Business

Wednesday October 21, 2009

Profitable, less leveraged firms gain more as markets rebound


PETALING JAYA: Companies that are more profitable and less leveraged are enjoying better valuations and prospects as stock markets rebound from the global financial crisis, according to a report by Citigroup’s financial strategy group.

The rebound in stock markets and stock valuations over the past few months showed that growth had returned, the report said.

“In fact, given the relatively low current earnings of many companies, the growth premium is a bigger component of the PE (price-earnings) multiple than ever before, accounting for 40% of the overall value,” it said.

“These valuation dynamics imply that it is now time to adjust corporate financial strategies to focus on future growth once liquidity and balance sheet risks have been addressed.”

The report, which studies companies in the MSCI Global Index, points out the ratio of capital expenditure (capex) to revenue dropped for the first time in five years last year as sales declined across all sectors.

The cutback in capex was disproportionately concentrated among the most capital-intensive companies within their sectors, with equity markets rewarding firms that maintained above-median capex levels throughout the crisis, with a 0.2 times price-to-book premium compared with those below the industry median, the report said.

While capex fell, companies’ cash positions started to climb.

The report said the median cash-to-sales ratio increased to 13.5% in the middle of this year and as a result, liquidity issues are no longer as pressing for many companies compared with last year.

“If capital markets continue to remain open and available and operating cashflows stabilise, many companies will soon find themselves in a position of excess liquidity,” it said.

The financial strategy group found that the gap in profit margins had widened between the highly profitable and less profitable companies and that the leverage ratios had also increased, more so among companies that were more leveraged prior to the crisis.

The leverage and profitability characteristics are also creating a valuation gap post-crisis as a larger number of companies are having more debt and lesser profit in a time when investors are looking towards growth.

“In the absence of a substantial re-equitisation of the balance sheet, these companies are typically weakly positioned to pursue aggressive growth strategies.

“As a result, we are seeing a wide dispersion emerge in valuation multiples within sectors,” it said.

This has led to weaker companies having a lower price-to-earnings ratio – from 12.4 times in 2007 to 1.7 times – while better-off companies were seeing a slight reduction in PE ratios – from 23.4 times to 19.3 times.

“Strong players are emerging relatively unscathed from the crisis by maintaining profitability, strong balance sheets and ample liquidity after having made sharp cuts in capex and operating expenditures,” the Citigroup report said.

“With equity investors increasingly focusing on growth, strong companies are in a powerful position to capitalise on business expansion strategies – both organic and acquisition-driven .

“Meanwhile, the challenge for weaker competitors will be to emerge from the economic downturn without becoming vulnerable acquisition targets or permanently damaging their competitive position in their industries,” it added.


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