Maintaining market confidence through an earnings downgrade

Insight

“Day one is always ugly – and the six months following might be too. But they’ll get over it, you’ve just got to go for it.” – Fund manager

The effective communication of an earnings downgrade can be complicated. The stakes are high and getting the delivery wrong will contribute to the discount that the market places on the credibility of the company and its management. 

As the market continues to review and price in a flood of future earnings downgrades in 2020, some companies will also be coming to market needing to raise capital.

In this environment, with the unfolding economic impacts of COVID-19, early, open and upfront communication will have a significant influence on the outcomes.

SenateSHJ has interviewed a group of leading New Zealand fund managers and research analysts, an Australian small cap fund manager and two listed entities which had previously reported material earnings downgrades. The insights gained have been compiled into a practical communications guideline for companies preparing to downgrade,

The guideline is presented in three short and simple chapters.

Chapter one: you need capital on call in the Bank of Reputation

Establishing a baseline of goodwill ahead of an earnings downgrade will influence what happens at the outset and along the road to recovery. This chapter looks at building your company’s reputation through an effective programme of early, ongoing communication.

Chapter two: leave no stone unturned

This chapter contains:

  • a look at what the market actually wants to hear
  • the key questions to ask and answer internally
  • a practical guide to building and announcing a downgrade effectively

Management credibility and pricing risk are the two big things the market is looking for. The market will discount the stock price if it thinks management isn’t credible. 

The market will also be looking, and listening, to understand whether a downgrade is cyclical or structural.

A cyclical downgrade is relatively straightforward from an announcement perspective. Changes occur. Often these are temporary, and as long as management has a clear and robust plan to address them, the market will be fairly understanding.

A structural downgrade often carries a fundamental underlying performance risk, which makes maintaining trust and confidence more complex.

As one fund manager commented: “We appreciate that from a management team perspective if you start with a structural issue and believe the board and management can self-help their way out of it, it is important not to go overboard at the outset. What we will be looking to assess is the strength of the fix-it plan, and whether we have confidence that the right team and resourcing are in place to manage their way through this.

 Another view which came through consistently: “We understand the challenges of being in business; all companies go through pain at times. What we worry about are the companies where everything’s too rosy. While no one likes to present bad news in detail, it generally pays off in the end.”

Chapter three: under-promise and over-deliver

A common point emphasised throughout our interviews was that companies that have got it wrong and continue to do so, have failed to meet this basic hurdle. This chapter gives a top-line overview to communicating post-downgrade.

To receive a copy of SenateSHJ’s practical guideline to maintaining market confidence through an earnings downgrade, please contact:

Hugo Shanahan: hugo@senateshj.co.nz / +64 275 111 561

Kate Walsh: kate@senateshj.co.nz / +64 21 858 619

Neil Green: neil@senateshj.co.nz / +64 21 660 872

Thank you

SenateSHJ would like to acknowledge and thank the following organisations for contributing their time, experience and expertise to help prepare this paper:

Castle Point Funds

Fisher Funds

Jarden

Milford Asset Management

Paradice Investment Management

Fletcher Building

Fonterra