IR in a Recession: Reacting Without Overreacting

Small cap Canada is getting destroyed. There is a subjective bias toward safety. Investors are going to risk-off our name in the name of safety for an extended period. The only thing that will drive capital markets now is macroeconomics.

These random thoughts capture the general mood in recent weeks of a cross-section of IROs – and for good reason. During the second quarter, North American equity markets fell precipitously, led by the S&P 500, which entered bear market territory (a decline of 20%). If leading indicators and newspaper columnists are accurate, an economic recession is in the cards in Canada. In the United States, the R-word appears to have already arrived, according to the media, although the U.S. National Bureau of Economic Research notes that to meet the traditional definition of a recession there must be “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

However measured, recessions have several implications, including the potential for investors to move away from your company due to so-called risk-off rotation. Technology companies have already seen evidence of this rotation.

In this issue of IR focus, we speak to IROs who have gone through the downsides of recessions and lived to tell their stories. Our hope is to give all practitioners advice and ideas on what to do when the bottom falls out of the economy (and the capital markets).

Don’t panic, IR is just as necessary in a recession as in an economic expansion

The first and arguably most important observation made by experienced IROs is that recessions do not alter the fundamentals of good investor relations. As one practitioner explained: “Don’t overthink it; don’t succumb to panic created by headline writers. IR is fundamentally the same in a recession. It’s still about delivering timely and credible information and managing expectations.”

What may change, according to several IROs, is how much interaction your company has with investors. Said one IRO: “I work in tech, which is getting crushed right now and the volume of inbound contact (with investors) has reduced from a full roar to a dull roar. Our plan is to use the recessionary lull in interest to position for a post-recessionary environment, which probably won’t occur until 2023.”

For this particular IRO, upgrading the investor website – which had been put off due to resource constraints over the past few years – is an example of wisely using now-available time in that company’s IR calendar.  

Work on your narrative

Not all companies or industries are susceptible to recessionary pressures. For example, utilities are often considered safe havens during times of economic duress. However, for companies in what could be termed recession-sensitive sectors of the economy (and which are the focus of this issue of IR focus), it is common, as one IRO put it, for shareholders “to look under every rock for weakness and negative stories.” As a result, many IROs shift their corporate narrative from an all-out focus on corporate growth/expansion to a well-crafted story of safety and prudence – bookended, of course, by adherence to CSA National Policy 51-102, which requires announcements of material changes and unfavourable news to be factual, balanced and disclosed promptly.

Playing up your company’s defensive characteristics is the best way to address the needs of the market today, said one IRO interviewed for this article. “The topics we are discussing right now are substantially different than they were four or five months ago. At the beginning of 2022, our messaging was all about growth. Overnight, we found that investors no longer wanted to talk about expansion; they wanted to dig more deeply into our defences to determine what they should expect from a performance stability perspective in a down market. I would say to any IRO that if you are not prepared to shift gears from offence to defence when the need arises, investors will come away with one of two impressions: you are either out of touch with reality or you do not have a decent story to tell. Neither of these perceptions looks good on your company.”

Playing defence means focusing on items such as your company’s:

• balance sheet health/ability to self-fund;
• dividend coverage ratio;
• market share leadership;
• customer stickiness (presence of long-term contracts);
• brand/pricing power (a key topic in today’s inflationary environment);
• scale;
• business model resiliency;
• supply chain diversification; and
• ability (and willingness) to quickly adjust costs and spending plans.

Defensive characteristics are not the same across industries. For example, a lender’s defensive posture might include adjusting its loan underwriting parameters or showing prudence in its credit reserves, whereas a manufacturer might discuss the flexibility it has built into its annual capital expenditure budgets or strategic changes in fixed versus variable costs of production. The point is to isolate and communicate effectively your own company’s attributes and approach.

“Stick with the best is one of the tenets of investing well in a recessionary period and to the extent you can, demonstrate that your company is the best in your industry and has the best offensive and defensive traits,” is the advice from one IRO.

Don’t forget about growth and opportunity

Of course, playing defensive does not mean abandoning the story of growth potential. A recession can create unusually attractive openings for strong companies to acquire weaker competitors and/or add market share.

“Recessions can make winners out of well-managed companies,” said one IRO. “So, by all means, tell the Street about your strengths and defensive traits but balance that with discussions about how you are prepared to advance your market position by exploiting opportunities. If it’s applicable to your business, remind investors of your M&A framework so they understand under what conditions you will pull the trigger on an acquisition and how macro-factors are influencing your management’s thinking around M&A.”

In the past few months, acquisition activity has diminished in many industries, while share buybacks have increased. This is not unusual in a down market, and it bears noting by IROs, as does another trend that often surfaces during tough times: rationalizations. (Please see IR focus Volume 15 Issue 1 - February 22, 2022 for more information on the role IROs play in rationalizations as well as other forms of restructuring.)

Beware of your history

Heading into a possible recession causes analysts to dust off their old spreadsheets and study peak-to-trough performance of the companies they follow to model what could happen to corporate earnings in a downturn. IROs should do likewise and then prepare to address the question: is the past prologue?

For companies with lengthy track records, an analysis of this sort can lead to unfair and inaccurate conclusions that become accepted wisdom if not properly countered by a different set of facts.

Said one IRO: “My advice, assuming it’s possible to do this, is to create a counterfactual argument to point out that your company is not the same as it was in previous market downturns. Maybe you have better customers or serve a more diversified range of end markets with some counter-cyclicality. Maybe your credit policies are tighter, your bad debt history is not indicative of current circumstances and your A/R collection process is better. Maybe you have a much larger backlog than you did when you entered a previous recession. Most good companies have taken steps to strengthen themselves so that the past may not be prologue, but they need to be prepared to show it, particularly if they faltered badly in a previous downturn.”

For companies with a public track record that does not include a prolonged recession, IROs should illustrate the operating skill and responsiveness of the management teams. One IRO said this could be accomplished by “highlighting your management approach during the short-lived, COVID-driven recession of 2020. I think the 2020 COVID recession gave every company the ability to flex their muscles and if their strategies worked then, I would absolutely use the evidence to showcase the value of their approach to a difficult period.”

While creating a counterfactual argument, it is worth noting that no two recessions are exactly the same, even though the technical definition of a recession in economic terms is. COVID-19 induced a different recession than did the financial crisis of 2008/2009. Canada is also subject to regional recessions, as Alberta-based businesses can attest. Understanding how different economic gyrations will affect your business is important, as is explaining any unique countermeasures your company is putting in place.

Be extra careful in setting expectations

Just as a rising tide lifts all boats, a recession can have the opposite effect. When the economy stops growing, it is easier to produce an earnings miss, particularly when management (or analysts) originally anticipated growth in the economy/end markets and the company has yet to restate its targets.

Advice from IROs is not just to be mindful about expectation setting in the first place but to also adjust guidance/expectations downward as soon as it becomes apparent that targets will not be met because of general economic conditions. The reason is summed up in one word by an IRO we spoke to: “credibility.” Dialing back is never easy but the worst approach is to leave targets in place hoping that an economic/market downturn will be short-lived or mild. “In an environment like we’re in now, with so much uncertainty, a case can be made for an economic soft landing as justification for leaving guidance unchanged. In my experience, if you string the market along for a quarter or two and during that time repeatedly miss guidance before finally moving the goal posts, investors lose more faith in your management team’s ability than if you came clean quickly.”

The same IRO said it’s better to see your company reduce guidance when those around you are doing so. “To me, it’s easier to justify (a reduction) when everybody else is doing it because you will not be singled out and punished as an outlier. Widespread recessions present an opportunity for your management team to look like the honest, forthright operators that they are by delivering bad news just as they deliver the good.”

Expect churn in your shareholder base

Volatile markets can lead to rapid changes in a company’s shareholder base as investors cut their equity exposures, rotate to other industries and so-called fast money moves out. It’s important to keep a constant watch on these movements including the arrival of activists who look for opportunities to exploit weakness. Market surveillance is always a key capability for IR teams, and it needs to be on full display in a recession as a form of early warning if churn leads to the presence of activists with an agenda.

Manage your own credibility

An important observation made by several contributors to this article is that investor relations teams must manage their own credibility carefully during recessionary times. Said one contributor: “It is vital that your Board and C-suite know what IR can and can’t do in a recession. IR can’t alter the reality of investors switching out of your sector because of a recession. But IR teams can and should be on top of changes in the shareholder base, serve as a source of information on up-to-date investor sentiment, and refine the annual IR plan if certain underlying assumptions have changed because of a recession. You know your power as an IRO; make sure your superiors do as well.”

Credibility for an IRO also comes from carefully managing IR budgets, a process that can be tougher in a recession (or a period like 2022 with rampant cost inflation). The advice here is to be strategic.

Said one IRO: “For most companies, the IR budget is completely immaterial. But it’s still important to secure the funds you need to maintain a professional presence in the market and protect those funds from budget cuts. In any kind of a down market, the worst thing to do is to shut down dialogue with shareholders because you don’t have the people resources to execute. But remember not to overspend your budget either. That’s never good when other parts of an operation are being asked to tighten up.”

Final Thoughts

Recessions are part of a natural economic cycle. According to the National Bureau of Economic Research, U.S. equity markets have been in recession 14% of the time since the end of the Second World War.

Rather than treating the R-word as a crisis, it’s best to prepare your defences and keep moving forward with a long-term IR plan adjusted to meet current realities as they arise.

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