Riding the Rollercoaster

Six firms in cyclical industries battle excess debt.

If A rollercoaster keeps cranking upwards for long enough it can be tempting to relax your grip—just for a moment. The bosses of some of the world’s biggest basic-materials firms did exactly this and are now suffering. Lulled by expectations that industrialisation in China and other developing countries would ensure sustained demand, leading firms in the steel, cement and mining industries have entered the recession with far more debt than is normally viewed as prudent (see table).

Much of this reflects the ambitious acquisitions of 2006 and 2007. For the six leading firms reviewed by The Economist, cash spent on deals in those two years accounts for four-fifths of their total net debt of $136 billion. The steel industry’s largest producer, the combined ArcelorMittal, has high gearing in part due to its cash-and-stock-financed merger, and the sixth-biggest producer, India’s Tata Steel, is burdened by the leveraged takeover of its Anglo-Dutch peer, Corus. In cement, the world’s biggest producer, France’s Lafarge, bought Orascom Cement of Egypt, and the third-largest, Mexico’s Cemex, purchased Rinker, a big Australian rival. Xstrata, the mining industry’s serial acquirer, is highly geared, and giant Rio Tinto has record debts thanks to its purchase of Alcan. Last month BHP Billiton, a rival mining firm, withdrew a stock bid for Rio, saying its debts and the difficulty of making disposals raised risks to an “unacceptable level”.

Economist Roller1

Such concerns are mirrored in the prices of credit-default swaps (CDSs), a type of insurance against bankruptcy, which have risen to alarming levels for all six firms (see chart). For those who mistrust the volatile CDS market, other red lights are flashing. As in past recessions profit expectations have fallen savagely along with demand and prices. From their peak, analysts’ forecasts of operating profits next year have dropped by 30-50% for all six firms, leaving less cashflow than expected to support debt. Share prices have plunged too, so that net debt is comparable to, or well above, the firms’ market capitalisations. Borrowing levels that seemed manageable in the boom now look rather high. Might they even pose a threat to these firms’ survival?

There are no quick fixes. Raising equity is tricky since investors have been sucked dry by capital-hungry banks. Dividend cuts would not help much: these firms sensibly stuck to stingy payout policies. Disposals could occur only at miserly prices, if at all, because most potential buyers have no access to funds themselves. Rio has abandoned plans to raise $10 billion from asset sales this year, for example.

That means the only option is to try to ride out the recession. But companies can do this only if they have enough liquidity (cash and undrawn bank lines) to refinance maturing debts. Relying on debt markets would be foolhardy: ArcelorMittal has managed to roll over some of its French commercial paper in recent weeks, but the prospects of being able to borrow large amounts on normal terms are bleak.

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