How CFOs can proactively respond to the COVID-19 crisis

Coronavirus is a reality that, in 2020, is directly affecting us all.

How potentially devastating could Coronavirus be for economic and business activity? Those that work in Risk Management know it doesn’t take long to reach “Catastrophic” as a potential impact for business in a worse-case scenario, which is exactly what’s unravelling for the travel, accommodation, education and hospitality industries across Australia and New Zealand.

The impact of China on our world

Chinese New Year fell on 25 January this year and lasted until 8 February. Given this coincided with the beginning of the spread of COVID-19, many New Year celebrations were postponed and eventually cancelled. This provided costly for Australia and its many businesses which rely on Chinese customers, supplies, and/or key relationships.

Inconvenient consequences quickly moved to problematic which are now catastrophic. Businesses have experienced significant losses of revenue with more to come. Businesses with supply locked up in China have suddenly realised the consequences of economic dependency on one supplier/region, especially its impacts on revenue generation and cash flow.

China is the world’s manufacturing superpower with more than 28% of world production and produces 40% of the output of the top 10 manufacturing countries, as the chart below demonstrates:

The practical impact of the economic dependency on China for manufacturing is illustrated by the following case study regarding Apple Inc. Apple was one of the first companies in the world to reveal how the coronavirus was affecting its business, cutting its sales expectations for Q1 2020. Apple is highly dependent on Chinese factories and consumers (China is its second largest market) and it quickly advised the market that its supply of smartphones would be slowed despite China reopening its factories. Apple closed all 42 of its Chinese stores in January. By March, they had reopened but damage had already been done, with the decline in market capitalisation for Apple following the adverse consequences has been USD $130b or more than 10% during February 2020 alone.

Consider also that many products are manufactured outside of China but assembled in China and indeed many of the supply chains around the world are dependent on manufactured parts from China, so the effect of a manufacturing shut-down or even slow-down in China has cascading negative impacts around the world.

While it’s clear that having an economic dependency on any one supplier, customer or financier creates a serious issue, the reality has become increasingly evident since the outbreak of COVID-19.

A proactive approach to the COVID-19 crisis

Air New Zealand is the national carrier for New Zealand (52% government owned) and an ASX-listed company. In the first half of FY2020, the company experienced a 33% fall in profits and in the first two months of 2020, the share price fell by 30%. The airline immediately slashed total capacity into Asia by 26% with the CEO Greg Foran voluntarily requesting a 15% reduction in his base pay. In March, passenger numbers fell by 50,000 and fast forward to late March and the outlook is even bleaker.

Foran has now announced that the airline will begin the process of materially reducing its workforce due to the impact of COVID-19, saying that he expects the airline to be 30% smaller in years’ time than it is today. Meanwhile, Foran has also been quoted as saying the company’s revenue was expected to fall from about $5.8 billion to less than $500 million, a 90% reduction. The situation is so dire that the New Zealand Government is handing Air New Zealand a $900 million lifeline.

And Qantas chief executive Alan Joyce announced sweeping changes to the airline’s operations in February. Joyce, chairman Richard Goyder, senior executives and board members will now receive no salary for the remainder of the 2019-2020 financial year. With Qantas (and its wholly-owned subsidiary Jetstar) grounding all its international flights, cutting domestic services by 60% and standing down 20,000 employees, it is now fighting to minimise job losses and ultimately to maintain its capability. And, on 19 March, its share price had slumped from $6.67 one month earlier to $2.14.

Meanwhile, Virgin has announced a suspension of all international services and major cuts to domestic capacity with an announcement mid-March that it was working with its staff to address the situation and was undertaking a range of measures including the use of accrued annual leave, leave without pay, redeployment and, in some circumstances, redundancies.

These are extraordinary, but prudent and very responsive measures by both airlines and one would expect other businesses in the travel, accommodation and hospitality sectors to follow suit.

State and Federal Governments in Australia have stepped up to counter the impacts and where possible, ensure that impacts on businesses, the economy, and the workforce can be reduced.

However, there is also a range of immediate actions businesses can take to address the adverse consequences of the Coronavirus:

Financial Management: The CFO is responsible for addressing financial issues, the key one here being the potential adverse impact on revenue and cash flow. Assuming a drop in revenues from delays in supply chains (i.e. exporting inventory out of China and other impacted regions) and a loss of confidence among customers, there could be significant loss of cash inflows. Loss of productivity from employees unable to work and indeed the entire shut down of workplaces will also heavily impact businesses. Even if variable costs offset the loss of revenues proportionally, fixed or overhead costs still need to be covered and with shrinking quantum of gross profits this will place strain on many businesses. Consequently, CFO’s should be engaging in regular flexible budgeting to account for these dynamic changes in the economy and their particular circumstances. CFOs should also be considering flexible expenditure plans which minimise any discretionary spends in the short-term to maintain as much cash as possible.
Capital Management: CFOs will need to be wary of breaching banking covenants and considering the possibility of alternative forms of capital in the form of shareholder or related party loans, convertible notes or re-negotiated loan agreements. Raising capital on market looks somewhat more difficult now for listed and pre-IPO companies, but consider that the sharp correction in share markets around the world in March 2020 is creating value opportunities, especially for cashed-up private equity investors.
Risk Management Committee: The Risk Management Committee should be reconsidering the accuracy of its Risk Register and revaluing ratings and risks, as well as identifying, rating and mitigating any emerging risks. If there is no Risk Management Committee in place, the Board should conduct this process and where no Board exists, management should be responsible.
People & Culture: Businesses need to be flexible with their policies and procedures during this time of uncertainty. Wherever possible, employees should be given the opportunity to work remotely to minimise direct contact between individuals. E-meetings could replace face-to-face where possible. There should be consideration for sick leave to be extended to all employees even if they have exhausted all of their existing entitlements. Hygiene procedures should be upgraded.
Communications: Regular updates to employees, customers, suppliers and other stakeholders should address certain concerns and assist in enabling a calm working environment.
Governance: what better time to revisit the Board’s skills matrix to determine whether changes in Board composition for a tougher economic environment may be warranted.
Merger & Acquisition: For businesses with a strong balance sheet, now may be the best time to open discussions on acquisition strategies, especially where the target entity is in a weak financial position. Alternatively, if your financial position is weak and your analysis suggests this is unlikely to be resolved through financial or capital management strategies, then a merger may be the best option available. Note that delaying merger discussions could reduce the existing value of the enterprise and viability of the business if economic conditions continue to deteriorate.

Business Continuity Management will be front and centre in 2020 and beyond. Below are some practical and best practice detailed strategies which APRA-regulated entities are required to implement:

The world has faced and contained pandemics time and time again. This will pass. While the crisis has clearly arrived, the best managers will make extraordinary efforts to respond to it proactively, countering potential damage to people and organisations.