Debt policy: changing attitudes to leverage
Tuesday, 18th September 2007 by Real IR
Clarity is needed. Our panel of experts offer their views on leverage and the implications of a credit crunch.
Glenn Cooper, chairman, Efficient Capital Structures
“Before we approached Vodafone proposing that the group take on more debt, we polled investors to find out their attitudes to leverage.
"The results revealed wide acceptance in the UK that large companies are in a position to take on more gearing and release shareholder benefit.
“Vodafone has slightly less than two times debt to Ebitda; our resolution is pitched at 4.5 times debt to Ebitda.
"To put it in perspective, it is common for private equity under current conditions to gear companies to eight to ten times Ebitda.
"That is not appropriate for a listed company but it is possible to go higher than two. What I want to understand is by how much and in what way.
“Private equity is able to accrue great increases in value by stripping out non-core assets and making balance sheets more efficient through loans and gearing.
"The balance sheets of large quoted companies are too comfortable.
"That means a nice quiet life for management but companies are obliged to deliver value and with increased gearing you see faster earnings growth. It is also more efficient to pay interest on bonds than paying dividends post-tax.
“More stress on the balance sheet doesn’t take away all borrowing capacity, it just means that management might have to come to shareholders to raise capital.
"If a company is so secure that it never has to come to shareholders for anything then something is inefficient.
“I am not advocating high leverage. There are clear dangers from high gearing. A company needs powerful repeating cash flows otherwise things can go wrong.”
Henri Alexaline, senior credit analyst, BNP Paribas
“In the industrial sector, which is a cyclical sector and therefore a good proxy for the rest of the economy, there has been increasing complacency about taking on debt during the past three years.
“Attitudes tend to change with the cycle. In the late 1990s, companies made a lot of acquisitions and overpaid for them.
"Then, during the recovery of 2002-04, there was a credit improvement as companies cleaned up their balance sheets and deleveraged.
"Now, with the resurgence of private equity looking for assets and debt becoming less expensive, companies have started releveraging.
"What is disappointing is that they are using debt to return cash to shareholders, rather than using it to grow organically or investing in companies without having to overpay.
“There has been a trend of companies that used to have single A credit ratings to move to BBB because it doesn’t affect their cost of capital in the current climate.
"The difference is 0.1-0.2 per cent but it won’t be like that forever. Home Depot in the US recently dropped three rating notches and then returned a couple of billion dollars to shareholders through a share buyback.
“The amount of leverage a company can take on depends on its sector but for a utility or a company that is not under competitive pressure it could take up to seven or eight times debt to Ebitda.
"But the issue is not how much it costs today to have high leverage, it is about what happens if there is a credit collapse. I expect to see default rates start to pick up and there are signs of that in the US already.”
Michael Mainelli, executive chairman, Z/Yen
“The problem for companies that have the objective of staying in public ownership at the moment is that debt is too attractive.
"That undermines the effective functioning of the equity market even though people claim that we have very equity friendly global markets.
“Many European companies are wary of taking on too much debt and high leverage is generally less acceptable than for US companies.
"But what investors and analysts are really looking for is certainty. They want to know that companies have a clear debt policy that won’t be changed willy-nilly.
“Taking on debt can be in the interests of shareholders. It benefits those investors who want cash returned through dividends but it also increases financial risk and therefore increases the volatility of shareholders’ earnings.
"When a company gears up, it changes the investment position. High or low leverage doesn’t necessarily matter as long as it is stuck to. But most firms are pretty poor at communicating debt policy.
“We have seen a record credit splurge internationally but people are becoming conscious that it is probably coming to an end.
"Covenants are being imposed that would not have been required six months ago. The availability of bridging finance has been enabling private equity to get large deals through but that too may be drying up.
"Many of the big deals that are in the headlines now have been in the pipeline for some time.”
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