Jul24
I will be a panelist at Australia in the Red, a forum on debt organised by The Daily Reckoning & Money Morning, to be held at the State Library of Victoria on Friday July 31st from 7pm-11pm. The evening includes a panel discussion on debt–with Dan Denning, Kris Sayce, Phillip Anderson and Gabriel Andre as well as myself–followed by the screening of “I.O.U.S.A.“.
The following information is taken from their promotion for the event, tickets for which are limited and cost $199–click here for the online booking form. The “I’ll” below is Dan Denning.
| 7:00pm | You’ll register in the auditorium foyer at the State Library of Victoria in central Melbourne (entry via the La Trobe Street entrance). Over complimentary champagne and canapés you’ll get the chance to introduce yourself to fellow delegates and members of our panel of experts |
| 7:40pm | Time to move into the auditorium and take your seat for the evening programme |
| 7:45pm | I’ll formally welcome you to our summit – and you’ll hear a special video welcome to Australian delegates from Daily Reckoning founder Bill Bonner |
| 8:00pm | Panel discussion begins – this is your chance to put your question about Australia’s debt crisis personally to our team of experts |
| 9:30pm | Sit back and enjoy the exclusive first ever Australian public screening ofI.O.U.S.A. We anticipate the event to finish by 11:00pm. |
MACCA,
I forwarded the chart to my father who replied thus:
“You guys [my brother and I] are the ones with the finance and commercial degrees so I am interested in your take on this. – Here is my layman’s view:-
Until 2 yeas ago, if an enterprise was yielding, say, 15% on its capital (assume capital of $100 Mill.), it had earnings of $15Mill. If it then borrowed $200Mill. @10%, this could then boost earnings to $25Mill. (5% profit on 200M) This was good business. (Bear with me … read on please)
Now… last year this enterprise decided to deleverage as fast as it could. (assume it’s bank was in trouble and it indicated an unpreparedness to renew the $200Mill loan). The enterprise repaid $100Mill (which it had liquid but the other $100Mill was tied up (stock, plant and machinery etc…)
Now it takes all its earnings at the end of this financial year (say this is back to $15Mill) and repays that off of the 100Mill. outstanding, this leaves it $85Mill in debt.
It pays it’s shareholders no dividend this year,…. but…..it is still in a very strong position. If it can reliably roll over its debt of $85 Mill. (banks are now more robust that last year), it is in fact bigger and stronger than 2 years ago when it had Capital of $100Mill. ….However…. its share price will take a bath because it will pay no dividend this year as all earnings have gone to debt redemption.
However, the market will look beyond this event and will price into the share, responsible management (because it chose to recover debt so promptly at this time) and the share price will find a floor of, maybe, 20 – 50% of its previous highs. We have seen the market do just this over the last year. As soon as the capital squeeze is over, responsible management will allow some earnings to flow through and consequently a return to (but diminished) dividend and the share price will start to climb. (as we are seeing at the moment)
This, of course, is the situation in the American market. Our local market is much healthier.
So…. low or even negative earnings do not necessarily spell zero value.
Publication of this kind of chart in isolation has, to my mind, limited use as it provides a limited and narrow focus on one aspect only.
Now, I could be way off beam. What do you two think?
Dad”
For others, the chart in question is this one:
http://www.chartoftheday.com/20090724.htm?T
Hi DrBob127,
Lets assume your fictitious business would be in some sort of essentials. In that case your assumptions may be correct. However many of the businesses in the US have a business model based on ridiculous levels of consumer spending. They (the US) are not the industrial powerhouse they were years ago. Some of these models built around this last 30 years of unsustainable consumption may never prove viable or profitable again. I think the market at present thinks it’s back to business as usual. Some casualties may have to reinvent themselves some may not be able too. I’m just not that sure that the old model will survive. If it does then I’d say we have just postponed the collapse,not fixed it. What do think?
DrBob127
Your father has confused leverage with how the market works. There is no reason for banks to call in debt, if the businesses are profitable. De-leveraging is only forced on businesses making losses. Leverage increases the volatility of the return on equity and its value is discounted by the market in poor economic environments. Dividends are largely irrelevant.
Markets have recently rallied because they believe dreadful earnings have already been priced in (as in the chart), but actual results have not been as bad as feared. This is a favorite Wall Street game: lower expectations to engineer short-term rallies. When the reporting season is all over, they sudden realize PE is at unsustainable levels…