Question

0. It can be observed that the average gearing ratio for the Pharmaceuticals industry is much lower than industries such as Utilities and Transportation. Explain why this is the case.

Answer 1

Gearing ratio varies because of different capital intensity levels between industries and whether the nature of the business makes carrying a high level of debt relatively easier to manage. We see that pharmaceuticals is a highly volatile business i.e., has high business risk in the sense that the R&D expenses might not always give the desired profits and many R&D costs would go waste. There is also no certainty in the cash flows. As debt requires fixed payments, sufficient cash flow needs to be generated by the business which pharmaceutical companies might find difficult at times. However, utilities and transportation businesses are stable businesses and have certain-steadier and more predictable cash flows. So, they have higher gearing ratio than pharmaceuticals.