Small to mid-cap listcos will struggle more with higher rates than larger counterparts

SINGAPORE-listed companies with high gearing levels and debt are feeling the strain of a higher-for-longer interest rate environment, but the pain – including margin pressures – could be deeper for small- and mid-cap stocks compared with their larger counterparts, market watchers told The Business Times. 

Thilan Wickramasinghe, head of research for Singapore at Maybank Securities, said that while individual corporate strategies should be assessed on their own merits, a higher debt ratio typically means higher risks for businesses.

This makes businesses more vulnerable to unexpected changes in market conditions and could hurt their ability to repay loans, he elaborated. 

Additionally, a company’s business continuity could be materially affected when creditors decide to remove funding lines due to changes in mandates or risk perceptions. 

While these risks exist regardless of the size of the company, Wickramasinghe stressed that mid-caps may be exposed to “relatively higher levels of risk than large-caps”.

“Mid-caps may neither have as diversified a funding portfolio nor may their revenues enjoy the same scale as large-caps. This means mid-caps have to operate within narrower tolerance limits compared with large-caps,” he said. 

Bloomberg data compiled by BT showed that six mid-cap stocks – with market capitalisations in the range of S$300 million to S$1 billion – have net debt to equity of more than 100 per cent. 

The most highly leveraged mid-cap stock was canned food producer Del Monte Pacific , with a net debt to equity of 707.1 per cent.

A number of property players appear highly leveraged. Mid-cap stock Oxley Holdings has the highest net debt to equity at 168.1 per cent. Further down the list of highly leveraged property mid-caps – though their net debt to equity had not hit 100 per cent – were Centurion Corp , Amara and Tuan Sing .

Some real estate investment trusts (Reits), namely Daiwa House Logistics Trust , United Hampshire US Reit and Prime US Reit also had significant debt to equity levels of over 70 per cent. 

Under the agriculture sector, agri-food giant Japfa has considerable debt too.  

Similar trends can be observed in small-cap local counters. 

Parkson Retail Asia was the most heavily leveraged small-cap stock, with a net debt to equity of 3,499.2 per cent. Palm oil player Kencana Agri ’s stood at 546.44 per cent, while property player Hatten Land ’s net debt to equity was 619.8 per cent. 

Alfie Yeo, senior research analyst at RHB Singapore, said that a company’s gearing also boils down to the industry it is operating in.

For instance, highly cash-generative companies such as grocery retailers have no gearing and are typically in an enviable net cash position. 

On the other hand, property acquisitions and developments require huge outlay. Companies that have a large manufacturing footprint, such as Japfa and Indofood Agri, may also be highly geared since more manufacturing assets are needed to generate sales growth.

“The key is the company’s ability to repay the interest commitments (interest cover) and eventually the principal,” said Yeo, adding that this depends on a company’s management and its risk appetite. 

“A management team that has decided on a high-risk approach and struggles to execute its plans would be more of a concern in our view,” he added. 

Kennedys Legal Solutions partner Robson Lee said that it is “par for the course for property players to leverage on their projects through debt financing” to facilitate cash flow during the various development stages of their ongoing projects.

However, he noted that investors should be concerned if a company has significantly more debt than what its assets are collectively worth. 

Lee added that investors should take note of “amber lights” – or warning signs – such as if the aggregate value of the company’s assets are not based on current market values, or if the stock’s cash outflow exceeds its revenue by more than 50 per cent for more than two consecutive financial quarters. 

“Larger-cap companies generally have more assets and reserves and can better withstand the vicissitudes of economic and financial uncertainties that can be fatal to highly geared companies,” Lee said.

He noted, however, that even large companies are not immune to collapse, such as Hyflux, owing to a combination of factors such as high gearing, mismanagement and tardy judgment. 

“Investors must, at all times, be vigilant in monitoring the financial reports and announcements of their investee companies and make investment decisions based on proper analysis and judgment, and not just navel-gazing at the gearing level of the company in question,” Lee added. 

Mak Yuen Teen, a professor at the National University of Singapore Business School, said that leverage levels for mid-cap stocks are currently not “unusually high”. However, he pointed out that debt ratios are just a starting point for investment decisions and stock analysis. 

“We need to look at things such as debt maturity, off-balance-sheet financing or other forms of accounting manoeuvres or treatments that lead to debt being understated, and use of perpetuals which are debt-like but classified as equity,” he said. 

While debt levels still appear under control for now, analysts said that companies need to actively manage or scale down their borrowings which could adversely hit the bottom line. 

“Inflation will definitely increase business costs and affect margins if companies do not respond and defend their margins. Reducing debt and interest expenses is one way of defending and mitigating margin pressure,” said RHB’s Yeo. 

Companies that are highly geared are dependent on the banking system for financing to run their operations, and if the banking system comes under pressure owing to market vagaries, funding options could narrow.  

Maybank’s Wickramasinghe estimates that close to 40 per cent of Singapore-listed companies have net cash balance sheets. 

For large-cap stocks, their debt to Ebit (earnings before interest and taxes) ratios have fallen to 7.7 times in the third quarter of 2023 from a peak of 12.9 times in 2021. This points to de-gearing and balance-sheet management amid higher interest costs, he noted. 

“Of course, sandwiched between these statistics are several mid-caps and small-caps carrying high gearing levels,” said Wickramasinghe.  

He advised: “We think investors should pay close attention to a company’s debt ratios throughout the cycle and include it as a key risk factor when making investment decisions.”