Debt burdens at the company level - not so bad
/It seems like everyone is talking about balance sheet bubbles and recessions. Much of it stems from this paper by David A. Levy from the Jerome Levy Forecasting Center.
The thesis is this (condensed into simplified bullet points):
Since the 1980s, balance sheets have grown while incomes have not. Or to put it another way, to keep the same level of income, private balance sheets have had to grow.
We have had a number of crises over the past 40 years, and each one has necessitated or resulted in larger balance sheets during boom times. This has been caused by or resulted from much lower yields. Basically, yields are falling, while balance sheets are growing.
Each crises has led to the next - a recession causes balance sheets to expands to bubble levels. The bubble bursts, leading to a recession. Rinse and repeat.
Source: American Council of Life Insurers (ACLI) and Real Capital Analytics (RCA), via Bernstein Journal
An easy way to think of it is real estate, because yields are central to investment decisions there (and I have a lot of experience in the sector). Back in the ‘80s, commercial real estate (say office buildings) would return a 10% yield. It stayed at this level until around 2000, and then it started falling. This report points to a low point of 7% in 2006 (see chart to right). It has been low since then. According to this report, it was just 6.3% in August.
These real estate yields are higher than most other “safe” assets like bonds. But they are still relatively low. And it doesn’t look like it changes.
Back to my point: Let’s say in 1999, you could buy a building for $1 million, and expect around $100,000 in net operating income (after all expenses) a year. Inflation was low, so were interest rates (relative to recent history at the time). But today, to get the same $100,000 in income, you would need to invest $1.59 million, or 59% more. Even if you raise your equity investment in percentage terms (keeping a down payment of 25%), debt will grow from $750,000 to $1.19 million. Just to keep the same amount of income.
Now do this for all assets all over the world, and you start to see why balance sheets have increased. Interest rates are low, and banks are willing to lend, so it doesn’t seem too scary now. But if there is a recession, and incomes fall, it will be more difficult to pay off these big debts.
Bringing it back to Vietnam
There is a lot more to get into in the report, but I wanted to look at how this is playing out in Vietnam. As you know, economy wide debt data is not great. But public companies have to disclose balance sheets and income statements every quarter, so I looked at the big constituents of the VNM Index based in Vietnam (we talked about these companies when we discussed the 1H2019 results here, here, and here).
Source: Company data, Vietecon.com, Vietstock
I looked at two main areas: debt-to-equity (both book equity and market equity) and ability to service the debt (debt-to-revenue and debt-to-operating profit, more on why this latter figure later).
A few things stand out:
Source: Company data, Vietecon.com, Vietstock
Debt-to-equity isn’t too bad, especially in terms of market cap. On average it is 1.2x D/E and 0.4x D/MC One way to think about this is to think of it as how much cushion is there before debt holders start to lose money. Book equity is one way of looking at it, while market cap (which takes into account the market’s view on company value) is another. Both have their downsides.
Having large amounts of debt isn’t that big a deal, if you can service it (meaning pay the interest and principle when needed). Debt/revenue is on average 1.1x, while debt/operating profit is 5.2x. I really should look at Debt/EBITDA, but that’s kind of hard to find for Vietnamese stocks (annoyingly), and I am lazy. Also, to be frank, it should be NOPAT (net operating profit after taxes) to give a real sense of what debt burden the company can bear.
Vietnam Dairy (VNM) is the one with the biggest D/E ratio, but it terms of D/MC, it isn’t too bad. Looking at the company’s ability to service the debt (in the second chart), it doesn’t look great. Seems like this is a pretty risky balance sheet.
These is little difference between D/E and D/MC for SSI Securities, mainly because, as an investment bank, it ain’t got much equity. For comparison, Goldman Sachs has a D/E of almost 3.0x, and it has been at that level. It also stands out for having a very high D/Op profit.
Vingroup also shows a very big difference between D/Rev and D/Op profit. This is a function of low operating margins - profit for $1 of revenue. Vingroup, as we have talked about, is enormous and has lots of nascent businesses. Hopefully, these will start to show better margins over time. It seems like it has been able to get plenty of money, so it should be fine. Plus, Vincom Retail (VRE) actually looks quite safe.
Conclusion, outside of Vietnam Diary and SSI, none of these figures bother me too much. It’s always hard to say what a “good” or “safe” debt level is, but most of these companies are fine. I need to now look at historical figures and see if we have seen a real growth balance sheets. If so, it might be more concerning.
Now remember, just because a few publicly-traded companies are fine does not mean that the economy in general may not have debt problems. That’s the bigger issue that Levy’s report talks about.