German Postman Delivers $3 Trillion Debt Reminder
Deutsche Post’s application of IFRS 16 shows its hefty impact on corporate balance sheets.
Perhaps Germany’s reputation for penny-pinching is undeserved after all. Net debt at Deutsche Post AG, the mail and logistics operator, swelled by a whopping 10 billion euros ($12 billion) in the first three months of 2018.
The bulk of that change of it relates to new accounting rules, rather than new borrowing. But that’s what makes it interesting (bear with me!).
The reason for my unnatural excitement about a mail company’s balance sheet is that it offers a foretaste of what’s going to happen when other companies start applying the same accounting reform, called IFRS 16. Helpfully, Deutsche Post opted for early implementation, providing everyone else with a chance to learn. 1
The reforms will oblige companies to include operating lease obligations, currently listed only in the notes to financial statements, on their balance sheets. The right to use property and equipment will be recorded as an asset, while the associated payment obligations will count as debt. 2 Overall, companies have about $3 trillion of leasing obligations.
Although ratings agencies already take these liabilities into consideration, the hope is that ordinary investors will now pay more attention to them and it will be easier to compare firms that fund themselves in different ways. What might strike you as a cosmetic change could well end up affecting the behavior of heavy lease users in sectors such as retail, transport and logistics.
So what did we learn from Deutsche Post’s review of about 25,000 leases? Here’s a slide showing what happened to net debt after adding things like rented warehouses and aircraft. It’s not pretty.
Some metrics used to assess the efficiency and riskiness of Deutsche Post’s finances look worse too. Return on capital employed is expected to decline by about 250 basis points, while net gearing 3 has gone up. Deutsche Post’s equity ratio (shareholder equity as a proportion of total assets) fell by almost six percentage points to 27.7 percent.
The company does, though, appear much more profitable — at least by one measure. Under IFRS 16, leases are depreciated rather than expensed. Hence Deutsche Post’s Ebitda jumped 36 percent year-on-year in the first quarter. For the full year it anticipates a similar jump of about 2 billion euros. The lesson for investors here will be to tread carefully with valuation multiples (such as enterprise value to Ebitda) and that Ebitda will probably become an even less perfect substitute for cash flow.
Institutional shareholders won’t be surprised by any of this, not least because Deutsche Post has been preparing them for several months. Management has stressed that accounting doesn’t alter how much money flows into the business and hence the dividend won’t be affected.
True, but other spending might be. Deutsche Post has leased quite a lot of the aircraft it uses on intercontinental routes. Now, it’s thinking about buying more of them. 4 The main reason isn’t accounting. Deutsche Post can borrow cheaply and it wants to avoid paying a leasing company’s profit margin. Buying planes requires a big cash outlay upfront, but in the long run it thinks ownership will be cheaper.
Still, it’s handy that under IFRS 16 Deutsche Post’s balance sheet will look just as efficient, regardless of whether it leases or owns the aircraft. If return on assets is the same, why not buy?
Of course, there are still advantages to leasing equipment, such as avoiding obsolesence and falls in residual values. 5 Even so, it’s quite likely that IFRS 16 will prompt companies to reconsider owning stuff, and perhaps that’s no bad thing. In a world where more and more corporate assets are intangible and not easily monetized, there may be comfort in knowing a company has something to sell if things go wrong.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Companies that report under U.S.GAAP will apply a similar reform from December 2018.
Discounted to reflect their present value
Net debt divided by the sum of equity and net debt
Purchasing more aircraft will cause Deutsche Post's capex-to-sales ratio to rise, temporarily, by up to 150 basis points.
Some companies also like the flexibility it provides, plus it helps conserve cash.
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