Debt could easily be seen as “steroids” for businesses.
Administered correctly, it’s possible to have a star performer achieve the unthinkable for decades, becoming a goliath of their field. Yet, many stars after seeing short term results, double down on their new “Holy Grail” only to come crashing down – usually on life support.
Today we are witnessing global debt levels at approximately US$244 trillion dollars, while most Central banks are at or near record low interest rates. This record amount of debt has led to new records elsewhere; in many stock markets around the world, equity prices have reached bubbly highs. Then in the last quarter of 2018 we had our first glimpse of what rising US treasury rates would look like; credit markets had the jitters and the result in the equity markets wasn’t pretty.
This bring us to one of the key pillars of our investment philosophy. All of our investee companies must have less than 2x debt to operating profits, while being operationally profitable for the last 2 years. This gives the businesses we invest in the best competitive advantage, now and in the future. As we continue to see issues throughout the credit markets, it’s sensible to look at the businesses you’re invested in and see which ones have unsustainable debt levels. We always ask ourselves if the “pumped-up” business that everyone follows is generating truly muscular profits or if they are “artificially” inflated and could be unable to service their debt when the tide goes out.
By being financially self-reliant, businesses with low debt levels can continue to service their debt when rates rise and have a better chance of withstanding a credit crunch. The ability to navigate tough times places our businesses in a far greater position to take advantage of their competitor’s complacency to rely on debt to fuel their growth.
Daniel Sharp & Adam Allcock
Microequities Relationship Management Team
02 9009 2900
Bloomberg “Global Debt Levels”, 16th January 2019
