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Printing money: Is De La Rue's debt crisis part of a wider problem?

UK PLC has surged by three quarters since 2010 to £443.2bn, up 6% in the past fiscal year

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A warning from banknote printer De La Rue PLC (LON:DLAR) about its worrying levels of bank debt has coincided with record levels of debt for UK PLC and fresh alarm bells about dwindling levels of capital markets activity.  

This year UK PLC’s net debt level reached record levels after eight consecutive years of rises, mirroring a rise seen around the world.  

Since the start of the financial crisis in 2007, global debt levels have swelled by two third to more than $250trn, the Bank of International Settlements revealed recently. 

Similarly, since UK PLC net debt was cut to a post-crisis a low in 2010, it has surged by three quarters to £443.2bn, up 6% in the past fiscal year, according to research by Link Market Services.

Debt has risen easily amid a low interest rate environment that has also driven investor thirst for yield from equities, while narrow credit spreads have meant it is relatively easy for companies to service borrowings as the economy has generally remained just about positive.

“This position may be manageable in the current low interest-rate environment, in which investors are still searching for yield and issuers are able to roll over maturities financed with new issues,” says Damian Watkin of DF King.

“Should rising interest rates close the high-yield market to lower quality borrowers, however, a significant rise in debt restructurings and defaults would be on the cards among highly indebted companies.”

Reassuring ratios?

While De La Rue shareholders were gawping at the alarming list of “plausible downside scenarios”, the wider UK corporate scene can offer a bit reassurance to investors.

This is because the ratio of net debt to equity and other measures are not at worrying levels, says Link, also pointing at cash balances rising 10% to £195.1bn in the past year. 

Core debt/equity ratios and the relationship between liabilities and assets, and short-term versus long-term debt have all improved year on year in 2018/19, with interest payments inching up but still below long-term averages. 

The value of debt reached its third-highest reading since 2008, but that debt was 2.6 times total operating profits, meaning it would take just over two and a half years to pay off.

This, says Link, is also below the 4x ratio it would see as "a rule of thumb suggests companies would likely face difficulty repaying debts if they were called". 

Also Link said the lack of big outliers suggested the majority of companies followed the trend for each of these measures.

“Borrowing will always rise over the long term because debt is almost always a cheaper means of raising capital for investment than equity. As companies grow, their capacity to take on new loans to finance their expansion increases,” says Michael Kempe, Link's chief operating officer. 

As well as the total burden of debt, he says the sustainability of this debt is equally or more important. 

“This is why the increase in borrowing in 2018/19 isn’t a cause for concern. It’s well backed by assets, and easily serviced at present by the profits companies are making.”

Causes for concern

Kempe admits that there are of course companies and sectors under strain, but felt that the overall picture is “reasonably comfortable.”

“Over the next year we expect companies to maintain a cautious stance as long as uncertainties abound in the UK, and while the risks to the global economy rise.”

He felt the trajectory of interest rates should provide some comfort, too, with the US central bank cutting rates three times this year, for example.

However, in the UK, given certain results in the general election and a Brexit deal in the new year, the Bank of England may see things differently.

“If the economy were to slow down or even roll over into a recession, or interest rates were to suddenly spike for any reason, then this could all change and very much for the worse,” says Russ Mould at AJ Bell

Quick facts: De La Rue PLC

Price: 113 GBX

LSE:DLAR
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Market Cap: £117.52 m
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