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I've got good news and bad news when it comes to U.S. companies, including those in the S&P 500 .
The good news, according to S&P Global Ratings, is that U.S. companies had $2.1 trillion of cash at the end of 2017. The bad news is they also had $6.3 trillion in debt for net debt of $4.2 trillion.
A 0.25% increase in the prime lending rate could cost American businesses as much as $10.5 billion in additional annual interest payments.
"These borrowers have $8 of debt for every $1 of cash," wrote Andrew Chang, the primary credit analyst at S&P Global. "We note these borrowers, many sponsor-owned, borrowed significant amounts under extremely favorable terms in a benign credit market to finance their buyouts at an ever-increasing purchase multiple without effectively improving their liquidity profiles."
If you go back in time and do a Google search, you'll see that Chang has been ringing the alarm for several years, and only now with rising interest rates are investors starting to pay more attention.
Who are the worst offenders? Read on I'll tell you which seven S&P 500 companies' debt scares me.
S&P 500 Companies With Scary Debt: First Energy (FE)
Ohio-based utility FirstEnergy (NYSE: FE ) first announced it was getting out of the competitive electricity business in November 2016 by selling or closing its coal and nuclear plants in Ohio and Pennsylvania so that it could focus on its regulated business, which is profitable.
As part of the company's exit from the competitive electricity market in those two states, First Energy has offered buyout packages to about 600 eligible employees who won't be needed once it's fully regulated.
"We're going to become a regulated only company," FirstEnergy spokeswoman Diane Francis said June 28. "We need fewer support staff to support regulated-only operations."
In early April, First Energy Solutions, the subsidiary that runs the company's competitive electricity business filed for Chapter 11 bankruptcy. On April 23, 2018, First Energy reached an agreement with two key creditors that should help pave the way for that division emerging from bankruptcy protection.
At the end of March, First Energy had $16.9 billion in long-term debt on its balance sheet, $2.1 billion less than at the end of December due in part to the removal of $2.3 billion in LTD from its competitive energy services business which is now discontinued operations.
In 2018, First Energy expects to generate as much as $2.55 in non-GAAP operating earnings per share which amounts to $1.2 billion based on 476 million shares outstanding.
That's the good news.
The bad news is that it still has approximately $1 billion in annual interest payments to make on the $16.7 billion outstanding. With interest rates going up, it's uncertain what will happen to its regulated business in the years ahead.
S&P 500 Companies With Scary Debt: Kinder Morgan (KMI)
Source: Roy Luck via Flickr
Texas-based Kinder Morgan (NYSE: KMI ) and its Canadian majority-owned subsidiary, Kinder Morgan Canada Canada Ltd (OTCMKTS: KMLGF ) have been in the news a lot lately for the astute poker playing it exhibited by exiting the controversial Trans Mountain pipeline and expansion project with several billion in profits.
According to the Institute for Energy Economics and Financial Analysis (IEEFA), Kinder Morgan and its Canadian operation have spent CAD$610 million to date on the pipeline's construction.
Given the May 29 announcement that the Canadian government would acquire the pipeline for CAD$4.5 billion, KMI and KML stand to generate a CAD$3.89 billion profit (637% return) on its investment.
I wasn't a fan of Kinder Morgan Canada's IPO in 2017, stating the debt levels of both its newly listed Canadian subsidiary and the parent were too high to justify an investment.
I called it a "dog with fleas," advising investors to stay away from its IPO because Kinder Morgan was simply using Canadians to finance its expensive dreams.
Now that the Canadian government's on the hook for completing the expansion of the pipeline, Kinder Morgan can use the funds to reduce its debt.
Currently, Kinder Morgan has net debt of $35.2 billion while Kinder Morgan Canada has net cash of $210 million due to its 2017 IPO.
I'm going to assume Kinder Morgan, which owns 66% of the outstanding shares, will ensure most of the CAD$3.89 billion finds its way back to Houston to repay some of its debt.
The problem is Kinder Morgan will still have approximately $32.3 billion in net debt (almost as much as its $39.6 billion market cap) after using all of the proceeds for debt repayment.
That should scare you.
S&P 500 Companies With Scary Debt: Campbell's Soup (CPB)
Source: Meal Makeover Moms via Flickr (Modified)
As far back as 2014, I thoughtCampbell Soup Company (NYSE: CPB ) was an obvious M&A target given its stock was fundamentally broken. Since then, it's down a couple of bucks while the markets as a whole have roared ahead.
Things are so bad at CPB that long-time CEO Denise Morrison stepped down in May; it's undergoing a strategic review to figure out what's its best foot forward. My guess is that the board will conclude it's better suited in the arms of another.
As far as debt goes, Campbell Soup has $8.1 billion in long-term obligations as of April 29, 2018; that's four times the amount of debt it held in July 2017.
Why such a jump?
Morrison looked to pivot from a dullard soup market by acquiring Snyder's Lance, a fast-growing snack foods company with brands such as Kettle Chips, Snack Factory Pretzel Crisps and Snyder's of Hanover pretzels.
Snyder's Lance came with a $6 billion price tag including the assumption of debt. Unfortunately, for Campbell Soup shareholders, the rest of the company is barely growing.
Add four times the interest expense to the income statement and you've got the makings of a very sad story.
I doubt it will be Warren Buffett buying CPB but it could be his friends at 3G Capital . If a deal doesn't happen by the end of the year, I'd be really scared of this debt and how it will weigh on CPB's stock price.
S&P 500 Companies With Scary Debt: Hologic (HOLX)
I have to be honest, I'd never heard of the Boston-based medical imaging and diagnostic company whose products include the 3Dimensions Mammography system.
However, anyone who's had a brush with breast cancer might have. Fast CompanycoveredHologic's (NASDAQ: HOLX ) Smart Curve stabilization system in 2017 and how it reduces the pain involved in undergoing a mammogram. Apparently, it's the number one reason why women avoid them.
OK, so we know the company's products are useful and meet the needs of women in the U.S. and elsewhere. How is its financial condition?
It has got $2.7 billion in long-term debt as of the end of March with $614 million in cash for net debt of $2.1 billion, three times 2016 operating cash flow, the company's best result in the past decade.
Unfortunately, a $686 million goodwill impairment related to its $1.7 billion acquisition of Cynosure, a maker of aesthetic lasers, knocked it for a $604 million operating loss in the latest quarter.
It's barely profitable, and $160 million in annual interest expense is not going to solve the problem.
S&P 500 Companies With Scary Debt: Waste Management (WM)
Over the last five years, you would have doubled your money by owning Waste Management (NYSE: WM ) stock. That's not half bad for a company that deals in garbage.
In March, the company's founder, Wayne Huizenga, better known for Blockbuster, died at age 80. It's not often you build one Fortune 500 company - Huizenga built three with AutoNation (NYSE: AN ) the last of the trifecta.
He was quite an entrepreneurial spirit so I'll tread carefully.
Garbage collection isn't as simple as it looks. You've got to have a massive fleet of trucks, not to mention the manpower, to collect the stuff on a routine basis. That all requires capital.
In Waste Management's case, it has borrowed $8.9 billion as of the end of March to keep the business running with just $52 million in cash on the balance sheet to show for it.
However, because it's accounts receivables that are three times its payables - once you've got the trucks, there's not much else required except maintenance of those trucks - it's able to generate $1.7 billion in free cash flow annually.
But there's the catch.
To generate this free cash flow it's constantly having to add new vehicles to its fleet to keep the number moving higher.
Since 2008, Waste Management's free cash flow's increased by 23% while its long-term debt's increased by about 8% .
That seems like a good deal until interest rates go up substantially. It currently pays around $363 million annually on its long-term debt, which doesn't seem like much, but it's about 14% of its operating income.
If rates double, interest expense would account for a third of its operating profit. Higher interest rates are great for banks; not so good for garbage haulers.
S&P 500 Companies With Scary Debt: Kroger (KR)
The grocery-store chain's having a devil of a time trying to figure out how to survive in a world dominated by Amazon.com (NASDAQ: AMZN ).
Now that Amazon's gone and bought Whole Foods and is using it as the last mile assault on the company's Prime members, Kroger (NYSE: KR ) definitely has its work cut out for it.
While a number of analysts have gotten on board the company's plan to protect its beachhead and earnings have been stronger than expected, one analyst from Pivotal Research Group feels the stock's just too darn hot.
"Right now, the stock has simply gone up too far and too fast from a valuation perspective," Pivotal Research Group's Ajay Jain wrote in his June 27 report to clients. "This falls into the category of a nice problem to have for Kroger investors."
In fact, Jain liked everything about Kroger's Q1 2018 results.
So, why am I picking on Kroger?
As of the end of May, it's got $11.3 billion in long-term debt. Knock off $691 million in cash and its net debt is $10.6 billion or almost half its market cap.
Here's the problem.
In the first quarter, it repurchased $1.1 billion of its stock - at a time when it's moving higher - from the $1.4 billion in after-tax proceeds of the sale of its convenience store business.
Talk about a bribe to keep shareholders from bolting. Kroger in the past decade has never generated more than $1.5 billion in free cash flow yet it chooses to buy back shares with its windfall from the convenience stores.
With interest rates moving higher, I see management's move as a poor allocation of capital.
Good earnings aside, the choice to line shareholders' pockets instead of reducing its debt is one that will come back to haunt it - hopefully, later rather than sooner.
S&P 500 Companies With Scary Debt: Iron Mountain (IRM)
I saw a Seeking Alphaarticle about Iron Mountain Inc (NYSE: IRM) from June whose title caught my fancy: Why Doesn't Mr. Market Recognize The Iron Mountain of Dividends?
As author Brad Thomas points out, sometimes it takes some time for Mr. Market to understand a company's story. Unfortunately, I'm not a PRO member so I have no idea whether his argument about its data center business holds water.
Here's what I do know.
Iron Mountain pays a very attractive dividend that currently yields 6.6%. It has increased its dividend by an average of 24% annually over the past three years since converting to a real estate investment trust.
In January, it paid $1.35 billion for IO Data Centers, a company with four data centers in Arizona, New Jersey and Ohio. This will be a complimentary business to Iron Mountain's core business of information storage and services related to that information.
Anyone who has followed the cloud knows that data centers are a big piece of the puzzle so it's possible this is the key to its future growth.
Certainly, its core business is generating reasonably healthy free cash flow - $303 million in 2017 - but it's stock's FCF yield is a very unattractive 1.7% based on an enterprise value of $17.7 billion.
As of the end of the March, Iron Mountain had $8 billion in debt. If Iron Mountain used 100% of its free cash flow to repay its entire long-term debt outstanding, it would take 26 years.
That to me is a scary thought if you're an income investor.
As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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