Our prediction last year that the gearing levels of mid-cap companies would increase in 2000 proved to be correct. The surprise, however, has been the extent of the increase, especially within the manufacturing sector.
Overall gearing levels have risen consistently since 1997.
The Net Debt to EBITDA levels for our sample of FTSE-250 manufacturing companies for instance rose more than 50% from 1999 to 2.04 times. Our prediction for 2001 is that gearing levels will rise further.
With signs that the economic environment is deteriorating, corporate earnings and cashflows will fall. Furthermore, the level of business investment is likely to decrease, and thus the need for additional debt will reduce.
This will result in the absolute value of debt within the FTSE-250 companies remaining relatively constant, as companies seek to increase their financial flexibility.
However, overall gearing levels will rise as earnings and market capitalisations fall. Furthermore we believe interest cover ratios will deteriorate further, with lower interest rates being insufficient to counteract falling corporate earnings. In our view the increase which we will see in 2001 should be followed by a gradual fall in the gearing ratios.
While there is currently no credit squeeze in progress, unlike the position in the US, there has to be a danger that debt providers will become cautious.
Clearly this will impact on the preparedness of FTSE-250 companies to maintain the predicted 2001 level of gearing.
The dramatic increase in gearing levels over the last five years has been a result of a number of factors. One of these has been the increasing difficulty that mid-cap businesses have had in accessing the equity markets.
Furthermore, the perception of many investors that many old economy stocks are low growth has driven such companies to increase gearing to maximise the efficiency of their capital structures. The acceptance by analysts and investors that corporate finance decisions should be made on the basis of economic value added, rather than EPS enhancement, has ensured debt has become an ever more important source of funding.
This will not change. In our opinion, the current high levels of gearing will reduce after 2001. But the debt levels of the FTSE-250 companies will never fall back to the lows of the mid 1990s.
Jonathan Trower is head of the debt advisory group at Close Brothers Corporate Finance.
If businesses do not take cyber security seriously in their business planning regulators may do it for them, the ICAEW has warned
The Financial Reporting Council has issued guidance regarding the annual reporting of 1,200 large and smaller listed companies. The letter highlighted the key issues and improvements that can be made in the 2016 reporting season
Deloitte's north-west Europe foray; BDO, Smith & Williamson investment paths; Shelley Stock Hutter; and Wilkins Kennedy discussed by editor Kevin Reed on our Friday Afternoon Live broadcast
Company bosses are considering relocating operations or headquarters away from the UK following the country's decision to leave the European Union