Markets

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

Corporate earnings in Asia are bumping up against the law of diminishing returns. Loading up on debt is becoming both increasingly useless and progressively risky, giving CEOs an incentive to put prudence ahead of profit.

Caution, however, won't come free. Although deflating the region's bloated balance sheets is a worthy goal, it might end up making things worse for shareholders.

The biggest disappointment may come from too much liquidity. According to Morgan Stanley, nonfinancial companies in the MSCI Asia ex Japan Index have boosted cash hoards to a record $1.15 trillion, from less than $600 billion in 2009.

This, the bank's researchers say, is a remedial step to ward off payment difficulties after the region's longest and most rapid debt buildup in the past 20 years. But with low-risk financial assets earning zero or less, idle cash will only delay the recovery in returns on assets and equity:

Long Wait for a Lift
Corporate profitability in Asia has weathered a multiyear slowdown*
Source: Bloomberg
*For companies on the MSCI Asia ex Japan Index.

And creditors are hardly insisting on precautionary behavior. The global high-yield bond market has all but shaken off the blues that beset it at the start of the year. If company bosses could extract any more juice out of debt, they'd gladly take on more. But in China, as well as in other parts of Asia, loans and bonds aren't as productive as they once were.  

Unlike four years ago, there's very little money to be made on borrowed funds:

Loans Lose Luster
Asian companies' excess return on assets over their cost of debt is shrinking*
Source: Bloomberg
*Data for 144 publicly traded, nonfinancial companies outside of Japan with market capitalization of more than $10 billion in 2012. June 2016 figures are for 67 companies.

When the Federal Reserve signaled an end to its easy money policy in 2013, investors feared that hot money outflows from Asia would lead to a collapse of debt-fueled corporate profitability. During that summer's taper scare, nonfinancial companies in the region outside of Japan sold for less than 12 times their forward earnings.

High Hopes
Large Asian companies are now 34 percent more expensive than during 2013 taper scare
Source: Bloomberg
*For a market-capitalization weighted index of the top 153 companies.

Valuations have firmed 34 percent since then, but the threat from stretched balance sheets hasn't gone away, it's only changed appearance. The risk deleveraging could trap companies just as badly as debt could trip them up deserves more attention than it's getting.  

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net