There are mutterings about European shares being cheap, based on depressed valuations. The logic being that the best buying occurs when everyone is running away from the market. To some extent a similar logic applies to debt: the best borrowing is avilable when everyone is de-leveraging. A simple truism of contrarian investing. Deutsche has a report that looks at M&As which sheds an interesting light from this point of view:
Over the past 20 years the net/debt equity ratio in Australia has averaged 47%. But in recent years this has been closer to 30%, and is forecast to remain there. De-gearing has been most pronounced for resources (25% vs 42% historically) but industrials gearing is also low (40% vs 50% LR avg).
While corporate bond spreads are considerably higher than before the financial crisis, borrowing rates are nonetheless low because of the fall in government bond yields. In the US the trailing earnings yield is ~7%, while 3yr BBB corporate bond yield is at 1.6%. The gap is also quite large in Australia (equities 8% vs bonds at 5%).
It may add up to some M&As, especially given the low valuations of equities against bonds. The forward earnings yield is 6% above bonds, and the forward dividend yield is 2% higher, similar to the 2008 situation. Deutsche’s top picks for potential acquisition are: ASX, Computershare, Consolidated Media Holdings, Echo, Goodman Fielder, Imdex, Paladin, Santos and Toll.
Equity is more expensive than debt, especially as in many parts of the developed world it is essentially being given away:
Gearing for companies remains low despite debt being considerably cheaper than equity. This of course reflects tough global conditions and general risk aversion, and is unlikely to change quickly. Nevertheless, over time there could be scope for companies to alter their capital structure a little to take advantage of cheaper borrowing costs. The charts below compare the trailing earnings yield from equities in both the US and Australia to 3year BBB corporate bond yields for both countries. In both cases debt is looking historically cheap.
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Logically it might suiggest debt funded acquisition, but markets are
not always logical.