Leverage Is A Risky Game

Debt is part and parcel of life. It means you owe other people money and you have to pay them back. Every month when you open your post box, you will see little pieces of paper asking you for money. If you bought a house with a loan from a bank, a mobile phone on contract or own a credit card, you have debt. If you have cash savings and a stable monthly income from a job, you would have no problem paying off the bills. The problem only starts when you accumulate more debt than your savings and income. When you have no more money to pay off your mountain of bills, you would have defaulted on your debt obligation. This is what happened to PT Berlian Laju Tanker Tbk.

PT Berlian Laju Tanker (B66)

Source: ShareInvestor.com

Berlian Laju borrows money to buy or lease very expensive ships that transport chemicals for its customers. When shipping rates were high a few years ago, there were more chemicals to transport than there were ships available. Banks were happy to lend as much money to Berlian Laju as needed. The problem now is there are more ships than chemicals to move around. This has depressed the rates for renting the ships. This means Berlian Laju isn’t making money from renting ships. The banks now want their money back.

Source: ShareInvestor.com

Current Ratio
(Also known as Working Capital Ratio)

Berlian Laju has a current ratio of 1.033 in FY2010 compared to 0.757 in FY2009. This means the company has S$1.033 of assets it can sell for cash to pay off S$1.00 of liabilities due within a year. A company with a current ratio of less than 1.00 has more credit risk than a company with a current ratio of more than 1.00. Looking at the current ratio, Berlian Laju’s credit risk has improved as its current assets in FY2010 exceeded its current liabilities marginally.

Debt To Equity Ratio
(Also known as Financial Leverage Ratio or Gearing)

Berlian Laju has a Debt To Equity Ratio of 2.880 in FY2010 compared to 2.704 in FY2009. This means the company owns S$2.880 of liabilities less the amount of cash it has to pay off debt at short notice for every S$1.00 of Shareholder’s Equity. A company with a Debt To Equity Ratio of more than 1.00 has more credit risk than a company with a current ratio of less than 1.00. Looking at the Debt To Equity Ratio, Berlian Laju’s credit risk has increased as its debt after deducting the cash it has to pay off its debt at short notice in FY2010 exceeded its Shareholder’s Equity significantly.

Leverage is a risky game but companies exist to take risk to make a profit for its shareholders. Debt is good when the economy is growing and customers pays up. Debt is bad when there is a recession and customers default.

Current Ratio and Debt To Equity Ratio on ShareInvestor.com

ShareInvestor.com provides a list of stock sorted by Highest Debt To Equity Ratio in descending order via this link for subscribers. Below is a screenshot of the list of stocks.

Source: ShareInvestor.com