Distance to default: a default indicator for Australian listed companies

Distance to default

Any business heavily exposed to a particular sector will have a vested interest in tracking the potential for corporate default with stakeholders important to their business. Understanding these trends can help organisations make informed decisions, and reduce their risk when dealing with companies in a sector experiencing declining or weak corporate health. Trends in declining corporate health for certain sectors can trigger episodes of systemic instability and have adverse impacts on lenders, counterparties and investors.

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KPMG’s new biannual report gauges if an industry has moved closer or further away from the default line. Our investigation brings together analysis from information available for the majority of Australia’s ASX listed companies and adopts the Distance-to-Default (D2D) measure used by the Reserve Bank of Australia, in order to provide meaningful insights into the trends in corporate health and suggestions on remedial action for distressed sectors.

Key findings

In this edition, we provide a spotlight on the energy, mining and real estate sectors, which have either fallen short or outperformed the average ASX D2D score.

Energy

The energy sector moved closer towards the default line, indicating that it experienced a period of sustained stress and default risk and was impacted heavily by the Oil, Gas and Combustible Fuels and Metals and Mining industries. Australia’s energy sector is undergoing a huge transition, driven by activity in both global and domestic markets. With continued interest in renewables, the role of coal and traditional energy sources is certainly under pressure. However, recent events – including the election of Donald Trump as President of the United States (US) – have introduced further uncertainty.

Materials

The materials sector D2D score also indicated experienced a sustained period of stress and default risk, underscored by the fact it has been rated the sector most at risk of default since the second half of the 2014 financial year. Yet, the sector has now come out of the bottom of the cycle and is in the middle of a spectacular recovery. The main driver of the Australian mining sector’s recent strong performance has been an uptick in commodity prices. The cessation of mining operations in China has cut the global supply of iron ore and coal, boosting domestic players.

Real Estate

The real estate sector consistently outperformed the average ASX score, indicating the sector has moved further away from default, driven mostly by the Real Estate Management and Development industry. There have been mixed messages over the past 12 months concerning the state of the Australian property market. While some authorities, including the Reserve Bank of Australia, are concerned about a property bubble – more notably in the Sydney residential housing market – indicators suggest a compelling proposition for astute investors in both Sydney and other parts of Australia. The analysis suggests the sector may be hot, however, it may also tell us the sector is close to overheating.

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