Since the beginning of March, 15 companies within the S&P/TSX Composite Index have gone to market to raise capital. All but one did so by raising debt. By comparison, of the largest LSE listed issuers, 23 have raised equity and 10 have raised debt. It is clear – European issuers are favouring equity during this crisis.
Now is the time for Canadian issuers to raise equity.
Early in their response to the COVID-19 crisis, Canadian issuers focused on raising debt. But given the recent strength in the stock market and the risk debt poses to an issuer's balance sheet, prudent issuers should pivot while they still have the chance and fill their war chests by issuing equity.
Market commentators have drawn comparisons between the Great Depression and the possible economic fallout from COVID-19. Despite this comparison, stocks around the world have rebounded dramatically from their March lows. The S&P/TSX Composite Index is up over 30 per cent and the FTSE 100 Index, almost 20 per cent.
Time may be running out to capitalize on the gift presented by the recent stock rebound. During the 2008 recession, both the Dow Jones Industrials Average (DJIA) and the S&P 500 saw an initial 20 per cent drop, then a large retrace followed by a further 50 per cent decline. The same pattern was seen during the dot-com bubble. History may be repeating itself.
There seem to be different explanations as to why Canadian-listed companies are preferring debt but the rationales are not compelling.
First, Europeans are said to be more risk adverse and therefore demand a cleaner, or even debt free, balance sheet. Given the current market conditions, the tighter covenant packages lenders are demanding and the potential for continued tough times ahead, Canadian issuers should be favouring the less risky strategy.
Second, issuers are citing the relatively low interest rates in Canada. For example, Ontario Power Generation was recently able to raise 10-year debt at 3.215 per cent. However, the European issuers are still beating Canada. The European energy company SSE PLC recently raised 10-year bonds with a borrowing cost of 2.9 per cent. Yield alone does not tell the entire story.
Finally, there appears to be a feeling that there is no demand in Canada for equity offerings. Yet, it appears institutional investors are willing to buy Canadian equities. Recent activity is showing a number of foreign equity offerings (including upsold offerings) that included sales into Canada.
The economic fallout from the ongoing crisis could be the worst of our lifetimes. To survive, it requires raising funds at the right time and in the right way. The right time is now as credit markets can seize quickly and demand for equity can dry up. The right way is with equity. Cash flow will slow, resulting in making interest payments and debt covenant compliance difficult.
While Canadian markets have, during the last month, focused on debt raising efforts, given the potential for further economic turmoil, the default risks associated with debt and the recent rebound in the stock market, issuers should strengthen their balance sheet through equity markets now.
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