Throw the textbooks out the window. SA's finance directors don't read them. Instead, structuring a balance sheet is about where the money is easiest, and which corporate finance outfit is bending whose ear.
A neat and appropriate balance sheet structure is a true indicator of a well-run company. Sadly, many SA companies don't put in the effort and insight to get it right. It's not only about gazing into a crystal ball, but about doing the maths, ensuring that shareholders benefit without taking unacceptable risks.
Unusually in Top Companies, being at the top of this list is no accolade. Instead, it shows companies with a high proportion of debt relative to equity in the funding mix that makes up their balance sheet. Debt is risky; it requires fixed funding costs, whereas shareholders, who provide equity, can go without dividends if something goes wrong. Companies with high debt find it difficult to weather a storm.
Take diversified media business Primedia, which tops the list of nonfinancial companies. In its last annual report, it had R570m of interest-bearing debt on its balance sheet, with a market cap of R807m at the time of writing. The debt was raised to help Primedia expand in Europe and the Middle East, where it had a 50% stake in cinema chain Ster Century, as well as a number of businesses in the UK. It was carrying a US30m international bank loan facility. The European assets underperformed, forcing Primedia to sweat cash out of its SA businesses to carry the debt load.
On top of that, R380m of the balance sheet is funded by debentures, which earn a fixed rate of interest. For its last financial year, the company paid almost R70m in interest to debenture holders.
But Primedia, under CEO William Kirsh, has taken steps since its last annual report to sort out the picture. It has sold its stake in Ster Century Europe, generating $18,5m to reduce debt, and is selling UK-based Primecom. It is looking to shed more international assets to tidy up its balance sheet.
More importantly, though, Primedia has converted its debentures into share capital. For its December interim reporting period, debt net of cash had declined to R167m, reducing interest payments by half.
International expansion is also behind IT company Intervid's high debt ratio. It raised $50m in debt (as a convertible loan) to fund forays into the US, Australia and the UK, and has failed to get those assets to perform. Much of the cash, though, remained unspent at the time of its last annual report, giving Intervid a net debt position of R32m.
Another IT company, MGX, is also heavily indebted but after this period got a R140m convertible loan from US-based Peregrine Systems to pay off other short-term debt.
Being at the bottom of the list is not good either. Mining companies such as Western Areas and African Rainbow Minerals could do much for shareholders by taking on some debt, so gearing the return to shareholders.
"When the guys who are making the decisions went to school, gearing was not on," says one corporate financier. "The only question they ask is: why should they add a gearing risk to their business? In my opinion, the guys are too conservative."
But pressure does mount, particularly from institutional investors, for companies to increase their debt burdens to give investors a better return. Some businesses optimise their balance sheets by taking on some debt, but corporate financiers say any company that does take on debt should be confident about its ability to repay it.
Companies regularly pointed out as getting it right are Sappi (paper and pulp) and Bidvest (investment holdings), which, despite significant expansion, have carefully walked the debt:equity route, taking advantage of low interest rates when the opportunity arose, but also using strong market ratings to raise equity.
But even if a company has clear cash flows from parts of the business, some directors are still afraid of turning to debt.
Of the 189 companies that disclosed their debt, the average ratio of debt to equity was 84%, but excluding the top two companies, it came in at 61%. Most analysts see a ratio of about 40% as appropriate for industrial companies. Keep in mind that our methodology does not net off cash assets against debt. Had that been done, it would have reduced the average to around 40%, in line with acceptable numbers.
Financial companies are a different kettle of fish, because their balance sheets include huge numbers that count as debt, made up of their obligations to policyholders or depositors. These are largely covered by assets on the balance sheet. Nevertheless, the gearing numbers are included here as a matter of interest in a separate table.