If there s one belief> that took hold during the financial mess, it s All debt is bad. After all, too many companies borrowed too much money, and when the recession hit, they couldn t pay back all that cash. Hundreds of firms saw their stock value plummet and filed for bankruptcy protection, and embittered investors lost billions. But some savvy pros are turning that conventional wisdom on its head rewarding some companies that recently have taken on debt and others that already borrowed money.
The key word, of course, is some. While lenders still wouldn t lend a wooden nickel to many would-be borrowers, banks and bond investors are welcoming back companies with dependable business and cash flow. Over the past few months, Cisco Systems raised $4 billion to boost its acquisition war chest, and Microsoft tapped the credit markets for the first time ever, borrowing $3.75 billion. Through September, bond offerings by investment-grade companies the good-credit bunch totaled $608 billion, up 31 percent from a year earlier, according to research firm Dealogic. But in the eyes of some pros, these good-credit companies haven t been rewarded for, well, being good-credit companies. They are using cheap debt to buy assets that will help their bottom line and future cash flow, says Jamia Jasper, manager of the American Israeli Shared Values fund.
Realizing that debt isn t poison is a far cry from late 2008 and earlier this year, when it was shoot first, ask questions later for companies with any debt at all, says Sam Dedio, a portfolio manager for the Artio US Smallcap fund. But as the financial crisis eased, it became clear that some of the so-called junkier companies the ones so debt-laden that their survival was in question weren t going belly-up. Ironically, it s these companies that have been leading the monster stock rally. The stock market recently started rewarding high-quality companies that have raised money in the bond market, but well-run firms such as Weight Watchers (WTW) and Viacom (VIA) that already had a manageable amount of debt are getting nowhere near the recognition they deserve, some analysts contend.
To be sure, the dangers of relying on debt were made clear by the crisis so much so that some money managers are sticking with companies that have enough cash to fund themselves entirely, without needing the credit market. And if the economy takes another hit, even steady businesses could falter, turning debt on the balance sheet from no problem to uh-oh.
Still, debt has long been used as a way to boost a company s returns, because it is often a cheaper way to finance a new plant or building than issuing new stock. Plus, interest rates are low these days, which means companies can pay less for the money they are borrowing. Having low-cost debt now, some analysts say, can mean higher profits down the road. Even typically debt-averse investors, including Brian Angerame, comanager of Legg Mason Partners Capital fund, are willing to take a risk on companies whose debt is proportionate to the sustainability of their businesses and consistency of their cash flow. Angerame likens it to a tenured professor with a 30-year-fixed mortgage whose paycheck can easily cover the monthly payments. No one would think twice about that type of debt, he says.
Some pros say these attractively valued companies have plenty of profits and cash flow to pay off any debt.
Market Value: $18.3 billion
2010 Price/Earnings: 13
Total debt/Capital: 69 percent
With hit shows like Dora the Explorer, the media company generates a steady stream of cash, says Stephen Yacktman, comanager of the Yacktman funds. Viacom s strength was underscored last year when it raised prices for cable companies to keep carrying MTV and other Viacom networks.
Market Value: $26.9 billion
2010 Price/Earnings: 7
Total debt/Capital: 95 percent
The offshore driller has been using cheap debt to buy hard assets namely oil rigs. Analysts say the firm is run conservatively, and Transocean has a stated policy of paying down debt before increasing dividends.
Weight Watchers Int l.
Market Value: $2.1 billion
2010 Price/Earnings: 10
Total debt/Capital: 74 percent
Despite the high debt load, the diet specialist generates enough cash to pay it off in six or seven years and pay a dividend, analysts say. Weight Watchers also benefits as more customers switch to its more profitable online service from in-person meetings.
Market Cap: $7.2 billion
2010 Price/Earnings: 16
Total debt/Capital: 16 percent
Although the toymaker has $1.3 billion in debt, it s sitting on $324 million in cash. It s nothing to be scared about, says Don Wordell, manager of the RidgeWorth Mid-Cap Value Equity fund. The firm now has a movie-licensing deal with Universal Pictures, which could help profits.