It concerned the balance sheets, spending plans and refinancing opportunities of six large multinational firms (Rio Tinto, Xstrata, ArcelorMittal, Lafarge, Tata Steel and Cemex):
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.
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. 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.
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.
[In] the fight to survive the biggest weapons are cuts in production and capital spending. ArcelorMittal has led the way on the former, with a reduction of output by one-third that even its chairman, Lakshmi Mittal, calls “very aggressive”. The cuts to investment plans are as dramatic: ArcelorMittal, Lafarge and Cemex have sliced their budgets for next year by between one-third and one-half, and on December 10th Rio cut its planned capital expenditure in 2009 from $9 billion to $4 billion. Xstrata has yet to announce its plans but a 50% reduction is possible. For the six firms combined, this would mean a $15 billion boost in annual cashflow—equivalent to about 18 months’ worth of interest costs.
As it tries to repair its balance sheet, Fortescue faces higher lending costs, and advisors are encouraging the firm to seek funding through new equity issues.
What’s noteworthy from The Economist article is the observation that banks and other financial corporations absorb much of the supply of equity finance, leaving less available for industrial and commercial firms, particularly when they most need it. International banking regulations and specifically capital-adequacy requirements have been tightened since 2008, and the much-vaunted stability of Australian-based banks stems in large part from their relatively low leverage ratios (though I’ve suggested the scarcity of domestic government debt among bank assets makes them more fragile than commonly realized). It’s not usually recognized that this has reduced the equity finance available to non-financial corporations and thus has tended to increase their indebtedness.
In these circumstances, the ‘big weapon’ of cutting expenditure – along with selling assets and paying off debts out of current income – may help to repair the balance sheet of an individual firm such as Fortescue. But it means, of course, that less money is thrown into circulation and less income is generated for the company sector as a whole. This is the means by which difficulties are propagated to other firms and generalized debt deflation sets in.