How IR professionals can talk recession with Wall Street
With the S&P having the worst first half of a year since 1970 and interest rates spiking faster than they have in 35 years, the markets are clearly signaling concerns about the future of the economy and corporate profits. At the same time 77 percent of companies in the S&P 500 beat first-quarter estimates - a strong indication that many companies are not yet experiencing distressed business conditions.
Investor communications during times of economic transition can ultimately make or break a management team’s credibility. By focusing on clear and thoughtful messaging that helps the investment community evaluate potential impacts on the near and long-term outlook, companies can earn investor loyalty and trust.
In thinking through investor messaging, there are two critical time periods to consider – the transition period we are in now when financial performance still remains positive but the markets are anticipating a slowdown and the actual economic slowdown when more financial indicators have begun to turn.
Navigating the transition to a recession
Following a recent industry conference, I noted a sharp divergence between management commentary, which was relatively positive, and Wall Street sentiment, which was focused on a potential economic slowdown and its probable impact on reduced revenues and higher financing costs.
For companies, this can be a tricky time to navigate - how do you bridge the gap between what you are currently seeing in your business, which may still be healthy, and what Wall Street is expecting or fearing?
Against this backdrop, there is a real danger of becoming the company that claims there is ‘nothing to see here’ too many times until they are forced to reverse course. This is when a company can lose significant credibility if it appears that management was not paying attention and planning ahead. As an equity analyst covering homebuilders in the mid-2000s and through the Great Recession, I saw this play out firsthand, as some homebuilding CEOs were the last to admit the housing party was over - and some never regained credibility as a result.
Here are a few thoughts on navigating this tricky transitionary period:
Acknowledge the disconnect. Explain that you understand the concerns in the market, but your current reporting is based on what you are seeing and hearing from your customers and end markets. However, take this a step further to illustrate what plans you have in place to address potential changes in demand.
Provide examples and data. If your company has gone through a previous slowdown, provide examples of how your business performed and adapted (Covid is not likely a good comparison period given the unique impact on businesses). Importantly, provide lessons learned and how they influence your decision making this time around.
Discuss stress tests/scenarios. If the company has not experienced a prior economic slowdown, provide stress tests or other scenarios to illustrate your preparedness as well as a range of potential impacts on key company metrics.
Sharpen your guidance. If you have provided guidance, be clear on the assumptions embedded in your guidance ranges so analysts can make their own decisions on whether they agree. The time to change guidance is when those assumptions no longer appear realistic based on your internal analysis. Above all, don’t bring down guidance ‘just in case’ things get worse. This can cast an enduring shadow on your guidance.
Investors do not expect management to have a crystal ball, but they do want the comfort of knowing there is a strategy in place that considers multiple economic scenarios and they want to understand what levers can be pulled to protect earnings power and capital as much as possible.
Credibly and proactively communicating during a slowdown
Successful communication during an economic transition period helps ease the way for conversations that will occur when company results begin to soften. When weaker results become a reality, here are some suggestions to consider:
Report meaningful new metrics. Are there metrics you can provide that you didn’t before - ones that become more meaningful in managing the business during a downturn? While it is hard to take information away once given, temporary metrics provided during periods of economic stress will be appreciated. In the same vein, do not hide metrics that you previously reported just because they turned negative. This is a slippery road to losing credibility.
Review your long-term strategy. While companies need to address the short-term impacts of an economic slowdown, investor communications should also focus on how the current environment can impact the long-term strategy. This is a good time to review what you have shared about your longer-term growth strategy and what the metrics and goals look like in the context of a prolonged slower economy (M&A, cost reductions, efficiency programs, capital allocation, product extensions, etc.)
Dissect the balance sheet. During economic slowdowns, cash is king. Make sure that ‘the Street’ understands your balance sheet and cash flow - something they may not have focused on while the economic outlook was rosier. Focus on what levers you can and will pull during a slowdown and how this will impact the company’s capital structure and targets (capex, etc).
Minimize surprises. With downturns often come P&L surprises (impairments and other one-time charges). Communicating these as early as possible and explaining the methodology to analysts and investors, who may not be familiar with the process, can potentially head off some difficult questions. If charges are potentially recurring, make this very clear on the earnings call so that each subsequent call does not turn in to an accounting lesson on impairments.
These times of uncertainty are nudging us toward a global economic slowdown. No one knows for sure if or when this will happen nor the depth and duration of a possible recession. What we do know is that economic cycles are ultimately inevitable. A solid communications plan should always consider best case, worst case and base case scenarios in good and challenging times. Never be caught in the exuberance of the moment because we all know - only too well - how quickly that can change.