regulators have also cautioned that these warnings are to be expected in the circumstances, in the hope that markets won’t overreact.
Investors can try to anticipate and avoid such potholes where possible. Yet they should also welcome the transparency provided by the warnings. Today’s business uncertainties make a clear view of estimates and key judgments increasingly important, says Stephen Griggs of accountants Deloitte. The exercise also forces management to undertake rigorous scenario analysis and think through how things might go wrong.
Liquidity warnings sound bad, but breezy optimism and an information vacuum would be much scarier for investors in the current circumstances.
Write to Rochelle Toplensky at rochelle.toplensky@wsj.com
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