Inventory is an interesting one – it is likely that some companies have been left holding higher levels of inventory as sales dried up, while some COVID-19 beneficiaries such as retailers saw a surge in sales and have struggled with restocking inventory in a short period of time, as called out by Super Retail Group in their results call:

“The actions we undertook in April – March and April … to preserve liquidity position of the business is compounded by the very strong bounce back in sales once restrictions eased, has impacted our in-stock position.”²

It’s important to note that not all companies benefited from strong cashflows during this period – in fact many that were significantly impacted by COVID-19 experienced significant cash outflows and in some cases had major liquidity issues. Webjet (travel) and IDP Education (international students) are two examples of this – both companies experienced a significant revenue drop due to COVID-19 and the working capital outflow was swift, leading to a requirement for a capital raising to restore liquidity³.

In aggregate however, most Australian small cap companies have emerged from COVID-19 with strong cashflows and the question now turns to how long it can last. The factors that have driven the working capital release, namely better receivables collections and lower inventory, are highly unlikely to be sustainable and may reverse at some point over the next few halves. We believe it is worth keeping an eye on cashflow and working capital items at the upcoming results season to see whether this is starting or delayed to future periods. In our opinion, investors should also be mindful of analysing balance sheet and gearing metrics using figures that have been temporarily boosted by a working capital release – there will undoubtedly be companies needing additional debt and/or equity to fund reinvestment in working capital as conditions return to normal.