When companies borrow money, it is usually a sign of confidence in their business. If a raft of emerging market corporate bond deals this week is a guide, some bosses are positively exuberant. And why not? The MSCI index of emerging market stocks has in the past nine days posted its biggest rise since November 2008. The question is whether investors really should be quite so cheerful. Considered in terms of earnings, emerging markets are at their most attractive since they began their rebound after the collapse of Lehman Brothers. So the corporate borrowing spree is justifiable: these are the economies that are supposed to drive economic growth around the globe while the developed world sits on the sidelines. If that scenario plays out, emerging market companies should be planning cash-devouring investments, while their developed market peers save against the downturn.
But investors must ask whether all the money that has flowed to emerging market companies in the past decade has left them flabby. Take free cash flow, the cash that companies retain after covering capital expenditure and the like. While developed market companies have been slashing costs and hoarding cash since the crisis, emerging market companies have been doing the opposite. Free cash flow for emerging market companies has fallen to 3.3% of sales from nearly 6% early last year, according to Deutsche Bank. Weak free cash flow reduces a company?s freedom to manoeuvre, and leaves the emerging world dependent on sales growth and vulnerable to a worsening of the global outlook. It is also unlikely to improve: nearly a third of the top 500 companies in the MSCI emerging markets index are subject to significant state influence, which direct projects for political, not necessarily shareholder, good. Given the dire state of the developed world economy, money will still?and should?flow to emerging markets. But investors must ask what it will be used for.
