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A long, growing list of Australian companies have raised equity capital during the Coronavirus (COVID-19) pandemic. Most commentary on these offers typically focuses on whether eligible shareholders should subscribe, rather than the company’s long-term prospects.
Emergency capital raisings can provide short-term gains for eligible active investors who trade stock bought in a heavily discounted offer. Such offers can also weigh on a company’s long-term Return on Equity (ROE), dilute small shareholders and destroy value.
The trick is finding high-quality companies that raise capital during market shocks to grow, rather than backing those needing funds to survive. A heavily oversubscribed capital raising can be a good sign as it shows investor confidence and removes funding risks for the company.
High oversubscription can also suggest the board panicked and approved new capital offered at an excessive discount. Institutional investors piled into the stock because of the discount size and also because of the risk of higher ownership dilution if they did not.
I have assessed several companies that have completed or are in the final stages of raising capital from eligible shareholders during COVID-19. Here are three to watch:
The receivables-management company raised $120 million at $12.50 a share through a placement in April and announced in May a Share Purchase Plan (SPP) for eligible retail shareholders of up to $30 million. Credit Corp trades at $15.43
The capital raising was mostly about enabling Credit Corp to buy more distressed-debt ledgers and increase its market share, rather than repairing its balance sheet. Credit Corp came into COVID-19 with a healthy balance sheet and has been a quality company for a long time.
Like other listed debt collectors, Credit Corp buys portfolios of distressed debt, usually unsecured loans, credit cards and unpaid bills, from utilities and banks. It might buy a debt ledger for, say, 10 cents in the dollar and look to recover 20 cents of each dollar of unpaid bills.
It is a no-brainer that there will be a lot of distressed debt available for purchase as Australia enters a nasty recession, thanks to COVID-19. This is potentially a lucrative period for so-called “hardship stocks” that collect debt or reorganise troubled loans.
The downside is high unemployment rates reduce the potential for more of that distressed debt to be collected by Credit Corp and its rivals.
Raising capital was a smart move. Credit Corp is better funded than its rivals to buy debt that becomes available during and after COVID-19 in Australia, New Zealand and the United States.
Operationally, the business was performing solidly before the pandemic with good growth in debt collections. Credit Corp says Federal Government support has cushioned the initial impact on customers from COVID-19 but expects a larger medium-term impact on credit-impaired customers when the JobKeeper wage subsidy ends in September.
Credit Corp has the balance sheet to get through a difficult period and looks well positioned to come out stronger in the next few years, given the amount of distressed debt banks and utilities will sell to debt collectors.
Yet Credit Corp has plunged from a 52-week high of $38 to $15.43. That fall looks overdone, but investors need at least a three-year timeframe with Credit Corp, preferably longer.
Chart 1: Credit Corp
The insurance giant in April completed a $1.17 billion placement to institutions at $8.25 a share and in mid-May said it expected to raise $91.5 million from its eligible retail shareholders through an SPP at $7.51 a share. QBE trades at $7.75.
Institutions that subscribed through the placement are down on their investment, but QBE looks undervalued for long-term portfolio investors.
Its capital raising surprised: QBE’s capital reserves were 1.6 times the prudential regulator’s Prescribed Capital Amount (PCA), albeit at the low end of its 1.6-1.8 range. The equity capital raising and separate debt issue boosts QBE’s reserves to 1.9 times.
QBE says it has the capital base to withstand “a range of severe economic and investment-market downside scenarios and capture organic growth as the crisis abates”. The capital raising looks like a bit of extra “insurance” against COVID-19.
QBE came into COVID-19 with good momentum in group-wide premium-growth rates in first-quarter FY20. But the economic effects of the pandemic will hurt QBE’s underwriting earnings – particularly in its riskier lines such as lenders mortgage insurance and trade credit – and lower investment returns for its investment portfolio (which has no exposure to equities or junk bonds) are another concern.
Every stock has its price. QBE, down from a 52-week high of $15.19 to $7.75, is trading at its lowest level since 2003. I nominated QBE as a turnaround play for this report in 2016 at $12.88 a share and after a few tough years, the stock steadily edged higher in 2018 and 2019 to $15.
COVID-19 has undone years of hard-fought share-price gains for QBE in a matter of months. Morningstar values QBE at $11 a share and the stock is trading at a 14% discount to its international peers on a two-year forward Price Earnings (PE) basis, notes Macquarie.
A takeover by a larger global insurer cannot be ruled out if QBE’s share price continues to languish. With or without M&A, QBE should reward patient portfolio investors with at least a three to five-year view from here.
Chart 2: QBE
The plumbing and bathroom products group raised $647 million in April through a placement, entitlement offer and SPP at $7.60 a share.
Like other companies exposed to the housing cycle, Reece has been hurt by COVID-19, but less so than many of its peers. The stock is down from a 52-week high of $11.91 to $8.19.
Reece raised capital to fortify its balance sheet, quicken its growth strategy and capitalise on opportunities. The Wilson family, Reece’s biggest shareholder, subscribed for $170 million of new shares as part of the placement, boosting market confidence.
I rate Reece on a few fronts. First, the capital raising was more pre-emptive than an emergency funding grab. Arguably, Reece did not need to raise capital, but doing so has it well positioned should the fallout from COVID-19 last longer or be more severe than the market expects.
Second, Reece came into COVID-19 in good shape. It grew normalised after-tax net profit by 7% to $113 million in half-year 2020 results released in February. Sales rose 9%.
Longer term, I like Reece’s US growth strategy and its focus on distributing exclusive brands and digitising the customer experience.
Third, plumbing is an essential service. Like other trades, plumbing will be affected by fewer new housing starts and reduced spending on renovations in a recessed economy. But Reece has shown over the years that it can grow in bad and good markets and that plumbing supplies are reasonably defensive.
After solid gains in 2019, Reece has tumbled to a three-year low. There is plenty of pain ahead for it and other building-materials suppliers, but Reece has the balance sheet, management and strategy to ride out the downturn and emerge from it stronger.
Chart 3: Reece