Debt danger lurks in Covid-19 shadow

In particular, the various measures to curb the spread of the Covid-19 pandemic have re­sulted in the temporary closure of many of its businesses. This has led to an adverse impact on the operations of many of its subsidiaries.

For instance, Indonesia-listed Astra Inter­national, the company’s largest contributor to its top and bottom lines, faced a “weaker” per­formance in April. Tunas Ridean, another In­donesia-listed subsidiary, also faced challeng­ing conditions, with lower earnings across all its operations. Jardine C&C owns 50.11% and 46.24% in Astra International and Tunas Ride­an, respectively.

In Singapore, the company’s 100%-owned Cycle & Carriage experienced lower sales due to a reduction in market size and weak consum­er sentiment. Across the Causeway, sales of its Malaysia-listed and 59.1%-owned Cycle & Car­riage Bintang were similarly affected. In Viet­nam, 26.6%-owned Truong Hai Auto Corp’s au­tomotive unit sales and margins, particularly in the passenger car segment, declined due to a fall in market volume. Meanwhile, Thai-listed and 25.54%-owned Siam City Cement’s operations were similarly impacted in the kingdom and Vi­etnam. Only Vietnam-listed and 10.6%-owned Vietnam Dairy Products’s (Vinamilk) operations have remained “stable” with moderate impact from the crisis thus far.

As a result, Jardine C&C is now concerned about its ability to meet its financial obligations. According to Bloomberg data, the group has net debt of $8.7 billion, making it the 10th highest among Singapore-listed companies, excluding banks and REITs.

“In each of the group’s businesses, debt lev­els and liquidity positions are being carefully monitored and steps are being taken to mitigate both operational and financial risks. A range of actions are also being taken to manage costs and preserve cash, including reducing capital expenditure and managing working capital,” the company says.

More worryingly, there is a swathe of oth­er highly leveraged companies. As at May 15, there are more than 400 other Singapore-listed companies with more debt than cash, accord­ing to Bloomberg data. Over 40 of them have a net debt position of above $1 billion. The 20 companies with the highest net debt position are composed entirely of blue-chip companies. Many of them are real estate companies and conglomerates.

The concern now is that the risk of a liquidity crunch is much higher than before. Given how wide and severe the pandemic has impacted eco­nomic activity, many companies are bound to struggle to tide over their financial obligations.

A case in point was the recent bankruptcy application filed by Hin Leong Trading, which shook the commodity trading hub of Singapore. The privately-held oil trading company, which boasts billions in revenue, could not repay its secured borrowings of some US$3.64 billion ($5.2 billion) after its lenders tightened their credit lines. This was compounded by the re­cent crash in crude oil prices as the pandemic destroyed global demand for the fuel.

Some bankers have indicated that Hin Leong Trading’s case is probably idiosyncratic rather than systemic as it involved the owner secretly selling off oil the company held in inventory that was pledged as collateral for its loans. Whatever the case, the oil and gas sector remains a con­cern for banks and investors.

More importantly, could Singapore-listed companies face a similar danger of insolvency?

Mixed view

Technically, insolvency occurs when a compa­ny have more liabilities than assets. So far, even companies that have had interest coverage ratios of less than a multiple of 1 — meaning, its Ebit­da is not sufficient to cover its interest expense — such as Perennial Real Estate Holdings, Aspial Corp and OUE, have more assets than liabilities.

Market observers hold mixed views too. Kum Soek Ching, head of Southeast Asia research, pri­vate bank research, Credit Suisse, believes com­panies here will be able to weather through the challenging operating environment. “We think most Singapore Exchange-listed firms are enter­ing this downturn with fairly healthy balance sheets,” she tells The Edge Singapore.

Citing the Financial Stability Review 2019 report conducted by the Monetary Authority of Singapore (MAS), she notes that the locally list­ed companies had a median debt-to-equity ra­tio of 37%. Based on MAS’s stress test, about a third of companies are at risk, if interest costs rise 25% and Ebitda fall 25%. The stress test factors in the companies’ cash reserves.

However, S&P Global Ratings warns that Sin­gapore’s corporate sector is among the most lev­eraged in the region, following years of signifi­cant capital spending and dividend payments. It estimates locally listed companies have a me­dian debt-to-Ebitda of five times.

According to S&P, debt capital markets and banks in recent years provided an enormous amount of liquidity to the corporate sector in the region, especially Singapore. This created a form of “funding complacency” among Singa­pore-listed companies, it says. Few companies — excluding the larger ones — bothered to di­versify their funding sources to reduce their ex­posure to market sentiment, it points out.

“Now that investor sentiment has shifted since the onset of Covid-19, companies with narrow funding channels, especially those re­liant on the bond market to refinance, will be most affected,” says Xavier Jean, corporate rat­ings analyst at S&P.

Worryingly, two trends have emerged. For one, Singapore-listed companies are taking longer to repay their borrowings, according to a study conducted by S&P last year. The average Singa­pore-listed company took about seven years of profits to repay its debt, compared with about 5.5 years on average over 2015 to 2018. “That level is the highest for listed companies in Ase­an, where the figure is averaging three-to-four years of profits,” says Jean.

From a sector perspective, real estate devel­opers and commodity producers are the high­est. The former takes 10 years of profits to re­pay debt, while the latter takes nine years to do so, says S&P. Secondly, Singapore-listed companies are holding less cash on their balance sheet than before. S&P estimates that their ability to cover short-term debt has fallen to a mutilple of one in 2019, from 1.3 to 1.4 times over the past four years. “There was also a growing reliance on debt to bridge the gap — a very attractive op­tion for companies at the time, given multi-year low funding costs,” says Jean.

As such, S&P warns that locally listed com­panies are facing tougher operating conditions with much weakened balance sheets, reduced liquidity and sizeable debt piles.

This could spell disaster for some of them. According to Fitch Ratings, two companies in its rating universe have a “high” Covid-19 ex­posure, followed by five companies with “mod­erate” Covid-19 exposure and four companies with “low” Covid-19 exposure.

Market observers warn that many companies are at risk of seeing their credit ratings get down­graded and defaults rise. David Gaud, chief in­vestment officer at Pictet Wealth Management, says this is especially the case for bonds that are rated BBB and below. “This is a crisis that is go­ing to last,” he said at an April 17 briefing. “Rat­ings agencies are downgrading issuers. We hav­en’t seen the end of it. There are more to come.”

“I think the number of defaults on loans and financial obligations is certainly going to increase,” said Michael Wu, Morningstar’s sen­ior equity analyst, at an April 7 media briefing.

Many sectors could face higher risk of de­faults. Travel, entertainment, restaurants and businesses more dependent on trade are likely to be the most at-risk sectors, according to Esty Dwek, head of global market strategy, dynamic solutions, Natixis Investment Managers. This is because travel and tourism will be slow to pick up since borders will be slow to open, he says. Crowded restaurants and bars will not be giv­en a priority to reopen, unless social distancing measures are implemented, he adds. Moreover, given the staggered nature of the recovery across countries and industries, global trade will take time to recover, he says.

S&P warns that the closure of non-essential shops imposed by Singapore to curb the pan­demic will likely continue to affect the credit quality of the real estate sector in general. Cash flows at some of the rated REITs could poten­tially decline 20% to 40% amid rental rebates, deferments or cancellations. At the same time, lower commodity prices and slower global trade will continue to weigh on commodity or trans­portation and logistics-related sectors such as marine and oilfield services and capital goods.

“The combination of structurally volatile busi­ness models, lumpy cash collection and risk-off sentiment mean that entities in these sectors will likely find their looming debt tasks more chal­lenging, time consuming and expensive to refi­nance,” says S&P’s Jean. “And the sectors’ eco­system will be significantly affected as well.”

Government support

Fortunately, the government is aware of the risk of defaults and has introduced various measures to help companies. MAS has teamed up with the finance industry to introduce a package of financial measures.

For one, SMEs will be granted the option of deferring principal payments on their secured term loans up to Dec 31, 2020. This is of course subject to assessment of the quality of their se­curity by banks and finance companies.

Firms will also be able to extend the ten­ure of their loans by up to the corresponding principal deferment period should they con­tinue to pay interest owed and remain in good standing with financial institutions. More than an estimated $40 billion of existing loan facili­ties to SMEs should qualify for this opt-in relief scheme. SMEs holding general insurance poli­cies may also apply to their insurer to pay their insurance premiums in instalments.

MAS has also lowered interest rates on SME loans through a new Singapore dollar facility for loans granted under Enterprise Singapore’s SME Working Capital Loan scheme and Tem­porary Bridging Loan Programme. Banks and financial institutions may apply for these loans until December if they are committed to passing on cost savings to SME borrowers. “These will go a long way to contain bankruptcies in this downturn,” says Credit Suisse’s Kum.

Beyond that, MAS has also adjusted the cap­ital and liquidity requirements for banks to sup­port their lending activities. It lowered the net stable funding ratio requirement, which is the amount of stable funding banks maintain for shorter-term loans, to 25% from 50% previous­ly. This will last until Sept 30, 2021.

“We expect banks to provide liquidity and restructure repayments for their banking cli­ents. With a ready flow of credit and low in­terest rates, we expect limited refinancing risk for most corporates and would be [incredibly] surprised to see material insolvencies among SGX-listed companies,” says Kum.

Still, these measures have the effect of push­ing up the indebtedness of companies, accord­ing to Rob Carnell, head of research and chief economist, Asia Pacific, at ING Bank NV Sin­gapore Branch. “It ensures their survival, but it does make the emergence from this crisis hard­er,” he tells The Edge Singapore.

As such, Carnell believes that some real debt forgiveness and write-offs might be a more effective way of ensuring that no firms go bust during the recovery phase. This is be­cause working capital is still likely to be in short supply, he says.

For instance, CapitaLand’s balance of $25.35 billion is the highest among Singapore-listed com­panies in terms of debt on the balance sheet. Furthermore, it raised more debt from two bi­lateral green loans in April. One was a $150 million four-year loan from DBS Bank; the oth­er was a $250 million three-year multi-curren­cy loan from HSBC Bank. This will, no doubt, raise its leverage level even higher.

It must be noted, of course, that CapitaLand has an interest coverage ratio of 4.3 times; pos­itive net tangible assets to the tune of $4.44 per share; and a net asset value of $4.64 per share, or total equity of $40.3 billion (see table). In addition, CapitaLand consolidates its REITs, and its net debt includes those of its REITs, in­cluding around $4.16 billion from CapitaLand Commercial Trust, $3.56 billion from Capita­Land Mall Trust, $2.35 billion from Ascott Res­idence Trust and $1.38 billion for CapitaLand Retail China Trust.

As part of government support measures, REITs will be able to conserve cash this year by lowering distributions. REITs will also be able to avail themselves of tax transparency so long as they distribute at least 90% of their income avail­able for distribution by the end of their FY2021.

Belt tightening measures

While the government is doing what it can to help, companies are not resting on their laurels. CapitaLand says it will take “disciplined reduc­tion” in operating costs and discretionary capital expenditure of over $200 million, with further cost cutting expected. The company has also cut board fees and salaries for board members and senior management, and implemented a wage freeze for all staff at managerial level and above.

At Frasers Property, the property develop­er has decided to temporarily suspend interim dividend in view of the “significant uncertain­ties in the months ahead”. The company, which has net debt of $16.51 billion and interest cover­age ratio of 2.2 times, according to Bloomberg data, has slashed director fees across its board and the boards of its subsidiaries, REITs and sta­pled trust. The company has also cut the sala­ries of its senior management.

Food and agri-business giant Olam Inter­national could be looking at potential divest­ments to unlock liquidity. The company has net debt of $9.42 billion and an interest cover­age ratio of 2.1 times, according to Bloomberg data. “We are maintaining financial discipline by divesting our de-prioritised, non-core assets as part of our strategic plan to release cash and increasing our cash position and available li­quidity. Looking forward, we are proactively managing our capital structure as we end the peak procurement season and manage market uncertainties amid the Covid-19 outbreak,” says N. Muthukumar, Olam’s group CFO.

Indeed, the Covid-19 pandemic is an unprec­edented crisis. Investors would do well to keep a close eye on corporate debt.