Sunday, 28 February 2010

Gunns' banking dilemma

David Symons this week in the Fairfax media canvassed the worth of Gunns and suggested it’s only got 4 months to sort out the restructure proposal else it may find itself in breach of its banking covenants (HERE).

A bit like FEA at the current time.

But what are these banking covenants? How do they work?

In Gunns’ case it appears there are 3 covenants, a leverage covenant, an interest cover covenant and a gearing covenant.

The leverage covenant requires the ratio of gross debt (as defined by the bankers) to cash earnings before interest, tax and depreciation (EBITDA) to be less than 4.5 times. In other words their debt is not supposed to be more than 4.5 times their earnings. If the first half results are repeated in the second half of 2009/10, the leverage figure will be 10 times. Possible trouble ahead.

The interest cover covenant requires earnings (EBITDA) to be more than 2.5 times the net interest paid to banks Again if the second half of the year replicates the first half, the interest cover will be just a little over 2 times, again a possible covenant breach.

The gearing covenant requires the gearing ratio to be less than 50%. This is the ratio of debt to debt plus equity. At this stage it looks ok, about 30%, but included in equity is the $180m+ spent on the pulp mill. Also the equity figure is affected by the value of the land which in turn is affected by the income to be earned from the trees growing on the land, 2/3rds of which belong to MIS punters and other investors. So in the current climate it is possible that the equity figure may need to be written back which will increase the gearing ratio.

Being in breach of banking covenants may make the subject debt immediately repayable, which would severely test the solvency of the Company.

The instos must be starting to grow weary at putting their hands into their pockets. They’ve put in $480 million over the last 18 months. How much more?

Interesting times ahead.

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