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Economic update & impact on corporate valuations during Covid – Premier Brains

Financial planning under current economic conditions – Holborn Assets

This webinar was conducted on 14 May 2020

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Ramadan Kareem everyone, hope all of you are keeping safe. Welcome to a joint webinar today by Premier Brains and Holborn Assets. The topic for our webinar is economic update and impact on corporate valuations during Covid 2019 and financial planning under current economic conditions. There are two speakers today Mr. Rishi Chawla from premier brains and Mr. Kapil moto from Harborn assets. Rishi Chawla is a partner with premier brains and has around 17 years of experience in the field of audit, business consulting, valuations, restructuring, and many assignments. Kapil matar is vice president business protection with Holborn assets. He’s a financial advisor and has around 20 plus years of experience

in this webinar, the session will start with Rishi Chawla who will be taking the topic economic update and impact on corporate valuation. And later Kapil will be sharing insights on financial planning under current economic conditions. We would like everyone to submit your questions via the q&a portal. And we will try to take as many questions as possible at the end of the webinar. So now I’ll pass on to Rishi Chawla who will start the session. Thank you,

Hello everyone, and I hope you all are safe and in good health. First of all, I like to thank the leadership of UAE for declaring so many good stimulus for the business community and for the people. So I will be taking the topic on

update and impact on corporate valuations during the COVID 2019.

So, first topic I will be covering is on economic impact, which has happened because of the current situation. So, now, just some figures to show, IMF has predicted that the global growth in 2020 will fall due to Covid 2019 by around 3% for the year 2020. And labor market as you know, have the biggest due to due to this situation which has happened. So, some of the facts which I’d like to share, like on 17th Of March 2020, International Labor Organization predicted that around five to 25 million jobs will be lost worldwide. And then in they revised the figure and they said no, it will be 195 million job losses. And just very recently on 29th of April, they have increased this number to

300 million jobs losses worldwide. But the good part is now that the clarity on the situation is more prominent. So we expect that should not increase more from here.

So now I’d like to share some of the measures which has been taken by governments worldwide in order to alleviate this impact. So, one of the area which has been picked by certain governments is like partial payment from the government to the company like for example, in Germany, around 60 to 70% of salaries for registered employees been paid by the government to the employers so they can distribute it to the employees and similarly in the UK around 80% but with a cap of GBP 2,500

per person which is subject to certain conditions which are there.

Then there are temporary mobility of staff, as you know, in UAE and Saudi Arabia, for example, where the people have been

made redundant have been given options to apply for virtual labour market. So, this is another measure which has been taken

then business continuity for that purpose allowing companies to reduce the working hours for people and to let them you use the paid leave and also to send them on unpaid leave has been taken by UAE and Saudi Arabia . And another the last one I would say is the direct disbursement like in US and South Korea, the government is actually paying the people who are sitting at home and not doing anything. So, these are some of the measures which has been taken by governments to cover up for these job losses worldwide.

So, moving on, I like to share this, this slide with you just to explain a little bit purchasing manager index which is PMI is is one of the indicators which is used to to assertain if

economy is growing or is it contracting. So, if you see, there is a median line of 50, so any country if it is above 50 on that parameter is expanding, and any country, which is below that parameter is actually contracting. So this is one of the measures, by which the growth of the economy is being looked at by the governments worldwide. And so you can very well see that UAE and Saudi has shown a big drop and actually UAE been contracting since December onwards. But one good point here is, it appears that the bottom has already reached and we should be seeing upward movement from here because of opening up the economy and so many measures being taken by UAE for example, and even Saudi Arabia showing a little bit of growth from here. I’ve also added China here just to give you a little bit of feel of it, that China has actually gone into lockdown much earlier than

us. So somewhere in Jan fab, they already started on it. So you can see the V curve, which has built up which shows that once this lockdown gets over the growth comes very quickly. And actually you can see that in China it’s already touched 50 at some point of time, because of this reversal. Now, because new cases have been found in China, there is a little bit of drop because of more restriction they are placing, but the recovery mode can be achieved very quickly. So, we expect that the UAE will also perform like that in the coming coming months.

So, this slide again on the same line, I just want to share this PMI of China, which has been developed. So here also I like to mention this is completely on the private sector and mainly on the non oil sector.

Further you can see that the manufacturing sector for example, it’s picked up really fast after the lockdown is over. So, which is quite a good factor.

One more thing important in case of China which needs to be considered here is that it also depends a lot upon the domestic demand. So, in China for example, the domestic demand because of the population is much higher, but the countries who are relying on export they will have to let the economy’s open internationally for it to see such a big recovery. However, the same is felt by China also to a certain extent, but domestic demand is one of the major factors which has really made a very fast rebound in the case of China. And one more thing which has been noted as per our research is that it has been noted that there change in the buying habits of people as you might have noted that people don’t really like to go to the malls and physically visit places, hence the way business

was done has been changed because of this, this new new normal which we are living in.

So again on similar lines, I also like to show the GDP, industrial production and retail trade. These things were growing in China at a very high pace, but suddenly dropped at the time of Covid outbreak. But the good point I want to focus on this slide is that the recovery can also come quite immediately provided the controls are well in place, which I think is very well taken care of it and we expect that things should improve in the coming months.

Moving further.

I like to discuss some of the recent measures taken by Saudi Arabia . VAT have been increased from five to 15% starting from the first of July 2020

There have been spending cuts, majorly large projects have been curtailed amounting to around $26 billion . So that’s mainly due to two reason one is the covid 2019 situation that we have and another is low oil prices, which we are facing right now.

And then canceling of cost of living allowance, which was there since 2018, has been discontinued from first of June. And this is expected to contribute around US dollar 13.5 billion to the economy. And oil production cuts which has also come as a surprise from Saudi Arabia as it has cut production of oil by 1 million barrels per day from June. And UAE also is going to cut around 100,000 barrels per day. So, I just want to go to the next slide where we like to discuss as to

why we feel that UAE might not increase the VAT, because this is one of the topic that has been discussed quite openly.

the deficit of Saudi has been budgeted around SR 187 billion when we compare it with the UAE, which has actually give a zero deficit budget, as you can see that so that is itself proved that that strength of the economy is much better for UAE compared to Saudi and another factor is that the oil contributes around 50% of GDP for Saudi compared to 30%. for UAE, and as you know, Saudi is more oil dependent compared to UAE and one of the major reason for oil drop as we know is because of drop in demand internationally which has led to its drop, so having a more diversified economy gives more strength to UAE. And again, the oil production cut has also reduced the revenues

One of the reason I like to mention as to why Saudi has taken that decision very quickly is that in the first quarter of 2020, Saudi already announced that their deficit budget was around 34 billion as compared to surplus budget last year for same quarter. Further one of the rating agency has actually given a negative outlook wihich has all contributed towards this action taken. But we see that UAE being a more stronger economy in terms of its budget so should be able to handle this very well.

So

some of the challenges faced by governments due to of this COVID situation and the oil price downturn. So one of the biggest challenges for governments at this stage is that they are giving lots of stimulus to the local government, but at the same time they also have to balance the budget in order to protect the deficit budget. So this is one of the adjustment, which governments are looking at. So they have to look for finding new funds in order to cover against all the stimulus which has been announced and also the revenue drop. Further we expect that sovereigns like Oman, Bahrain, Dubai might look for new funding avenues in the coming months.. Governments might also look for new revenue generation areas such as

Introduction of VAT and excise in countries where it is not yet introduced in GCC, I just want to touch upon this point that recently one of the minister In Saudi Arabia has said that even though they increased the VAT from five to 15, but do not expect a lot of contribution from that to the state revenue because of the overall consumption went down. So it’s pretty early to do it. But we don’t expect UAE to introduce any kind of taxes at the moment. Another challenge which is going to be faced by the countries due to current situation is the danger of going into a state of deflation, as you know the real estate has been coming down for some time and the government spending has dropped because of the recent changes in the budget. So one of the biggest challenge will be to control the deflation because the deflation spiril downwards is even more dangerous than having a high inflation or moderate inflation.

Now I’d like to share up on some of the positives for UAE economy.

Why we think that UAE has a low chance of bringing any kind of taxes. So one of the things which we have noted is that the Abu Dhabi government debt is around only 5% of the total assets under management. So that shows that the amount of debt pressure on the government is very low.

Secondly, even before the covid situation, the government was taking measures in order to stimulate the economy. So the mood was already set just that it has accelerated because of the situation. So that shows that the government has already planned certain kind of measures to protect the economy and to let it grow further.

Further Abu Dhabi fiscal strength is also because of the larger reserves that it carry which will protect against any kind of such events.

So some of the action plans which we see from government side is like they are already talking about how the economy will look like post Coronavirus. So that shows there’s so much ready and planned in order to handle current situation. Some of the other things in pipeline are such as merging certain ministries in order to allow faster action, to go big on digital space such as 5g networks and develop more market for artificial intelligence.

In case you have any questions till now, please write it in the Q&A section and we can handle towards end of the webinar

So, this is one chart taken on second of April as you can see the all the industries for that matter has come down because of the current situation. So, the biggest drop as you can see is in air & travel, commercial aerospace. Banks have taken a big hit and one of the big biggest issues in case of banks are chances of increasing non performing loans. And that’s why globally the share prices of banks and financial sector have taken a big hit.

Some of the good performing sectors as you can see are healthcare and pharma . And also e commerce business has really done well. Because in situation of a pandemic, healthcare become important and if people cannot really go anywhere, ecommerce is the best mode to reach to people. So, this is just to give you a snapshot of how the industries have performed recently.

So the major hit as you can see is taken by aerospace and the major reasons being the high fixed costs and the long term learning curve in the airplanes sector . So the fixed costs which is committed, it’s very difficult to cut or curtail those. So it is not possible to immediately stop production. Another reason is that summer months are normally peaks months for travel industry but that has already been impacted

So this is already factored in the stock markets . Oil and gas – demand versus supply – The demand internationally have reduced and but supply is still there. So that’s what is pulling the oil and gas prices down. Automobile the major challange is due to demand side and also supply chain because in order to produce it, you need to get many different materials which is getting hard to get by these days. Insurance being another tricky as lot of claims can come out because of the current situation especially in the Life and Health Insurance, there is a high level of possibility that

the claims may happen so the reinsurance are at a high risk. That’s why there’s a big drop seen recently.

So the best performing

sectors are healthcare, technology, ecommerce platforms utility and gold. So healthcare obviously aging population and the current pandemic has really

push the demand high. And as vaccines are been looked at all around the world the moment there is a news of any company in the healthcare which is showing any signs of success, is really going very high. Technology, artificial intelligence, machine learning and work from home online platforms are really doing well. Some of the sectors which are performing quite well are in ecommerce such as Amazon. Reason being people avoid visiting malls or shops and at the same time e-commerce is giving large range and at competitive prices

Utility, of course, people have to live on a gas, water electricity. So this is going to be a stable sector. And gold, of course is considered as a safe haven. And it’s a good hedge against inflation. So one thing is worth noting is that when central governments announce packages, there’s a lot of printing of money . So the more supply depriciate its real worth but gold is still a scarce resource.

So I like to just share some of the m&a results which has happened recently. As per the McKinsey report, the m&a

activity has improved in quarter one of 2020 compared to last quarter of 2019. As you can see, the deal activity has grown to 95 deals as compared to 89 deals in the last quarter of 2019. One of the reason we feel that M&A activity has increased is due to valuation of companies have gone really attractive. So, this can be seen as a time to buy stocks. So more deals are expected to happen so it could be a good time to look at m&a activity provided that industries are strong and they have a really nice structure to carry on from here. One of the top

acquisitions in terms of volume have came from India in the first quarter 2020 and in terms of value it is from US.

And the top industry target in terms of volume has been in the technology side. And in terms of value industrial sector is getting a lot of attention from the m&a side.

The valuation which we use to do in past has undergone a major change as the very fundamental assumptions need to be relooked at as to how practically are those acheiavble. The major areas in case of any valuation are revenue projections, cash flow forecast, discount rate,

asset impairment, future projections etc and these need to be closely watched before agreeing on a valuation.

One of the dilema of valuations is that the projections we use to look at December 19 projection has completely changed when we look at March 2020 because the factors which were at the end of December are not there right now, so, let’s look at it in little bit more detail.

Revenue projection is one of the things which needs to be looked at very closely since there has been shift in demand already in the market and disruption in supply chain which is also contributing to lower growth in revenue. So how the companies who are ensuring that offers are given and how realistic they can acheive there budgets is one of the challenge for which we do not have a precedence to fall back into. So one needs to look at really close how realistic the revenue projections are prepared by the management and if these have been updated. And cash flow. Cash Flow forecast is again going to be a really important thing to look at because the collections from the market is going to be a challenge because of the cash flow shortages which companies are facing.

Another thing need to be looked at is how the cash flow is balances for companies since one of the contributing factor these days is due to government stimulus by asking banks to postpone the loans have given more cash flow cushion to companies. So, there cash flows are already been protected by the bank in a way. But question is if such companies can still be going concern after the stimulus has been taken away in few months of time. Also how well the companies are able to manage their inventory holdings as physical movement of goods have really slowed down.

Another important factor in the case of valuation has is the discount rate used. So, discount rate can be looked at like when a person invests into a company, what is the payout and what is the level of risk, one has to take and which also means, what is the rate of interest when should get So, for example, if somebody puts money in the bank rate of interest could be one percent but of course, if you invest into a corporate entity, you might not expect one percent becuase

risk is high. Bigger the risk, higher should be return. So, finding the right discount factor is going to be an important factor to look at. Further in case of a valuation, there are two things which are always looked at are the risk free rate and the market rate. Delima now is that the risk free rate is no more risk free rate. The bonds or soveriegn assets which were considerd as risk free are not in same level of strength, so whether they still hold the ground in terms of being risk free or not is a question mark to get answers to. The market risk is another important factor which is factored in the discount rate has to be looked as well because the share prices which you might be looking at to evaluate the market risk are all historical prices. So how far the current prices are

actually factoring the current slowdown? Further another problem is how representive a listed entity compared to a small entity in similar business since they have a completely different risk profile. So, one of the way people can look at an industry for that matter is how comparable companies are in terms on industry size etc

On the asset impairment side, this is something which needs to be looked at very closely because the revenue generating assets like investment properties in the real estate or the equities held in the balance sheet might not hold the similar prices and the return we’re going to get might not be the same, further a lot of balance sheets carries goodwill. So, is that good will still hold value or not?

Also the expected credit losses in terms of receivables and other assets in the balance sheet to be looked at. So, have those been factored during the valuation, are some of the questions which needs to be looked at during an acquisition.

When any company prepare projections for future, there is always a growth story but now, the dilemma is that the growth story is going to be a V curve or is it going to be a U curve or is it going to be a W curve. So, when we say w curve means it is going to fall down come back again and with a new wave of covid cases and goes down again and goes up again. So, now, these these are some of the factors to see, how well the organization has looked at the fundamentals before projecting

How strongly companies are structured to survive the drop and how well they are financed to cover up, how strong is management action taking and their ability to handle the changing circumstances is going to be an important factor in determining the future projections.

And the last one, the valuation date when when an acquisition is happening , so company acquisiton as on December 2019 and on March 2020 will be entirely different. So, at the time of acquisition, it’s very important that one should look for the latest valuation in order to determine the fair value price for the acquisition to go forward.

Further under the current market market conditions it is advisable to look at more than one valuation approach to see how realistic valuation is looking.

The most popular approachs in valuation are the cash flow discounting model and the market model. These are quite well established valuation techniques but with the current changing circumstances, are these still going to be the same or we need to relook and redefine?

So, we feel that it is important then that company should look at different models, different approaches to find out the right valuation .

Under current circumstances it also become imperitive to develop sensitivity analysis . So, for example, if there is a V growth model or a U growth model or a W growth model, so, how that sensitivity is going to happen? So, that will give a little bit of

circumstances, so it will help evaluate the risk

in a more precise way.

Fair market value of businesses today will be impacted by crisis and it actually gives a lot of negotiating room at the same time. So when the market is down, we feel that this could be a right time to look for acquisitons which can add value in terms of diversification or enhancing the business model. So this could be a right time to look at new acquisitions provided the company shows strength that it will continue and cover up against any eventualities because of the current situation.

Further is it very important that the balance sheets needs to be looked at quite closely before an acquisition especially fair valuation of assets on the balance sheet

One of the common valuation techiques are by valuing in terms of EBITDA multiples. So how much EBIT the earnings before interest, depreciation, amortization, how much multiple is the fair price to give. So that multiple is also going to be looked at quite closely because the situation now has changed.

how much multiple is the fair price to give. So that multiple is also going to be looked at quite closely because the situation now has changed.

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