EDITOR NOTE: A few years back, before the pandemic hit, the big talk on Wall Street was the risk of companies carrying leveraged loans, and the growing number of zombie companies that took advantage of low interest rates to keep funding their life-support mechanisms. Hardly will you hear about those issues in quite the same way these days, but that doesn’t mean they’ve disappeared. With monetary easing and interest rate suppression operating as the rule across the globe, global corporate debt rose to $13.5 trillion last year--many of the companies holding debt as cash reserves. The risk, of course, is the reckoning of revenue and earnings. Holding on to cash for forthcoming investments--or in some cases, malinvestments--is a dangerous wager when a lack of earnings begins to erode on the reserves upon which interest payments are due. Dangerous for the companies that fall into this trap, the situation can be especially detrimental to investors or retirees who hold onto nothing but stocks and bonds--a diversified position in the markets, but not a diversified monetary position which, considering the economy’s current state, should be every investor’s top priority.
Global corporate debt rose 10 per cent in 2020 to a record US$13.5 trillion, according to the latest Janus Henderson Corporate Debt Index.
Based on analysis of the financial reports of 900 of the world’s largest companies, the index shows companies took advantage of low interest rates to issue debt and bolster their balance sheets last year.
With much of the debt held as cash reserves rather than being spent, net debt rose by only 1.8 per cent to US$8.3 trillion.
Holdings of cash and cash equivalents rose 27 per cent to US$5.2 trillion.
Only 40 per cent of companies in the survey increased their net debt. Overall interest cost fell from US$390 billion to US$381 billion.
With the overall fall in corporate earnings last year, the ratio of interest to operating profit rose from 15 per cent in 2019 to 17 per cent in 2020.
Janus Henderson said this ratio is at its highest level in five years but with earnings picking up this year, it expects the ratio to improve.
Janus Henderson predicts that with the combination of high cash balances, general corporate thrift and lower dividends, gross borrowing will not increase much at all this year. In the first half of the year the face value of outstanding corporate bonds was largely unchanged from the end of last year.
However, depending on how much of their cash holdings companies use, net debt may rise. Janus Henderson said it expects half of the surplus cash to be spent this year.
Among industry sectors, utilities increased their debt the most last year, up US$80 billion. This increase had little to do with the pandemic; utilities are investing heavily in the shift to renewable energy.
Transport companies were heavy borrowers, relying on debt to cover fixed costs as revenues for toll roads, airlines and other transport infrastructure collapsed.
The leisure sector was in a similar position.
While most of the indicators in the index were positive, Janus Henderson did sound a warning: “The diversion of free cash flow from capex to debt reduction is a positive in the short term but too little capex over time is detrimental to a business and so can increase credit risk.
Original post from Banking Day