The Motley Fool

Why I’m avoiding high-debt companies like Transurban and Virgin Australia

I am avoiding buying shares in Transurban Group (ASX: TCL), Virgin Australia Holdings Ltd (ASX: VAH) and other high debt ASX-listed companies as I have a preference for investing in companies with little or no debt.

In my opinion, companies with little or no debt are easier to value. This is because their earnings are less susceptible to changes in interest rates and their dividends are less likely to change due to a company’s decision to pay down debt. Companies with lower debt also have less risk of defaulting on loan repayments.

When debt is used effectively, it can boost a company’s profits. This is easier to achieve when interest rates are low, as it’s inexpensive to borrow money. For this reason, some investors are happy to buy shares in companies with debt, especially when rates are low like they are today.

ASX 200 companies with debt

Debt to equity is a common ratio used for comparing and measuring debt levels. It measures how much debt a company has relative to the amount of equity contributed. The ASX market average is a debt level of approximately 30% of equity.

Transurban has a debt to equity ratio above 2. This means it has a debt level which is more than double its level of equity. This is a high level when compared to the broader market. Transurban’s total debt level has risen each of the past 10 years and over this same time period, Transurban shares have averaged a superb annual rate of return over 20%.

Virgin Australia owns and operates Virgin Australia Airlines. At the end of FY18, Virgin Australia also had a debt to equity ratio above 2. Again, a high level of debt when compared to other Australian public companies. Over the last 10 years, Virgin Australia shares have averaged an annual rate of return of -8.4%. For comparison, Qantas Airways Limited (ASX: QAN), a competitor of Virgin Australia, averaged 10.3%

Foolish takeaway

Companies like Transurban and Virgin Australia that have high levels of debt can, but are not guaranteed to, deliver superior long-term results to investors. They are also, in my opinion, harder to value accurately than companies with little or no debt. This is why I generally choose to avoid them when investing as I only want to invest when I am confident that I’m getting shares for a cheap price.

My preference would be to invest in a company like Altium Limited (ASX: ALU). Altium has been able to demonstrate an ability to grow with little debt. Unfortunately, Altium shares are not cheap and therefore I will need to wait for a price drop before investing.

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Motley Fool contributor Mitchell Perry has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Transurban Group. The Motley Fool Australia owns shares of Altium. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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