Many people are rightly looking at which world class ASX companies they can add to their portfolios. However, with the current global credit crunch it is very important to consider just how much debt each candidate is carrying before investing.
What is a credit crunch?
Credit is like any other product in a capitalist society. It is all about the tension between supply and demand. In the past decade there has been more supply than demand, largely because of quantitative easing in the United States ensuring that credit markets didn’t dry up in the wake of the GFC.
Today that situation has suddenly, and dramatically, reversed. The global economy is rapidly grinding to a halt for no reason other than the coronavirus pandemic, plunging our share markets into a bear market. Most other global economic indicators were very healthy.
Therefore no one is earning money. In other words, there is a global shortage of cash or a credit crunch. Banks don’t create money. They lend money entrusted to them or raised on the bond markets or other debt facilities.
When credit was cheap, it was a perfectly valid strategy to regularly refinance at lower levels. Today bond markets are not going to allow that without an additional premium. Many companies now have low credit worthiness as they are no longer earning revenues.
In short, this credit crunch is a once-in-economic-history event.
A once in a lifetime battle
The Reserve Bank of Australia (RBA) is attempting to keep interest rates low through quantitative easing. It is basically using “new money” to buy Australian bonds with the goal of keeping them at 0.25%. This is the first time this has ever happened in Australia.
It is also a battle the RBA cannot afford to lose. If interest rates are allowed to rise again the impacts will ricochet through the domestic and corporate economy.
Which companies may be in trouble?
The travel sector is the obvious first casualty of this pandemic, but the management of Qantas Airways Limited (ASX: QAN) has positioned it well for a doomsday scenario like this one. Also the federal government has indicated it will act to save the company if it comes to that.
Other travel and entertainment companies may not be so lucky. Flight Centre Travel Group Limited (ASX: FLT) is holding a lot of debt with a dramatically reduced revenue stream to pay for it. Crown Resorts Limited (ASX: CWN) has recently reduced its debt load but still may find itself in trouble.
Many companies in more capital intensive sectors may be facing even more problems, particularly in the oil and gas sectors due to the oil wars being fought between Russia and Saudi Arabia.
Oil Search Limited (ASX: OSH) is one of these companies. It has seen expansion projects fall over, threats to margins from the oil wars, and is now faced with the credit crunch on its heavy debt load.
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As of 17/3/2020
Motley Fool contributor Daryl Mather has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Crown Resorts Limited and Flight Centre Travel Group Limited. 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.