Cash is the lifeblood of any business. No matter how much paper
"profit" a company might report, it is cash flow that's truly vital
to a company's survival.
Companies that continually burn through cash generally must rely on
external financing to keep the party going. Or as Kathryn Staley
The Art of Short Selling
"banks and other short-term lenders control the destiny of a
company that has negative cash flow."
And if a cash-strapped company already has large amounts of debt,
further financing to keep it afloat is likely going to be very
costly - assuming it is even able to obtain that financing. That is
a dangerous place for any company to be.
Liquidity vs. Solvency
When talking about a company's financial health, it is important to
distinguish between its
Liquidity is a measure of the firm's ability to meet its
obligations. Solvency is a measure of the firm's ability to meet
obligations. It's more of a measure of a firm's long-term survival.
It is possible for a company to have poor liquidity but still
remain solvent, especially if it doesn't carry much debt. This is
often the case with small, rapidly growing firms.
But for a business that's already strapped for cash
highly leveraged, look out. A relatively minor downturn in business
could spell disaster.
So what are some ways to measure a company's financial
One of the most common liquidity ratios is the
. This compares a company's short-term assets to its short-term
liabilities: Current Assets / Current Liabilities. The higher the
current ratio, the greater a firm's ability to pay its bills as
they come due.
But not all current assets can be converted to cash quickly. For
instance, a company may have trouble selling obsolete inventory in
a short amount of time to meet current obligations. That's why many
analysts will strip out inventory when looking at a company's
liquidity. That calculation is known as the
: (Current Assets - Inventories) / Current Liabilities.
An even more conservative ratio is the
, which measures only a company's cash (including cash equivalents
and short-term securities) against its current liabilities: (Cash +
Cash Equivalents + Short-term Securities) / Current Liabilities.
This ignores both inventory and receivables and is the strictest of
all liquidity ratios.
These ratios will vary across industries, so it's important to
compare them to their peers. But in general, the higher the ratios
One of the most common solvency ratios is the
ratio: Total Liabilities / Shareholder Equity. The higher this
ratio, the more leveraged a company is. This is important for
stockholders to consider, since debtholders have first claim on a
company's assets. If a company becomes distressed, you can bet that
those interest payments will get sent out before any dividend
One important ratio to measure a company's ability to meet its
long-term debt obligations is the
Interest Coverage Ratio
. This takes a company's earnings before interest and taxes over a
given period and compares it to its interest expense: Operating
Income / Interest Expense.
The higher the debt burden a company has, the lower its Interest
Coverage Ratio will be and the higher its D/E ratio will be. Again,
these will depend on what industry a company operates in.
Capital-intensive businesses will typically carry larger amounts of
debt on its balance sheet. So it's important to consider industry
Highly Leveraged Companies Burning Through Cash
So what are some highly leveraged companies currently burning
I ran a screen using
to look for companies with high debt burdens, poor liquidity ratios
and negative operating cash flow. Here were the criteria:
- Quick Ratio less than 0.8
- Cash Ratio less than 0.5
- Operating Cash Flow less than 0
- Debt / Equity greater than 1.0
- Interest Coverage Ratio less than 1.5
Here are 4 names from the list:
Quick Ratio: 0.6
Cash Ratio: 0.02
Trailing Twelve Month (ttm) Operating Cash Flow: -$41 million
Debt / Equity Ratio: -3.2 (total stockholders' deficit of -$501.0
Trailing Twelve Month (ttm) Interest Coverage Ratio: -0.1
(operating income was negative)
Verso Paper primarily supplies coated papers to catalog and
Maui Land & Pineapple
Quick Ratio: 0.5
Cash Ratio: 0.1
Operating Cash Flow (ttm): -$3 million
Debt / Equity Ratio: -2.7 (total stockholders' deficit of -$27.8
Interest Coverage Ratio (ttm): 0.0
Maui Land & Pineapple Company owns more than 23,000 acres of
land on Maui and develops, sells, and manages residential, resort,
commercial, and industrial real estate.
Quick Ratio: 1.6*
Cash Ratio: 1.2*
Operating Cash Flow (ttm): -$92 million
Debt / Equity Ratio: -3.1 (total stockholders' deficit is -$112.5
Interest Coverage Ratio (ttm): -9.6 (operating income was negative)
* Includes the temporary liquidity benefit from the issuance of
significant debt in Q1. Quick and cash ratios were 0.7 and 0.2
before the debt issuance, respectively.
Amyris applies its industrial synthetic biology platform to provide
sustainable alternatives to a broad range of petroleum-sourced
Quick Ratio: 0.9
Cash Ratio: 0.3
Operating Cash Flow (ttm): -$183 million
Debt / Equity Ratio: -2.9 (total stockholders' deficit of -$4.1
Interest Coverage Ratio (ttm): -4.1 (operating income was negative)
Navistar is a holding company whose subsidiaries and affiliates
produce commercial and military trucks, diesel engines, and school
and commercial buses under the International, MaxxForce and IC Bus
The Bottom Line
If cash is the lifeblood of any business, then these 4 companies
are on life support. Each have high debt levels, poor liquidity and
negative cash flow.
Todd Bunton, CFA is a Stock Strategist for
and Editor of the
Income Plus Investor
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