With the economy teetering on the edge of recession and interest rates still climbing, investors are paying even closer attention to the financial health of New Zealand companies.
By in large our biggest listed company balance sheets are in good shape, although firms are likely to face funding challenges in the year ahead, especially small or medium-sized businesses that have less diverse funding sources.
Among NZX50 firms, 47 have drawn bank debt, according to analysis by Chapman Tripp, a law firm. Just three companies are debt free – Winton Property, Pacific Edge and AFT Pharmaceuticals.
Chapman Tripp’s latest funding composition report shows 18 top 50 companies have unsecured bank facilities, including eight within the top 10 index, while 29 have offered security for their bank debt. That number is rising – up three on last year – and the trend is expected to continue as banks are increasingly requiring security as a condition of interest cover waivers.
Size also matters with the report showing 80 per cent of companies in the NZX second 25 have granted security to their banks. This category is also still very reliant on bank debt as their primary source of funds.
Most in the Top 50 have reasonable access to diverse funding and banks are still “pretty supportive”, Chapman Tripp finance partner Cathryn Barber says.
“What we are seeing though is a number of companies are requiring interest cover waivers. With rising interest rates, some of them are needing waivers or changes to interest cover covenants.”
Banks often set covenants on lending based on an interest coverage ratio which measures whether companies can pay their outstanding debts. A covenant breach can lead to a demand for repayment, although often banks will temporarily forgive a breach by granting a waiver.
“Firms are getting those,” Barber says. “Sometimes it is requiring some concessions from the companies, but it is happening across the board.
“When interest rates go up the way they have these covenants were set in a very different environment and so that’s not necessarily a sign of a problem within a company.”
New Zealand companies reacted to the global Covid pandemic with those most affected raising large amounts of equity from investors. Think Auckland Airport’s $1.2 billion equity raise, Air New Zealand’s same amount plus debt and Kathmandu’s $207m raise. Smaller companies like Vista Group also had no trouble raising $65m.
But situations can change rapidly.
Retirement village operator Ryman healthcare provided a prime example earlier this year when it was forced to go to the market to raise capital amid rising interest rates and the slowing economy.
Ryman successfully raised $902m to pay down $709m of US private placement debt, $134m costs associated with terminating the debt agreement early and $16m of negative cost adjustments.
Chief executive Richard Umbers told the Herald’s Markets with Madison video show that the company “certainly hadn’t breached any” debt covenants, but forward modelling showed it was an increased risk so changes were made.
“We certainly weren’t happy with that level of risk into next year,” he said.
Dairy company Synlait is another company feeling the squeeze, having issued its second profit guidance downgrade in the space of six weeks due to falling commodity prices.
Investors are displaying concern over the milk processor’s balance sheet, which is affecting the price of its listed bonds.
The yield on Synlait’s $180m worth of bonds recently topped 14 per cent compared to their coupon rate of 3.83 per cent. The bonds were issued in 2019 and mature next year.
Analysts remain cautious on the outlook for Synlait.
A Forsyth Barr research report recently noted the company’s balance sheet remained under pressure despite some short-term covenant relief.
“As part of its ongoing capital structure review, it stated it is not considering an equity raise. In light of the covenant amendments we view this as plausible, but it is not without risk … and is contingent on a large inventory unwind.”
Forsyth Barr noted that Synlait’s retail bond expires in December 2024.
“This currently provides a cushion between common equity and senior lenders. Focus remains on the balance sheet and how this will be refinanced, and its banking syndicate’s appetite to expand its Synlait’s exposure.”
Chapman Tripp’s Barber says some consumer-facing businesses will find things a lot tougher as the cost of living crisis bites along with higher interest rates.
“So the those in retail, hospitality or more reliant on that discretionary spend are going to find things a bit more difficult.”
Having a good relationship with your bank is therefore vital in the current environment.
“Being open and transparent with your bank is important and providing them with lots of information, maybe making sure you have got a bit of headroom in your facilities so if things are a bit tougher you can work through that in terms of facility amounts and perhaps in your covenants,” Barber says.
On the whole, equity investors are increasingly moving their focus from inflation and central bank responses to the impact of a slower economy on earnings expectations, says Chris Di Leva of Harbour Asset Management.
He says stock markets appear to be in a catch-22 as investors digest lower inflation numbers while trying to assess how much of that is down to lower growth, which may flow throw to earnings.
“The economic reset in response to higher rates has been relatively normal so far,” Di Leva says. The key point is that the reset of equity valuations is quite progressed. The response to higher rates has been in line with the historic playbook. Housing markets have softened. Inventory levels are now being run down.
“Within equity growth portfolios our strategy remains to position for a range of scenarios and to be selective. We remain wary of the impact of a severe local economic slowdown or recession on the earnings for cyclical businesses,” he said in a note to clients on May 8.
“Our strong preference is for relatively higher exposure to Australian equities and companies exposed to the global market.”
The current mini-reporting season, which sees big names like Fisher & Paykel Healthcare and Infratil and a raft of property firms report full-year results, will provide further insight into how these companies are fearing.
OPINION: Tensions are likely to become more evident next year.