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Nigerian firms growing corporate debt loads are bumping up against aggressive interest rate hikes by the central bank seeking to tame inflation, meaning companies are paying higher interest expense on borrowings.
The corporate debt (a combination of short and long term obligation) stood at N6.29 trillion as at June 2023, which is 27.18 percent higher than 2022’s N4.92 trillion.
Companies have a variety of ways to finance their operations, including using their own earnings, issuing new equity, issuing bonds, or taking out loans. The composition of financing options that a company chooses matters, particularly during economic downturns.
While debt financing is advantageous because it is cheaper as it enjoys tax shield and it does not lead to ownership dilution, a deteriorating cash flow that is not able to cover interest obligation might lead to bankruptcy.
Of course, a low interest rate environment that started in 2020 fueled by central bankers slashing of monetary policy rate to spur growth during the coronavirus pandemic spurred companies to tap the debt market to fund their working capital requirement and expansion plans.
But the interest that these firms will be paying to service the debt has been rising since the first quarter of 2022 when the central bank began its tightening campaign to rein in inflation exacerbated by the Russia and Ukraine war that sent commodities and grains prices higher.
The total finance costs of non-financial firms surged by 127.44 percent to N621.30 billion as at June 2023, according to data gathered by MoneyCentral.
Nigeria 10 year bond yield was 13.22 percent on Friday August 4, according to over-the-counter interbank yield quotes for this government bond maturity.
It is worth noting that yields were as low as 4.29 percent as of October 26, 2020.
The monetary policy committee of the central bank raised its benchmark rate to a record 18.75 percent at its last meeting from 18.5 percent.
Nigeria’s inflation rate rose to 22.79 percent in the month of June 2023, representing a 0.38 percent increase from 22.41% recorded in the previous month.
The balance sheet of most companies are healthy even amid higher costs as they have enough operating profit to absorb finance cost and still remain profitable in the face of foreign exchange losses brought on by incessant currency devaluation.
The median interest coverage ratio for Nigerian companies stood at 30 at June 2023, substantially higher than last year’s 21.44, according to data from MoneyCentral.
The figure is a measure of a company’s ability to repay its debts, with a ratio of at least 2 generally considered the minimum acceptable amount for a company with solid revenues. Analysts typically prefer a coverage ratio of 3 or higher.
Analysts say with the reinvigorated bullish sentiment in the equity market, corporates would seek to take advantage of the renewed hope for capital raising in both the equity and debt markets.
However, they added that expectations of a lower interest rate environment in the near to medium term suggests that most corporates would delay tapping the debt capital market to avoid locking in a high cost on long term debt, thus financing Capex programmes through relatively shorter term bank loans of say one year.
“Indeed, I see prospects for gradual renewal of interest in the primary segment of the equity capital market over the next few quarters, as new valuation in the secondary market provides some excitement for issuers to tap seasoned or new equity capital raising opportunities in the capital market,” said Abiola Rasaq former Economist and Head, Investor Relations for United Bank for Africa (UBA).
“So, the corporate financing outlook should be a blend of debt and equity, as both segments of the market begin to open up. The right blend of both capital options would be dependent on the sector, the stage of the company in contest and the type of projects each company is seeking to finance, amongst other factors relevant to the assessment of the capital structure of the respective issuers,” said Abiola.
Issuances of commercial papers (CPs) have risen sharply year on year by 57.80 percent due to heavy fundraising by companies that seek to meet their working capital requirements and fund future expansion plans.
The amount raised by firms spiked by 57.80 percent to N786.59 billion in June 2023 from N498.50 billion as at June 2022, according to data gathered by Afrinvest Securities.
Of course, the number of issuances followed the same growth trajectory as it moved to 104 in June 2023 from 55.
“The short-dated nature of CPs provided comfort for issuers to refinance and raise new capital while navigating uncertainty in the period,” said analysts at Afrinvest Securities Limited.