Financial forecasters expect a recession in the US. Paul Tudor Jones, a well-known investor, billionaire, and founder of Tudor Investment Corp, believes the recession will materialise this autumn as reported by Yahoo Finance. The reason could be the rise in debt and asset prices. It is believed that such events could be followed by an economic downturn. However, Jones does not suggest pulling funds out of the stock market. He is investing in two companies from the medical sector, the first is Abbott Laboratories, and the second is Johnson & Johnson. If this is a purchase he is making with the recession in mind, then it could be assumed that he is looking for something of crisis resilience. There are two ways of looking at this: you can think that these companies could do well despite the recession, or because of it. Let's take a closer look at them and try to answer the question of what could make them attractive during the crisis.
Which industries might be crisis-resilient?
Whether a company is recession-proof depends, among other things, on the industry in which it operates. Crisis resilience can manifest itself in a number of ways, such as supplying necessities for which demand is not very elastic. Another example might be a company supplying things that are needed more than usual when a crisis strikes. This supports the rare situation where a company has an inverse correlation with the overall economy and the market as a whole. A good example could be the medical sector during the Covid-19 crisis. The other side is also worth looking at - i.e. not only at the demand for goods and services provided by the company but also at the supply of what it uses in its operational process.In case of a shortage of such a product during the crisis, the related company could suffer badly. It may also be that its competitors for inputs from other industries go out of business, making competition for them easier for the company in question. The question is, can we find any of these characteristics in the medical industry? In times of economic downturn, healthcare stocks are often considered defensive investments because of their resilience and stability in the face of recessionary pressures. One reason may be that, regardless of lower disposable income during a crisis, people would prioritize health and medicine.
Preparing for a crisis
Recessions and difficult times in general and regardless of the industry, it may be possible to be better or worse prepared for a crisis. The saying goes, "cash is king during a crisis". Indeed, it may be true because, for many of the unsettling situations that arise during a crisis, cash is the remedy when everything comes down to liquidity. If we have to face a sudden collapse in revenue, a stockpile of cash and other liquid assets could allow us to survive and cover ongoing liabilities.
Simply put, in a crisis, what makes a difference is whether a company's finances have been taken care of. Liquidity, high debt service, and low level of indebtedness may allow a company to emerge from the crisis with its feet firmly on the ground. In turn, if these aspects are neglected, surviving bad times could be much more difficult.
Looking at the data, we can see that Abbott Laboratories has more than half of its assets financed by equity, i.e. the D/E (debt to equity) ratio is below one, which is a good sign. However, the company does not meet the golden accounting principle of covering non-current assets entirely with equity, as equity covers only 75% of non-current assets. This might not be a positive sign, but it might be acceptable if the silver accounting rule is met at a favourable level, which is the case here. According to the silver accounting rule, equity and long-term liabilities need to cover non-current assets. The liquidity ratio - which measures whether and how the company is able to pay its liabilities for the coming year (current assets/current liabilities) - is at a decent level of 1.7. Converted into a quick ratio by subtracting inventories from current assets, it is still above 1 and by some margin, as it is above 1.2. The company also has 9.5bn USD of cash on hand, with total assets of nearly 74bn USD, making it 12.8% of total assets. That seems a substantial amount. It is also worth mentioning that operating cash inflows have been consistently positive every quarter for many years
Looking at Johnson & Johnson in the same way, we see that the overall level of indebtedness is already higher here, as liabilities exceed equity quite significantly, and the D/E ratio of around 1.76 is significantly higher than that of ABT. The golden rule of accounting is also not respected. In fact, equity finances only 54% of fixed assets. The silver accounting principle is met, but with a much lower percentage of provisions than in the case of ABT. The liquidity ratio is 1.06. This is the accepted minimum of more than 1 (i.e. compliance with the silver rule), but the result does not seem impressive, especially when compared with ABT. The company's quick ratio, on the other hand, is just 0.85. However, the company has as much as 32 billion in cash on hand, which, with 195 billion USD in assets, is 16%, proportionally even slightly higher than ABT, which compares more favourably with all other ratios. Cash flow from operations has also been positive every quarter for many years.
In summary, with regard to financial readiness in terms of liquidity, cash reserves, debt size, and health, etc.,ABT seems more prepared for a recession. On the other hand, it is difficult to say that currently, we are living in good times. We have had high inflation and relatively low GDP growth since the Covid-19 crisis. We have been operating in difficult times for a good few years now. The global crisis may not be something we expect; instead, it may be more of a reality in which companies already operate. Even if the forecasts of a recession come true, it might make little difference to the conditions we have today.
Paweł Szarmach, MPW, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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