Most investors, and much of the commentary in markets, focus on the earnings of listed companies. There are thousands of earnings measures (some suspiciously creative), and many ways to interpret them. There is also a huge focus on the valuation of these earnings.
But good investing is also about being able to avoid large losses, and in this respect there is often not enough discussion around company debt.
As the world goes through a tough economic period, interest rates rise and consumers tighten their belts, the analysis of listed company debt becomes more and more pertinent.
Put succinctly, profitable, cash-generative companies without debt are highly unlikely to go bankrupt overnight.
Thus more debt (and less in terms of profits) often correlates with higher financial risk.
For this reason, I am going to unpack some common debt ratios and highlight which JSE stocks have these ratios in dangerous territory (on a gross debt basis, but one can and should take cash out of these ratios to arrive at net ratios).
Interest cover ratio (ICR) = Ebitda/interest expense
How to calculate it: A range of earnings measures can be used to calculate the ICR, but the most common is to take earnings before interest, tax, depreciation and amortisation (Ebitda) – considered an accounting pre-gearing cash proxy – and divide it by the interest expense.
What it means: This measure indicates by how much profits (and linked cash flows) can fall before the company will struggle to service the interest accruing from its debt (it ignores capital payment). At worst, a company may freeze capital repayments and just keep servicing the accruing interest expense in perpetuity.
|JSE stocks with the lowest ICR (non-negative/non-zero)|
|LUX||Luxe Holdings Ltd||0.10x|
|SSK||Stefanutti Stocks Holdings Ltd||0.10x|
|EEL||Efora Energy Ltd||0.30x|
|ASC||Ascendis Health Ltd||0.40x|
|TGO||Tsogo Sun Hotels Ltd||0.60x|
|WEZ||Wesizwe Platinum Ltd||0.60x|
|BUC||Buffalo Coal Corporation||0.70x|
|NUT||Nutritional Holdings Ltd||0.70x|
|MKR||Montauk Renewables Inc||0.90x|
|REB||Rebosis Property Fund||1.00x|
Source: Profile Media
Debt/Ebitda ratio = debt/Ebitda
How to calculate it: Once again using Ebitda, take debt and calculate what percentage of a company’s annual Ebitda that debt is.
What it means: This is a measure of how many years’ Ebitda it would take to pay off the capital owed by a company.
Put differently, this is how many years’ profit shareholders may lose to pay off a company’s debt.
JSE stocks with the highest debt/Ebitda ratio
|Code||Name||Net debt/Ebitda||Gross debt/Ebitda|
|CCO||Capital & Counties||17.4x||26.3x|
|SRE||Sirius Real Estate||9.7x||11.1x|
|FFA||Fortress Reit A||9.3x||9.6x|
|FFB||Fortress Reit B||9.3x||9.6x|
Debt-to-equity (D:E) ratio = debt/shareholder equity
How to calculate it: If you take the debt and divide it by equity, you get to see what percentage of assets are financed by debt in a company.
What it means: This ratio shows what percentage of each R1 of a company’s assets is financed with debt versus shareholder equity. If a company was to liquidate, the more debt that has financed assets relative to equity implies that there will likely be less left over for shareholders.
JSE stocks with the highest D:E ratio
|JSC||Jasco Electronics Holdings Ltd||990.1%|
|NHL||Nictus Holdings Ltd – Namibia||812.8%|
|PIK||Pick n Pay Stores Ltd||791.2%|
|WHL||Woolworths Holdings Ltd||547.7%|
|AVL||Advanced Health Ltd||473.1%|
|TXT||Textainer Group Holdings Ltd||381.1%|
|WEZ||Wesizwe Platinum Ltd||356.3%|
|TSG||Tsogo Sun Gaming Ltd||317.2%|
|REB||Rebosis Property Fund||298.5%|
|SPP||Spar Group Ltd||296.9%|
|MCG||Multichoice Group Ltd||245.4%|
|PSV||PSV Holdings Ltd||235%|
|CLH||City Lodge Hotels Ltd||234.7%|
|FBR||Famous Brands Ltd||227.2%|
Source: Profile Media
Debt-to-assets (D:A) ratio = debt/total assets
How to calculate it: Much like D:E above, take debt, but this time work it out as a percentage of assets of a company.
What it means: This is similar to D:E, as it shows you the balance sheet underpin that a company has borrowed against, but this time focusing only on the company’s assets.
|JSE stocks with the highest D:A ratio|
|TSG||Tsogo Sun Gaming||63.9%|
|PIK||Pick n Pay||56.7%|
|SRE||Sirius Real Estate||42.7%|
|IPF||Investec Property Fund||40.1%|
Source: Profile Media
While useful, all these ratios have their shortcomings.
Highly profitable companies doing share buybacks, for example, can ‘eat’ up their own equity, making their D:E ratios artificially high, while actually being low-risk companies themselves.
Likewise, many companies do not have their most profitable assets on their balance sheet (such as employees or undeveloped mineral resources), thus distorting D:A ratios.
Finally, solvency (which debt analysis reveals) is not the same as liquidity, thus even lowly-geared companies can hit speed bumps if their cash flows and near-term liabilities are not sufficiently covered.
Despite this, it remains relevant – and is likely to become more so – for investors to consider the downsides, risks and, indeed, the debt of the listed companies they are considering investing in.