After years of rock-bottom interest rates, the debts of the UK’s listed companies have soared to a record high of £390.7bn, easily surpassing pre-crisis levels, according to the new annual Link Asset Services UK plc Debt Monitor. In the vice of the credit crunch, companies had cut their borrowings by a fifth in just two years. But since the low point in 2010/11 net debt has jumped by a staggering £159.6bn. Moreover, most of this increase (£122.6bn) has been in the last three years alone.
Over the same three-year period UK companies have paid their shareholders £263bn in dividends, despite profitability being squeezed and dividend cover levels (the relationship between profits and dividends) falling to record lows in 2016/17, before recovering this year. Faced with the demand from shareholders to continue their payouts, and needing also to invest in new assets and acquisitions, companies had to increase their borrowings significantly.
This is particularly so in the oil sector. The oil sector has seen the fastest growth in net debt, up 459% since 2008/9. In 2017/18, BP and Royal Dutch Shell accounted for an astonishing £1 in every £7 of all UK plc’s net debts. Faced with a collapse in the oil price in 2015, both undertook major restructuring exercises, and took on additional debt to fund their activities and help maintain their dividend payouts while profits were at rock bottom. In Shell’s case, net profits over three years of £15bn compared to dividends of £31bn. Its net borrowings rose by £35bn, though this includes the absorption of the debts of BG Group, which it acquired in 2016. Almost one-third of the £122.6bn increase in net UK plc debts since 2014/15 was in the oil sector.
The consumer goods sector is the UK’s largest borrower, accounting for almost a quarter of UK plc net debts. Tobacco giants Imperial Brands and British American Tobacco account for almost three-quarters of all the debt in the sector. BAT has recently taken on huge additional borrowings to finance its acquisition of Reynolds American, assuming the latter’s debts in the process. Its £45.4bn of net loans are the largest of any company in the UK, accounting for £1 in every £11 of UK plc’s borrowings. Consumer staples groups Unilever and Reckitt Benckiser make up the rest of the sector’s debts. Housebuilder Persimmon, by contrast, boasts net cash of £1.3bn, the highest net cash position of UK plc.
Justin Cooper, chief executive of Link Market Services, said:
“Tobacco and consumer staples can sustain high borrowing levels because they have very stable businesses that generate lots of cash. In Shell’s case, it’s an enormous enterprise with very deep pockets. It has not cut its dividend since World War II. It seemingly judged that a temporary increase in borrowings was justified to weather the oil price storm, all the more because it was rather under-borrowed compared to the wider market in 2015. Even today, after adding so much more debt, Shell’s gearing levels are still well below the market average, partly because it has added more assets too.”
Simply totting up the absolute value of debt is not enough on its own to determine whether it is sustainable, however. Instead, investors measure borrowings against the value of shareholder capital in the company, the so-called debt-equity ratio. The ratio is a measure of how highly geared a company is - in other words, how large its debt burden is. As the credit crunch hit, UK plc collectively had very high debt/equity ratio of 89%. Total debts of £402bn were almost equal in value to the amount of equity accumulated on corporate balance sheets. Moreover, the relative debt burden of the smaller and medium-companies was much greater than their multinational counterparts, who were far better placed to weather the storm.
Within three years UK plc collective gearing had reduced sharply to just 64%, but after 2011/12, when credit conditions began to improve, companies quickly allowed gearing to rise. It peaked again in 2015/16 at 83%. Since then, even though the absolute value of debts has continued to grow, shareholder equity has risen more quickly, bringing the debt/equity ratio down to a more comfortable 73%, thanks in part to a sharp uptick in profitability in 2017/18. Smaller and mid-cap companies now have lower gearing than their larger counterparts.
“It seems we may now have seen peak indebtedness. Two years ago, corporate borrowing soared higher, gearing levels approached those seen just before the credit crunch, and company profitability was still in the doldrums. Investors had good cause to be concerned, particularly as the interest rate cycle was primed to turn upwards again.
“Now, healthy global growth means higher profits. That has both brought gearing levels down, and means that interest costs and dividends are much more comfortably covered by profits. What’s more, companies are less dependent on short-term borrowings than at any time in the last ten years.
“The economic recovery since the credit crunch has been slow, but very long, and some commentators suggest the cycle may be drawing to a close. Total borrowing may continue to rise as it’s a vital part of the investment financing-mix, but gearing, or the burden of debt is on the wane. Investors may prefer to see UK plc focus on reducing gearing further to provide itself more breathing space in the next global downturn.”