Companies went into COVID-19 leveraged up to the eyeballs

Companies around the world went into the COVID19 pandemic carrying heavy debts, with global corporate borrowings hitting a record $12tn in calendar 2019.

The money was going into takeovers, share buybacks and dividends as companies tried to lift shareholder returns in a flat market, according to a report by asset management group Janus Henderson Investors.

It said debt levels were up 8.1 per cent in 2019 over the prior year, thanks to ultra cheap interest rates.

Borrowing is continuing apace as companies contend with the fallout from the COVID-19 pandemic. The investor group predicts corporate debt to rise by 12 per cent this year, or $1.45tn.

“Companies today owe almost two fifths more than they did in 2014, and growth in debt has comfortably outstripped growth in profits,” the Corporate Debt Index found.

“Pre-tax profits for the same group of companies have risen a collective 9.1 per cent to $3.3tn.”

The Corporate Debt Index covers the largest 900 non-financials in the world.

Boom in bonds

Janus Henderson analysts believe corporate bond markets will fly as companies wean themselves off government support.

“Acquisitions, share buybacks and dividends each funded by debt often precede an economic downturn. This has certainly been the case this time round. As the global recession takes hold, profits and cash flow will be sharply lower,” said Jay Sivapalan, head of Australian Fixed Interest at Janus Henderson.

“As the economic cycle came to an abrupt end this year, companies faced the downturn with record borrowings. They have now scrambled to issue new bonds and borrow from banks to ensure they have enough ready cash to weather lockdowns of varying severity around the world.”

“With market conditions calmer, thanks to central bank support and a gradual reopening of economies, companies will want to reduce their reliance on state hand-outs, so we expect bond issuance to rise further.

But just as banks begin to find out who can pay their mortgage and who can’t, bond holders are beginning to find out who can pay their debts, and who can’t.

‘The most infamous bond issuance today is Virgin Australia’s $325m of AUD bonds and $US425m of high yield bonds sold last year to buy back its Velocity frequent flyer program.

The company collapsed and administrator Deloitte chose a proposal by private equity firm Bain over one pitched by bond-holders.

Sivapalan is looking for signs that a company is strengthening its position when conditions improve, such as using surplus cash flow to pay down debts rather than spending it or issuing new shares to rebalance the financing mix between equity and borrowing.

Who owes who the most?

The report found Australian companies have higher borrowing levels than its neighbours, but lower levels of debt compared to the rest of the developed world.

Net borrowings in Australia fell from$124bn in 2014 to $87bn in 2019. Industrial companies were the most indebted, followed by those in the materials industry and media.

Australia’s most indebted companies are Telstra (ASX:TLS) and Transurban (ASX:TCL).

Matt Gaden, head of Australia at Janus Henderson, says the provided companies have enough cash to bridge the lockdown gap, corporate bonds returns may look increasingly attractive to investors.

Australia’s bond market is dominated by the banks, with just a small handful of large companies issuing corporate debt.

A Senate inquiry into the Development of the Australian corporate bond market is currently reviewing submissions, which closed in May.

One of the key reasons for the lack of market depth here was that locally issued bonds are taxed more heavily than capital appreciating assets such as equities, or than internationally issued bonds.