• Research
  • June 10, 2021

Corporate Strategy: From Preservation To Allocation

Post-COVID, the strategic focus for ASX200 companies is likely to shift from capital preservation to capital allocation.

Post-COVID, the strategic focus for ASX200 companies is likely to shift from capital preservation to capital allocation as they seek to take advantage of circumstances which seem conducive to growth. The allocation choices they make will be important for investors.

Financial conditions for both consumers and companies are well-anchored by RBA policy, and relatively easy credit conditions are likely to boost growth prospects in the early stages of reopening. Given these conditions, it’s important for Australian companies to consider acting on growth and investing activities. It’s equally important for investors, when making investment decisions, to consider how these companies are likely to allocate capital during the coming cycle.

A framework of four pillars

Morgan Stanley Research identifies several areas where we think boards and executives are likely to allocate capital in the recovery phase of this economic cycle.

1. Dividend payout
Globally, Australia remains a high-yielding market, and while dividend returns were heavily curtailed due to COVID, the rebuild to historically higher levels of payout has started. Dividend per share (DPS) outcomes surprised strongly in the first half of 2021. Morgan Stanley sees dividend rebuild as an enduring theme this year but suggests investors focus on growth at reasonable yield (GARY) – companies where there is capacity to grow the dividend over time.

Exhibit 1: The payout ratio for the ASX200 has quickly returned to 70%

Exhibit 1: The payout ratio for the ASX200 has quickly returned to 70%

Source: IBES, RIMES, Morgan Stanley Research

2. Capital return
In the recent past, listed companies have typically favoured dividends over buybacks when planning to return capital to investors. Morgan Stanley’s view is that this decision may be more finely-balanced post COVID given the potential for restructuring to accelerate. 

Exhibit 2: Equity Capital Raisings in Australia by number
has broken out of prior cycle ranges

Exhibit 2: Equity Capital Raisings in Australia by number has broken out of prior cycle ranges

Source: Dealogic, Morgan Stanley Research. Data to 28 Feb, 2021.

3. Growth capex
For much of the post-global financial crisis and pre-COVID period, the focus of ASX larger cap industrial companies had been to constrain capital, pursue cost-out and efficiency opportunities and distribute free cash flow via elevated dividend payouts. Morgan Stanley Research sees the potential for capital expenditure to accelerate in this post-COVID environment. Fiscal incentives are only likely to add to this trend.

Exhibit 3: Capex for ASX200 Ex Financials was low in FY20;
we expect this to normalise in FY21

Exhibit 3: Capex for ASX200 Ex Financials was low in FY20; we expect this to normalise in FY21

Source: Factset, Morgan Stanley Research. Capex based on Morgan Stanley coverage only

4. M&A activity
The merger and acquisition (M&A) cycle in Australia has lagged, with activity having found a new cycle low. We are not convinced that will continue given valuations remain elevated and supportive of carefully selected transactions. Against that backdrop, Morgan Stanley Research has identified the sectors and stocks that show the greatest potential for future M&A activity – those that have both appeal (in terms of generating shareholder value) and the strategic capability to engage in capital deployment.

Exhibit 4: In Australia, both the M&A number and total value
has decreased to the lowest levels in the past 10yrs

Exhibit 4: In Australia, both the M&A number and total value has decreased to the lowest levels in the past 10yrs

Source: Dealogic, Morgan Stanley Research

 

For more on corporate strategy, or to read the full article ‘Pause and Reflect’ (16 May 2021), speak to your Morgan Stanley financial adviser or representative. Plus, more Ideas from Morgan Stanley's thought leaders.