Norwegian rescue, earnings to watch, a cautious Buffett and US-China tension on the rise
Head of Equity Strategy
Summary: Norwegian bondholders and lessors have agreed to debt-to-equity swap rescuing the airliner from immediate bankruptcy and the swap will increase the equity ratio above 8% needed to get a bailout by the Norwegian government. Earnings to watch this week are PayPal, Shopify, Uber and Booking as technology sentiment is still key for equity market to hold the line after the ugly session on Friday. Especially Booking is interesting given its nexus in the global travel industry collapse. The weekend also offered the first virtual AGM at Berkshire with Buffett talking the state of markets and the economy, and rising US-China tensions as US secretary of state, Mike Pompeo, launched into an attack on China.
With global airline industry fighting for its lives the weaker and more indebted airliners have been pushed to the brink of bankruptcies with Norwegian as the most imminent case. But over the weekend bondholders and aircraft lessors have finally agreed to a deal that will be swap around NOK 10bn of debt into equity with potential more debt-to-equity swaps in the future. The deal will push the equity ratio (the amount of equity to total assets) above the 8% required by the Norwegian government to provide state funds through the Government State Aid Package. In addition to the debt-to-equity swaps Norwegian expects to raise NOK 400mn in a public offering of new shares. The entire deal will go to vote on an extraordinary general meeting this morning.
Last week was the most important one for earnings and ended on a negative note with the disappointment from Amazon and Apple. This week we believe technology sentiment again is the most important to watch and therefore investors should watch earnings from PayPal and Shopify on Wednesday and then Uber and Booking on Thursday. Booking is an interesting earnings release because the company sits in the middle of the travel industry’s collapse and is expected to see revenue decline 40% this year. But expectations from Wall Street analysts are also very optimistic as consensus expect FY21 revenue to reach FY19 levels with even better cash flow generation. In our view this is way too optimistic which means that Booking could get downgraded on Thursday when they update the market on the business situation.
Today the earnings from Itau Unibanco, which is one the largest banks in Brazil, is interesting due to the crisis over COVID-19 and the economic fallout but also because their projections for the economy has implications for Banco Santander that’s also running a large banking operation in Brazil.
While bondholders and lessors have agreed to save Norwegian and the airliner apparently confident in raising additional NOK 400mn in equity in a public offering some must be more positive on airliners than Warren Buffet. On Berkshire Hathaway’s Annual General Meeting this weekend Buffett talked about how the investment company had sold all its stakes in the four major US airliners. He could do it because it was a minority position and went on to say that if Berkshire had owned an airliner 100% it would have been a much more difficult decision; he said that he was unsure of how long Berkshire would have funded operating losses.
Buffett also said that the Fed did the right thing in March but ultimately closed the window for Berkshire to do any acquisitions thereby indicating that he believes the equity market is overvalued. This is also what we have been saying for weeks now and reiterated on this morning’s podcast with the chart showing the fair value in the S&P 500 and how the market is clearly valued above the fair value and even the Dec 2009 valuation which is the comparable level to our analysis on S&P 500 dividend futures for 2021. Buffett said that the event is so unprecedented that Berkshire is just trying to preserve cash and weather the crisis which stands in stark contrast to the buy-the-dip investors in April.
Finally Buffett talked about negative interest rates and how this was the biggest unknown for the economy in the future. He also said that is was a clear negative for the insurance industry and that the insurance industry on top of potentially negative rates would experience massive litigations over COVID-19.
Besides monitoring Italian government bonds (BTPs), oil markets and VIX as our risk indicators we have to add USDCNH this morning as this weekend came with rising US-China tensions- The US secretary of state, Mike Pompeo, said on Sunday that there is “enormous evidence” that COVID-19 originated in a Chinese laboratory. The statement came parallel to leaked material from Five Eyes, the anglophone intelligence alliance, stating that China had concealed human-to-human transmission and silenced whistle-blowers.
Chinese media has already refuted the US claims, but the market is already pricing in further tensions with the Chinse currency weakening against USD. A big part of the global economy rest on the US-China economic integration in the global supply chain so further tensions would make the economic recovery more fragile. As the US elections are getting closer we should expect the US rhetoric to hardened against China which will add to the noise in markets. The real threat is if the two countries choose to disentangle from each other over the coming years as it will disrupt the current globally supply chain structure.