Introduction
It's too easy to say "once the world normalises", and present the pre-COVID-19 narrative for companies close to the epicentre of this crisis. We need to study and understand what the consequences are before that "normalisation" happens, and appreciate the likelihood it does for that business. Many businesses might not make it that far. Others will make it permanently damaged, and some will sail through and come out stronger. But we need to understand the possibilities of different scenarios by stress-testing our companies and comparing this output with the market's expectations embedded in the current stock price.
I myself recently wrote a piece on Rolls-Royce (OTCPK:RYCEF), a business that may likely suffer permanent damage due to this crisis. This doesn't mean the pre-COVID-19 narrative is incorrect at the time of writing. But the pain now going through its income statement will damage its balance sheet, perhaps leaving a deep scar that can lead to either substantially increased debt, forced selling, or reduction of assets (human and fixed), which could reduce future growth and profitability potential, and perhaps a rights offering depending on the length of time air flight volume remains significantly below normal levels. It would be foolish of me to analyse the business today simply assuming "once the world normalises". Stress-testing the current period would be an essential element of the analysis.
A Framework to Analyse the Business's Evolution Before "The World Normalises"
We suggest analysing businesses close to the epicentre of this crisis in three distinct phases:
- Phase 1: Distress Period
- Phase 2: Recovery Period
- Phase 3: Normalised Period
Ignoring steps 1 and 2 and simply assuming step 3 will eventually happen ignores the study of the likelihood of (1) not making it through those phases, and (2) the potential burden the business will carry to pass those phases.
