written by Pankaj Mataney, Derrick Y Kam, Jonathan F Garner, Chetan Ahya, and Helen Lai.
JAKARTA - Morgan Stanley revealed that Gross leverage remains high in Asia ex-Japan. However, a number of companies are taking remedial steps to improve their balance sheets. They then developed a debt scorecard for countries, sectors, and stocks that incorporates the three key themes they have highlighted in this report to give a comprehensive picture of the key trends and themes behind debt dynamics in the region.
Key point of the research note:
Tracking the debt dynamic has taken on greater importance for the Asia ex-Japan (AxJ) region owing to the significant buildup of corporate debt. In this collaborative report, our analysis of AxJ debt trends reveals three key themes:
1) Gross leverage (whether measured as debt-to-GDP ratios or debt-to-EBITDA) has continued to rise: Gross debt to GDP has risen from 147% in 2007 to an estimated 221% in 1H16, mainly led by China. This marks the longest and strongest period of leverage buildup in the region over the past two decades.
2) Policymakers are still aiming for a gradual adjustment: Deleveraging headwinds are likely to persist for longer, weighing on economic growth and limiting major improvements in corporate ROE/ROA in the next 1-2 years.
3) However, corporates have taken remedial steps to improve their balance sheets: These include slowing corporate debt growth; increasing cash buffers to record levels (now US$1.15 trillion), leading to a fall in net leverage; increasing free cash flow to total debt; and reducing short-term and foreign currency denominated debt. From a macroeconomic perspective, macro stability measures have strengthened for the AxJ region (higher current account surpluses/reduced deficits and higher real rates). These measures have reduced MSCI AxJ’s volatility relative to MSCI AC World (global equities) to pre-“taper tantrum” (2013) levels.
Morgan Stanley developed a debt scorecard that incorporates these three key themes:
Country level: Taiwan, Korea, Indonesia, and India have the most favourable scores based on the recent trends and current levels of our key debt metrics.
Singapore, China, Malaysia, and Thailand have the weakest scores.
Sector level: Staples, IT, Telecom, and Healthcare debt metrics have the most favorable scores, based on the recent trends and current levels of our key debt metrics. Industrials, Discretionary, Real Estate, and Energy have the weakest scores. Backtests of this framework (both at country and sector levels; Top 4 ranks minus Bottom 4 ranks’ average performance) has generated sustained alpha, particularly since the taper tantrum episode that led to the confluence of tighter monetary conditions and high leverage.
For stocks, we highlight: 1) Stocks to own – companies that have shown the most improvement on our debt metrics, with our equity analysts expecting further improvement; and 2) Stocks to avoid – companies that have shown deterioration on our debt metrics, with our analysts expecting further deterioration.