How vulnerable are FTSE 100 debt levels?
12:54, 18 March 2022
Which FTSE 100 stocks (UK100) can shield themselves from higher interest rates? Soaring oil and commodity prices, plus a cheap pound, generally support the energy and mining-intensive FTSE 100 index.
Monetary policy is on the move though and it’s not so easy going. More indebted UK-listed companies have been kept alive by unprecedentedly low interest rates, pinned to the ground for years.
War-time pressures
Debt-to-equity ratios can work out how much any company owes, but revenue risk and a company’s business model vary hugely. Comparing a miner’s debt-to-equity ratio with, say, Lloyds (LLOY), is of limited use.
Pulling rare earths or gold out of the ground is far riskier than making a business on loan margins. Above ground, banks like Lloyds – up 15% over a year – benefit from rising interest rates. But their business is umbilically tied to the economy.
And a war in Europe means higher defence spending and cost pressures are seeping into the economy from other directions. These aren’t normal times.
What is your sentiment on UK100?
Mine the debt
Recent record profits from miners and oil companies mean, inevitably, lower debt. So consider miners BP (BP), Shell, Rio Tinto (RIOus) and Anglo American (AALI), for example, says content writer and market analyst David Morrison from Trade Nation.
But he warns on getting too near companies close to consumer discretionary spending. Retail, travel and leisure stocks remain vulnerable as they’re simply less able to pass on price rises to customers.
And while mining and commodity stocks are having their moment now, a slowdown in China could cause significant damage, warn other analysts.
Which returns us to banks – like HSBC (HSBA), with strong Asian interests. The FTSE 100 is highly exposed to overseas earnings and emerging markets, in particular, are exposed to rising interest rates (more of shortly).
Debt lite isn’t always good
- If a company has total liabilities of, say, £20bn ($26.2bn) and shareholder equity of £10bn, then the debt-to-equity ratio works out at 2.0.
- Unilever, for example, had a 2.80 debt-to-equity ratio at the end of 2021, according to Macrotrends.
- A debt-to-equity ratio doesn’t give the full picture; low debt might mean low-growth prospects. Much depends on where the company’s growth path is – debt levels are an arbitrary science.
Debt damage risk? Think FTSE 100 dividends
Morningstar says recent positive dividend news is where confidence still reigns. It cites pest control player Rentokil Initial (RTO), upping its payout by 18% from 2020, in particular.
Other FTSE 100 companies increasing their dividends include asset manager Schroders (SDR), chemical company Croda (CRDA), Bunzl (BNZL), London Stock Exchange Group (LSE), WPP (WPP) and engineer Spirax-Sarco (SPX), Morningstar said yesterday.
Debt, good and bad
- Cash loses its real-term value when inflation is running hot. With UK inflation at 5.5% (CPI) and interest rates at 0.75%, the real interest rate is -4.75%.
- However, debt also loses its value in real terms too. So you’re paying down debt in a ‘devalued’ currency, in real terms – which is not so bad.
Did corporate debt climb in the pandemic?
The Bank of England says UK corporate debt in the UK climbed by £79bn between the end of 2019 and the first quarter of 2021 – a rise of around 6% in total corporate debt compared to pre-pandemic levels.
Debt for large, listed companies debt didn’t increase significantly it says. Much smaller companies were more heavily impacted. Companies’ cash holdings rose by £152bn, or 29%, since the end of 2019.
Rate swivel?
It’s less clear how far UK rates will rise. In contrast to the Fed, which last night indicated it could hike rates close to 3% next year, the MPC is more worried about downside risks to growth and inflation says Paul Dales, chief UK economist at Capital Economics.
“In other words, the MPC appears less convinced now than it was in February that rates need to rise very far. It may be that the Bank raises rates to 1.00% or 1.25% and then stops due to fears that it will go too far and cause a recession.”
Break-up risk
Investment director at AJ Bell, Russ Mould, thinks future UK interest rate rises may be limited also.
“My guess – and it is a guess – is that the Bank of England won’t get too far with rates before something breaks – economy or markets – and it will back off and leave us to take our chances with inflation.”
He cites the US Federal Reserve’s experience in 2017-19 before the economy slowed “and the repo rate [debt repurchase agreements for cash] began to surge”. Result? The financial plumbing got totally clogged up.
Elsewhere? Yesterday’s Bank of England guidance still expects modest further tightening said Deutsche Bank this morning, “albeit with risks around that path being much more two-sided than they previously were”.
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