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European stock investors on alert for heightened balance sheet stress

November 14, 2022 00:00:00

MILAN, Nov 13 (Reuters): Stock pickers have a message for company finance bosses and it's getting louder: bolster your balance sheets before the downturn strikes.

After more than a decade of ultra-loose monetary policy, financing conditions are tightening, inflation is rising and the global economy looks poised to fall into its first recession since 2009.

Highly indebted businesses could be looking at trouble as their interest payments rise and profit growth shrinks, say fund managers, who are already switching out of debt-laden companies.

S&P Global believes global credit conditions are at an inflection point and expects heightened credit stress in late 2022 or early 2023.

Ratings downgrades are set to pick up and overall defaults of corporates globally are expected to double by mid-2023 from historically low levels currently, S&P says. Europe, which is grappling with an energy crunch and war at its borders, will see the biggest hit to credit quality.

"There seems to be a shift of attitude over the most indebted stocks," said Gilles Guibout, head of European equity strategies at AXA Investment Managers in Paris.

"This is pushing investors towards companies that will not be affected by the rising cost of debt. And the pressure on executives (of indebted firms) is piling up," he added.

Bank of America's most recent fund manager survey shows 60 per cent of investors want executives to use cash flow to improve balance sheets rather than increasing capex or dividends, roughly the same percentage as during the COVID-19 crash and the global financial crisis.

"Time has come to save something for rainy days," said Giuliano Gasparet, head of equity at Generali Insurance Asset Management in Milan. "I wouldn't be surprised if, in the next surveys, this percentage increases even further".

The importance of a solid balance sheet has been reflected this month in a series of wild share price swings.

SBB, for example, jumped 46 per cent over two days as lower bond yields offered the heavily-shorted property firm some relief over refinancing. The Swedish company sold property for SEK 700 million ($64 million) a few days later and on Wednesday launched a tender on bonds for a similar amount.

Real estate (.SX86P) is Europe's worst-performing sector this year with a 40 per cent drop. Investors fear the highly leveraged industry could see restructurings and dividend cuts. SBB shares have fallen almost 75 per cent this year.

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