Balance sheet overconfidence

A bit technical this one. Business Spectator column about the health of Australia's companies. All good...for now.

Balance sheet overconfidence

Corporate Australia's balance sheets are now showing virtually no vestige of the credit crunch, but they are by no means home and hosed.

Australia confirmed its status as the great escape artist in the most emphatic way this week. While most central bankers are still assuring their constituents that they had no immediate intentions to withdraw support measures, the RBA thrust us atop a pedestal by becoming the first of the G20 nations to lift rates.

But nowhere is the ability of the Australian economy to dodge a bullet more evident than in the financial metrics of Australia’s largest corporations.

Be it by good luck or good management, there are no remnants of the stress of the past two years in the sets of statistics presented by Fitch Ratings at a recent market gathering. The agency says that although gearing levels remain elevated, cash has continued to flow and credit metrics are healthier than during the last downturn in 1992.

Part of this perky outcome for Australia’s corporates is down to what Fitch calls "the residual positive impact of the resources boom" as China continues to scale up economic activity. Australia is well endowed and well positioned in the current circumstances and corporate balance sheets are benefiting.

The big get out of jail card dealt to local treasurers, and one which credit investors are grateful for, is our deep and liquid equity markets. While banks and bondholders ran for the hills, equity investors were happy to recapitalise those companies with stronger business models but whose financial profile was impaired by the downturn.

This cash injection, equal to over 10 per cent of total shareholder funds, pushed debt ratios back to 2006 levels. Without this backing, debt to earnings would have soared to a 1992 number.

With the help of the massive equity raising and a timely re-opening of bank and debt capital markets, treasurers have to some extent managed their liquidity profiles and ensured that most of their looming debt is refinanced.

But it is not time to celebrate. Finding bears at a credit rating agency gathering is not hard (it is the job of a credit analyst to fear the worst) and there is much for corporate Australia to be concerned about.

While the property sector has found its way back into favour, it continues to worry some. Commercial property values remain opaque due to a fairly dysfunctional market, while the inherent structure of AREITS means that companies are obliged to pay out most of their profits. The leverage of the sector becomes apparent when comparing like-rated corporates. While a firm like Foster's can easily pay back all its debt in several years, it would take Westfield – the most lauded of property firms – well over 20 years, even if it was allowed to halt all its dividends to clear its debt.

Another sector that has attracted attention is the energy and utilities sector. Steve Durose from Fitch ratings points out that firms in this sector are likely to need a combination of both debt and equity to meet the massive capital expenditure requirements to maintain networks' security of supply and to transition to a lower-carbon electricity generation mix. Expect to see deals done in both local and international capital markets to support the increased need for new funds.

Many of the other sectors should be alright and could benefit from the booming offshore bond markets. Borrowers in non-cyclical sectors are finding plenty of interest in their bonds. An Australian dairy firm recently tapped markets at margin that was almost half that paid by property trust Dexus, while demand for beverage companies’ bonds is said to be strong. In the domestic market, Wesfarmers has seen its bonds sought after, and perform much better than some of the other new issues, due mainly to its non-cyclical retail assets. And overnight, telco Optus priced ten year bonds 32 basis points inside of Commonwealth Bank, considered among the safest in the world.

Refinancing still remains an issue for many corporates. As James Wadell, director of capital markets origination at NAB noted: “The price that you pay on a bond issue is not important, it is the ability to access the market, and for some that access is still not there.”

Fitch estimates that over $A223 billion of refinancing needs to take place until the end of 2012, most of which is bank debt. More imminent, the ‘twin towers of debt’ loom with large spikes of corporate debt maturing in 2010 and 2011.

This massive task is for the most part expected to be handled. The figure is distorted to some extent by facilities that may never be used, and a winding down of capital expenditure in the material sector will increase the ability to pay down debt.

While the credit crunch doesn’t show in the aggregate stats, treasurers will be humbled by the experience. One lesson they would have learnt is that concentration of maturities and markets will cause headaches down the line. This could result in a strategy of tapping more markets, more frequently and in smaller amounts to smooth out debt profiles and avoid refinancing spikes.

And it is not only corporations that should be wary of celebration.

Despite the chest beating that this week’s rate rise brought, Fitch still has Australia’s foreign currency sovereign rating below AAA to reflect the reliance of our financial institutions on the continuous functioning of offshore debt markets.

Local corporates also face significant uncertainties in the context of the broader economy.

Sarah Percy Dove, Colonial First State’s head of credit research, comments: “We see the rally continuing across all risk assets until government stimulus is removed globally. There is a general acknowledgement among policymakers that it must be done. The unexpected consequences however remain to be seen.”