>Leverage – no longer a dirty word! (MACQUARIE RESEARCH)

Event
■ Corporate Asia is, arguably, undergeared. We identify companies that could see a significant ROE uplift over the course of the next cycle by taking on more debt.

Outlook
■ Scarred by the events of the 1997–98 Asian financial crisis, Asia’s CEOs have spent the last decade paying down debt. By the end of last year, net debt to equity had reached 27.2% in Asia, a fraction of the 65% it was at its peak in 1998 (see chart in grey column opposite).

■ This placed Asia in very good stead to weather the recent financial crisis. There were fewer corporate bankruptcies than there otherwise would have been, and the economic downturn was less severe than would have been the case had debt levels been higher. Equity markets would have also fallen even more than they did, as high-leverage companies were punished more than
low-leverage companies during the crisis.

■ But with the financial crisis now largely past, the benefits of low leverage are much diminished. Indeed, there is a strong argument that Asian corporates are underleveraged from an efficient balance sheet perspective. At 27.2%, the aggregate net debt to equity level is low by any standard, and, with two-thirds of the companies in our universe having an ROA that is above their effective interest rate (EIR), there are clearly many companies with the potential to
increase ROE by leveraging up their balance sheet.

■ The companies that have the greatest potential here are those where leverage is currently low and the financial incentive to take on debt is large (ie, the gap between ROA and the company’s EIR is significant).

To see the full report: ASIA STRATEGY