Companies face liquidity challenges post-pandemic: Report

James Gellert, RapidRatings CEO, joined Yahoo Finance Live to discuss the liquidity challenges facing companies as they recover from COVID-19.

Video Transcript

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ADAM SHAPIRO: All right. About 16 minutes to the closing bell. We talk a lot about the economic resurgence as we try to emerge from the pandemic slowdown. But one of the companies that keeps a tab and a look on how the industries that all of us rely on are performing, especially when it comes to their future outlook, debt loads, all of it, is RapidRatings.

And their CEO James Gellert joins us now, because you've done some research, and a lot of us were breathing a sigh of relief. But in your most recent note, I guess I'd say, to clients, many industries are still in a state of financial weakness, kept afloat by record leverage. So for those of us who are just average Jane and Joe investors, what are you telling us?

JAMES GELLERT: Well, Adam, I would never put you in the average category, by any stretch. Look, we're-- I think the important point is that, from a headline perspective, people are paying attention to public confidence. And they're understanding how public companies are rebounding relatively well. And earnings in general across different industries are showing good signs of coming through this past year.

But underlying that are a lot of indications that we're not through the woods yet. From a core health perspective, which is our measurement of the two to three-year out fundamental view of how strong companies are, we've seen deterioration over the last, certainly during the course of 2020 and, in many industries, even into '21.

From a financial health rating perspective, which is the shorter-term view, it still remains reasonably strong, because companies have been able to raise such an incredible amount of liquidity, whether it's through equity or debt capital. But when you start to peel away layers of the onion, there are definitely causes for concern, given how much debt has been raised, how much liquidity is on balance sheets. And really the question is, how long that will last before recovery in the underlying businesses really comes about?

ADAM SHAPIRO: And James, if we can pull up, I think it's the core health rating graphic that you sent us. We were just showing it on the screen. For the people watching, what you want to know is you have a statistic, is it about when companies score at a certain level or below a certain level in their core health score the potential for problems in the future is what?

JAMES GELLERT: So on our scale at 40 and below, that's where 90% of companies that have failed historically have been rated. That doesn't mean every company that's rated in that zone is going to fail, but it does mean that they're at significantly higher risk. So when you look at the-- and this is an algorithmic process, so we're processing a tremendous amount of data on the financials of any company and profiling it against 12 million company years' worth of historical financial data to come up with these scores.

And what the core health is telling us is that there's been a significant decline in a lot of these companies in a lot of these industries, even those that have really cashed up. And what you see in some of the industries, like the ones on screen now, you see autos and business products and services, consumer products, these are ones that have raised a lot of capital in this past year. For instance, the autos reduced their current liabilities significantly and the cash to current liabilities last year went up 57%. So it's a significant number.

That's kind of a relatively common theme across industries for this past year. But what you're seeing in the first half of '21 is that they're beginning to burn down that cash. So the auto industry, as an example, has burned down 17% of the cash that was raised during the course of last year. If the underlying industries don't pick up or, if even worse, things turn worse through greater shutdown with the Delta variant, et cetera, we could end up in a situation where there's further deterioration of these industries before they're able to pick back up using the cash that they have raised over this past year.

And with such an incredible access to capital over the last decade, but particularly with government support during the pandemic, most companies have been able to raise money, public and private. Give you one more example. In the transportation industry, overall, if you look just at the public companies there, it's significantly less capital that's been raised than if you include the privates as well. You look at private companies--

ADAM SHAPIRO: Right.

JAMES GELLERT: --there's about a 48% increase in debt across the board.

EMILY MCCORMICK: James, this is Emily. I want to ask, if I'm an investor and I'm seeing some headlines occurring, a company is raising debt or conducting a financing round, how should I be thinking about whether this fundraising and this access to liquidity is ultimately going to improve the core health of the company or just provide a temporary lifeline?

JAMES GELLERT: Well, excellent question, because it's very difficult to know that. Generally, you have to pay very close attention to what the company states its use of proceeds is going to be. General corporate purposes is what a lot of companies will say, and that's a giant basket.

So it's really about paying close attention to the quarters after a capital raise to see whether the new money that's come in is being put in place, is being used efficiently to create greater returns on assets and to ultimately be affecting profitability. And at the end of the day, the purpose of these companies is to generate returns for shareholders. And if they're just able to burn capital to stay afloat, that's not generating returns for anybody, really.

ADAM SHAPIRO: All right. We appreciate you joining us. James Gellert, RapidRatings CEO, always good to see you. And look forward to your return.