Living with stocks: Which corporations are most indebted

When the Federal Statistical Office presented the preliminary inflation data for August on Wednesday, investors followed the data with excitement. The rate of inflation in some important federal states exceeded expectations. The result: the Dax gave way slightly. The bottom line is that the figures from Wiesbaden provided relief. At 6.1 percent, inflation fell slightly compared to the previous month.

While inflation is beginning to recede, interest rates remain high. The US base interest rate is currently 5.25 percent, the main refinancing rate of the European Central Bank (ECB), which is decisive for the EU, is 4.25 percent. These are the highest values ​​for almost 15 years. This moves the stock markets – for several reasons.

First is the value of a company equal to the sum of its discounted future earnings. When interest rates rise, they must be discounted at a higher rate. Thus, the present value falls even if the expectation of future returns remains constant.

Secondly the probability increases that finance ministers will at some point also want to optimize the revenue side if their states have to borrow more expensively because interest rates are rising. In plain language, this means that tax increases could soon be demanded, especially in over-indebted countries.

And third companies also have debts that need to be serviced and eventually repaid. Rising interest costs weigh on income. And high repayment or refinancing costs restrict entrepreneurial freedom. The money is then missing for investments in research and development, for example.

This is where the mountains of debt are highest

But what about the financial freedom of companies? We analyzed the Stoxx Global 1800, which tracks 600 companies each from North America, Europe and the developed countries of the Asia-Pacific region, in terms of net debt.

Since financial stocks already have debt and refinancing in their DNA, a comparison with other sectors makes little sense here. What is striking about the other values ​​is that three out of four companies have debts on balance. Conversely, a quarter of companies have more cash than debt on their books. From a regional perspective, there are notable differences: In Japan, 40 percent of companies are net cash positive – a unique selling proposition. In Europe and Asia as a whole, only one in five companies is debt-free.

In a sector comparison, the technology sector stands out, in which the majority of companies are net debt-free. It is striking that the indebted companies have recently tended to weaken, such as IBM, Intel and Corning. But there are exceptions like Oracle and Broadcom. One thing is certain: it is worth taking a closer look at indebted tech companies.

The healthcare sector and manufacturers of cyclical consumer goods, such as car manufacturers, are also well capitalized. In contrast, utilities and real estate stocks all have net debt. Even in the case of basic materials, there are only a few with a thick cash cushion – including three German companies with Aurubis, K+S and Thyssenkrupp.

How investors classify the debt correctly

Debt doesn’t have to be a bad thing, it’s an element of the capital structure. Companies that hoard capital instead of using it do not create value for shareholders. However, it is important that companies are not overwhelmed by their debt. Debts must therefore always be considered in relation to each other. Either to balance sheet sizes, i.e. the ratio between equity and debt capital. Or to profit, for example to operating earnings before interest, taxes, depreciation and amortization: the much-cited Ebitda.

A rule of thumb is: net debt three times the amount of Ebitda is still tolerable. If necessary, the company could completely pay off its net debt with three annual profits. Those companies in the Stoxx Global 1800 that have net debt have a median of 3.3. Here, too, there are large differences between the sectors: the median Ebitda debt of the utilities is 5.2. On average, companies in the energy sector are only indebted with simple Ebitda.

These differences are a reflection of the earnings stability. But one has to ask oneself whether investors will tolerate such a large upward deviation in the current interest rate environment for much longer. It is quite possible that the energy sector in the form of oil and gas companies will be more attractive to investors in the medium term than conventional suppliers.

But it is also important that averages say nothing about individual cases. 20 percent of the companies in the index examined operate beyond the debt limit of triple Ebitda. 14 percent are even more than four times Ebitda in debt. A good one in ten companies would need at least five times the annual profit before taxes, interest and value adjustments in order to pay off their debts in full – these include by no means only utilities and real estate values.

Depending on business activity, Ebitda is fairly cyclical. Especially when the economy is weakening for a long time, a company’s operating income can quickly be halved. Therefore, when it comes to classifying debt, it’s always a good idea to look at earnings history, and perhaps use a five-year average EBITDA (or even a five-year minimum) rather than a trailing-12-month figure. It was perhaps still influenced by a good economy – that is a possibility, especially in the industrial sector.

In the podcast, Horst von Buttlar and Christian W. Röhl talk about the new BRICS members and whether it is worth investing there. It’s also about debt, cigarettes and avocados. Listen now.