Many companies on the Australian Stock Exchange have some debt, but when it is excessive, they are exposed to changes in business performance, industry and the economy. We will look at some examples to see what debt can do, if it is not managed well.
Babcock and Brown, the international investment company, had a share price at it’s high, of $34.78, which dropped to mere cents, and then into the hands of the receivers. At the end of December 2007, it had a debt to equity ratio of 465% which means for every dollar of equity, the company owed $4.65. That is $$2.5 billion equity, owing $11.6 billion in debt (with it’s associated interest bill). And the interest bill? $505 million during 2007, with revenues of $2 billion. That is interest payments were 25% of the sales.
Credit Corp purchases debt ledgers and implements debt collection procedures. It’s debt to equity in 2004 was a ratio of 81.5% which can be managed. But the company added debt each year until by June 2008 its debt to equity was 179.6%. When the economy tightened, the price of Credit Corp crashed from $12.00 in 2007 to 39c 18 months later.
Transfield Services had a share price that plunged from $11.00 to $1.24 with a debt to equity of 200%. They have been able to bring debt down to 95.8%, and lower recently.
Colorado Group has lost its battle to escape from under its $440 million of debt, with a syndicate of 18 lenders rejecting a last-ditch attempt to restructure on 30 March. The company owes another $27 million to unsecured creditors, although exactly how much might be recovered when the Colorado’s various brands – including Colorado, Jag, Diana Ferrari and Mathers – are sold off is unclear. There were also other management issues, but debt a major factor.
“We’ve said countless times that too much debt is a recipe for disaster and in Colorado’s case having a debt load greater than annual turnover proved fatal. Debt reduces your ability to make changes to your business and makes it much harder to respond to shifting consumer trends. But it’s also a giant distraction. Colorado has been negotiating with its lenders, preparing reports into its financial state and generally trying to escape being buried under its debt mountain for months, if not years – which doesn’t make it easy to run a retail group in the toughest conditions in a generation.” James Thomson reported for Smart Company, http://www.smartcompany.com.au/retail/20110331-five-lessons-from-the-collapse-of-colorado-group.html.
Warren Buffet says every year in his company’s annual report that he is looking for companies “earning good returns on equity while employing little or no debt.”
For more information and examples of investing lessons, as well as whether self managed super is for you, come to a free meeting – see the up-coming seminar listed above for more details. See http://ow.ly/4olRZ .