KEY POINTS:
Debt has been one of the major issues at the latest round of company result presentations.
This is consistent with other countries, particularly Australia, where companies with high debt levels have fallen out of favour with investors.
It is a turnaround from a few years ago when
analysts were criticising companies for having too much equity and not enough debt. Analysts and investment bankers argued that these "lazy balance sheets" were not conducive to capital repayments and wealth enhancing acquisitions.
Several companies succumbed to this pressure and borrowed heavily to acquire assets, make capital repayments or even pay dividends.
These high debt strategies are now having a negative impact for several reasons including:
Bank lending is contracting and banks are beginning to ration loans with the most worthy borrowers receiving priority.
Corporate earnings are falling and, as a consequence, some companies are breaching their bank covenants.
Debt amplifies earnings movements, it increases the upside in good times and the downside in recessions.
Several companies have borrowed from international syndications that specialised in securitised debt instruments. These loans will not be rolled over when they mature and borrowers will have to refinance in New Zealand. This will create further competition for loans, particularly as the Government will also be a big borrower.
The competition for funds is one of the main reasons there are a large number of corporate bond issues at present. Companies are raising long-term debt from public markets because they are becoming increasingly frustrated with the banks and their unwillingness to enter long-term loan agreements.
The accompanying table ranks the debt position of several listed companies that have had profit announcements or debt level issues in recent weeks.
The 18 companies are ranked on the basis of the net debt to net debt+equity ratio, which is a company's borrowings minus cash, relative to the book value of its total equity. Corporates with a low percentage ratio have relatively little borrowings whereas those at the bottom of the list are relatively highly geared.
The first point to notice is that the median gearing ratio of these companies has fallen slightly, from 35.8 per cent to 35.5 per cent, over the past twelve months.
There is no hard and fast rule as far as gearing ratios are concerned because each industry and company has a different earnings and risk profile but it is probably fair to say that companies with gearing below 30 per cent are in good shape and those in excess of 40 per cent probably need to retire debt in the current environment.
NZX, which announced an excellent full year result on Monday, has $8.3 million of cash and no debt. The NZX's balance sheet is far less important than the intellectual capital and drive of chief executive Mark Weldon and his staff.
Air New Zealand announced an 84 per cent decline in normalised earnings for the six months ended December 31 but it is facing the recession with a strong balance sheet.
The carrier has a gearing ratio of only 6.2 per cent, with $1.4 billion of bank deposits and $1.5 billion of debt. Qantas had a 37.9 per cent debt ratio as at December 31 although it has had an equity raising since then.
One of the bright spots of the week was the Pumpkin Patch results presentation, which was fronted by chief executive Maurice Prendergast and chief financial officer Matthew Washington.
The children's clothing company has had a tough time - with its share price going from a high of $4.95 in January 2007 to $0.78 earlier this month - and Prendergast and Washington have often been grumpy and lacking in enthusiasm at analysts' presentations. But there was u-turn on Tuesday when the two executives gave a more energetic presentation although they did warn that trading conditions, particularly in the United States, remain difficult.
The big change from last year is that Pumpkin Patch is facing the recession with much more determination and decisiveness and its gearing ratio has been cut from 37.9 per cent to 16.6 per cent.
Port of Tauranga, Sky Television, Contact Energy and Mainfreight have relatively low debt levels although the latter two have geared up in the past 12 months.
Fisher & Paykel Appliances' net debt to net debt+equity ratio looks relatively conservative at 34.9 per cent but there has been a substantial increase in borrowings since the September 30 interim balance date. The table's right hand column, which calculates equity on the basis of a company's sharemarket capitalisation rather than book value, shows that the company has the second worst gearing after Nuplex on this market value of equity basis.
The right hand column, which is arguably more realistic than the other two, shows that investors have a totally different view of the two F&P companies. They have the same 34.9 per cent gearing ratio but when the market value of equity, rather than the book value, is taken into account F&P Appliances has a 70.7 per cent net debt to net debt+equity ratio whereas F&P Healthcare has just 5.5 per cent.
Concerns over Nuplex's debt levels were confirmed this week when the company said it was "considering the merits of issuing ordinary equity" and was not paying an interim dividend.
The company's share price, which peaked at $7.81 in October 2007, slumped a further 11.1 per cent, to $1.20, following the announcement. Market reaction to the earnings announcement was negative because Nuplex did not reveal any specific debt reduction strategy.
The response to PGG Wrightson's interim result and presentation, which was particularly well attended, was more positive because the company had signed a new deal with its banks earlier that day and chairman Craig Norgate was upbeat and positive.
But the company is not out of the woods yet as it has committed to repay $125 million of bank debt by December 2010, its major shareholder also has funding problems and its Uruguayan dairy farming operation needs a major capital injection.
Norgate is a visionary and innovative businessman but his execution, as demonstrated by the failed Silver Ferns Farm deal and Uruguayan farming problems, is less than perfect. He could end up with the same end result as Bruce Judge or some of the other visionary leaders of the 1980s unless several experienced and strong willed directors are appointed to the PGG Wrightson board to ensure he focuses on one new expansion at a time.
SkyCity has a particularly high gearing ratio and most of its loans have been acquired through offshore syndicates. One of the company's big challenges is the $485 million of syndicated loans that mature in June 2012 as these will have to be refinanced by either bank debt or bond issues.
The good news for SkyCity shareholders is that the company has strong cash flow and a much lower gearing ratio when its equity value is assessed on the market, rather than a book basis.
Freightways has the highest gearing ratio, with 72.1 per cent. This is a legacy of its IPO, which was a sell down by the hedge fund ABN AMRO Capital (Belgium). The former owners left the company with a gearing ratio of 67.6 per cent, an excellent management team and strong cash flow.
Freightways' high gearing is not a concern but it could restrict its growth potential because the company has received a strong contribution from debt financed acquisitions in recent years. It will be difficult to maintain this debt financed growth strategy because corporate borrowings will be more difficult to obtain in the months and years ahead.
* Disclosure of interests; Brian Gaynor is an executive director of Milford Asset Management.
