One in five companies threatened by higher interest costs

With the Governor of the Bank of England last week again confirming that bank base rates will be rising, Company Watch, the corporate financial health trackers, has analysed the impact on UK companies of higher debt costs.

Research from Company Watch shows that one in five UK companies pay more than 90% of their operating profits to meet their current interest commitments, which makes them potentially vulnerable to higher borrowing costs. Company Watch estimates that there are 300,000 UK companies in this group.

Using the Company Watch measure of financial health (the H-Score®) these vulnerable companies have a median H-Score of just 15, which is deep in the Company Watch Warning Area (25 and below). Any increase in the cost of bank debt will compromise the financial strength of these companies, even a rise of only 0.25%.

The research found that two thirds of the companies with high interest costs to operating profits fall into the Company Watch Warning Area.

Historically, Company Watch has recorded that one in four companies in its Warning Area will go on to fail or require major refinancing.

Company Watch also identified a subsample of one in 20 UK companies highly at risk. These companies have no funds to absorb any increase in debt costs because they pay out more than 90% of their profits in interest payments and have negative equity (liabilities greater than assets). This makes them particularly susceptible to rises in interest rates as they have no net asset cushion to fall back on.

This high risk group has a mean H-Score of 10 and a debt pile of £65bn.

Equally worrying is that independent research* Company Watch commissioned earlier in June 2014 found that over a quarter (26.5%) of 500 UK firms had not budgeted for a rise in the cost of their bank debt.

An example of a company with high debt costs compared to its operating profits is Premier Foods (H-Score 15), the UK’s largest food producer.

Premier Foods owns iconic British brands such as Mr Kipling, Homepride and Oxo. Its most recently reported financial results show current annual interest costs of £62 million, which are higher than its latest reported operating profits of £52 million. Moreover, Premier Foods reports it is sitting on a giant debt pile of £990 million.

Other companies with low operating profit ratios compared to debt costs include communications and media services group Arquiva. Its most recent accounts show that its operating profits of £124 million were dwarfed by interest charges of £450 million, and it had debts of £2.8bn, including £1.2bn in bank loans.

Another is Acorn Care, one of England’s largest providers of education and care for vulnerable young people. It reported an operating loss of £14 million, and had £75 million in bank debt against £63 million in tangible assets. Its interest payments were £29 million, including £5.6 million in bank loans.

Some of the industries most exposed to higher interest costs include:

• Health Care Services
• Publishing and Broadcasting
• Motion Pictures and Theatre
• Catering and Licensed Premises
• Accommodation
• Food Retailing
• Household Product Retail

Denis Baker, Chief Executive of Company Watch, said:

“Interest rates, having been at a low level for so many years, have left some companies ill-prepared for higher debt costs. For one in 5 companies, even a small rise of just 0.25% might be difficult to meet.

“Our advice to companies is to make sure your key suppliers and customers are not going to be compromised by higher costs of debt, which now appear to be inevitable, either later this year or from early next year.”