Secondary capital-raising activity has continued to chug along this calendar year with an average of $2.88 billion raised each month, including $5.1 billion in October. Despite this, larger and smaller companies have begun to diverge in terms of their attitude towards debt. Average gearing levels for Australia's listed corporates began to rise again in the most recent financial year after two years of concerted effort to strengthen balance sheets.
The average ASX-listed entity's total debt/equity ratio declined to 47 per cent in FY11, from 75 per cent in FY09, then edged up to 48 per cent in FY12. But the average figures hide the movements of larger companies, which have swung back towards debt in a far more significant manner. On a market-cap-weighted basis, average debt/equity was slashed to 44 per cent, from 72 per cent, after the financial crisis, but in FY12 it shot up to 54 per cent.
Nineteen of the top 25 stocks increased their total debt/equity ratio, while among companies with market capitalisations between $50 million and $1 billion, only 29 per cent increased this gearing measure.
Of course, while we'd like to think this reflects the robustness of all these small companies, it also likely reflects, in part, the restricted availability of credit.
A similar trend is evident when we look at debt serviceability. The interest cover ratio (EBITDA over interest expense) has improved for both the average and median ASX-listed company. Yet when we weight by market capitalisation, there is a notable decline in FY12. Of the top 25 companies, 44 per cent lowered their interest cover in FY12, compared with only 16 per cent with sub-$1 billion market caps. Not that it has any alarm bells ringing - market cap-weighted average interest cover has declined to a still robust 30 times, from 41 times.
Looking beyond data for listed companies, data from the Reserve Bank and Australian Bureau of Statistics shows a 9 per cent increase in loans and other liabilities held by private non-financial corporations in FY12. Bank loans rose by 9.5
per cent.
Reducing things to the most basic of forms, return on equity can be improved one of three ways (as set out in DuPont analysis): increasing turnover increasing margins or increasing financial leverage. In this low-growth environment, financial leverage is the only obvious lever large companies can pull.
Running through the FY12 figures, three of the six companies with the largest changes in percentage gearing were infrastructure owners (and five of the top 20) who had hard assets to borrow against. Only two of the top 20 had increased leverage as a result of funding substantial M&A (telecommunications challengers iiNet and M2 Telecommunications).
While talk of lazy balance sheets may have recommenced (cynically we might note that banks are seeking to grow their business loan books to cover for mediocre growth in consumer debt), we continue to favour companies with lower debt levels. Low gearing not only means a more secure position for equity holders but significant option value for the company: it provides the option of pursuing an accretive acquisition the option to increase dividend payments to shareholders and the option to increase gearing at a later date, potentially an important point for larger suitors seeking to buy growth.
Of the 28 industrial and financial stocks we have under coverage, 10 held net cash positions at June 30. Among these 10 are some of the best performed ASX listings in the post-GFC environment:
Jumbo Interactive (JIN - $16.4 million net cash at June 30). Has returned 330 per cent over the past three years.
Lycopodium (LYL - $24.6 million, 124 per cent).
Webjet (WEB - $33.8 million, 122 per cent).
LaserBond (LBL - $1.4 million, 59 per cent.
Academies Australasia (AKG - $200,000, 50 per cent).
ClearView Wealth (CVW - $50 million, 26 per cent over the past year).
These returns are just the share-price appreciation - all of these companies have paid respectable dividends as well. For the most part, these companies have grown organically and in a methodical, progressive manner. They had sound business models that to varying degrees have proved scalable. They have not needed to gear up for acquisitions to satisfy market expectations for growth.
It is difficult to find large companies in such a position.
Martin Pretty is head of research at Investorfirst Securities. mpretty@investorfirst.com.au
Frequently Asked Questions about this Article…
What does 'low gearing' mean for everyday investors and why does it matter?
Low gearing means a company has relatively little debt compared with its equity (a low debt/equity ratio). The article says low gearing gives equity holders a more secure position and adds option value for the company — for example, the ability to make accretive acquisitions, raise dividends, or increase leverage later. For everyday investors, that typically means less balance-sheet risk and more flexibility for future growth or shareholder returns.
How have gearing levels changed for ASX-listed companies recently?
According to the article, the average ASX-listed company’s total debt/equity fell to 47% in FY11 (from 75% in FY09) and then edged up slightly to 48% in FY12. However, when weighted by market capitalisation, average gearing fell to 44% after the financial crisis and then rose to 54% in FY12, showing larger companies have pushed leverage higher more recently.
Why do market-cap-weighted gearing numbers differ from simple averages, and what does that mean for investors?
Market-cap-weighted figures give bigger companies more influence. The article points out that while simple averages showed only a small rise, market-cap-weighted debt/equity jumped from 44% to 54% in FY12 — meaning large companies have increased leverage more than smaller ones. For investors, that signals you should look beyond headline averages and check how much debt the largest holdings in an index or portfolio are carrying.
What is interest cover and what are the recent trends in debt serviceability?
Interest cover is EBITDA divided by interest expense and measures how easily a company can pay interest on its debt. The article notes that average and median interest cover improved overall, but market-cap-weighted interest cover declined in FY12. Specifically, market-cap-weighted interest cover fell from 41 times to a still-robust 30 times, and 44% of the top 25 companies lowered their interest cover in FY12 versus only 16% among sub-$1 billion companies.
Which types of companies have increased gearing the most, and why?
The article says infrastructure owners have been among the biggest increasers of percentage gearing — three of the six largest changes and five of the top 20 were infrastructure companies that could borrow against hard assets. Only two of the top 20 raised leverage to fund substantial M&A (telecommunications challengers iiNet and M2 Telecommunications).
Can companies improve returns without increasing debt, and what does the article say about the alternatives?
Yes. The article references DuPont analysis: return on equity can be improved by increasing turnover, increasing margins, or increasing financial leverage. In a low-growth environment, the article argues financial leverage is the obvious lever for large companies, but it also highlights the appeal of companies that have grown organically and methodically without needing to gear up.
Which ASX companies does the article highlight as having low net debt or net cash positions?
The piece says that of 28 industrial and financial stocks covered, 10 held net cash at June 30 and highlights several high performers with net cash: Jumbo Interactive (JIN) – $16.4m net cash and 330% return over three years; Lycopodium (LYL) – $24.6m and 124%; Webjet (WEB) – $33.8m and 122%; LaserBond (LBL) – $1.4m and 59%; Academies Australasia (AKG) – $200,000 and 50%; ClearView Wealth (CVW) – $50m net cash and 26% (over the past year). The article also notes these companies paid respectable dividends and largely grew organically.
How should everyday investors use gearing information when selecting stocks?
The article recommends favouring companies with lower debt levels because they offer more security for shareholders and valuable strategic options (acquisitions, higher dividends, or increased gearing later). For practical investing, check a company’s debt/equity ratio and interest cover, consider market-cap-weighted trends if you hold large-cap stocks, and look for companies that have grown organically without relying on heavy borrowing.
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