Till Debt Do Us Part: 5 Debt-Ridden Stocks

For years, I've been hearing about the differences between good debt and bad debt. Whether it's for your education or that new pair of shoes you've been craving, all debt is bad debt in my opinion, because it represents an obligation to pay back a creditor. It's an obligation that follows you around and reminds you that you purchased something you didn't have the funds for. Can you tell I'm not a fan of carrying debt?

But that doesn't mean I don't understand that sometimes debt-financing is necessary to expand a business or make corporate buyouts possible. It's actually quite normal in the business world to run across businesses, especially newer ones, that are financing their purchases through lines of credit. The key aspect is whether or not those businesses can meet their debt obligations. The answer to this great riddle can be found in a company's cash flow.

Keep in mind that large levels of debt aren't exactly a damning factor, because strong cash flow will easily allow a company to meet its interest obligations. Using the Motley Fool CAPS Screener, I was able to come up with a couple dozen companies that currently boast a long-term debt-to-equity ratio in excess of 10. From there, I focused my attention on highly indebted companies in which the free cash flow appeared weak enough that it would cause me concern if I were a shareholder. I came up with five companies that I consider the worst offenders:

Company

Long-TermT Debt/Equity

Total Debt

Free Cash Flow (TTM)

Caesars Entertainment (Nasdaq: CZR  ) 1,880% $19.8 billion ($46 million)
Commercial Vehicle Group (Nasdaq: CVGI  ) 1,957% $250 million ($14 million)
Newcastle Investment (NYSE: NCT  ) 1,780% $3.4 billion ($323 million)
Halcon Resources (NYSE: HK  ) 3,401% $202 million $4 million
US Airways (NYSE: LCC  ) 3,044% $4.57 billion ($121 million)

Sources: Morningstar and Yahoo! Finance. TTM= trailing 12 months.

Caesars Entertainment
Perhaps no one in this group is rolling the dice more than Caesars Entertainment. The casino operator, which just went public a few months ago, is mired in nearly $20 billion in long-term debt -- which doesn't even count the $1.25 billion it recently priced. The interest expensing alone on that debt in 2011 was $212 million versus just $194 million in adjusted EBITDA. As Fool Travis Hoium explains, that's a big problem that is going to have Caesars shareholders on the short end of the stick sooner rather than later.

Even Caesars' earnings results have been far less impressive than its peers'. Almost 20% of its sales are derived from the Atlantic City region, which has suffered from the warmer weather, while its total sales in fiscal 2011 rose by a pitiful 0.2%. All I can say is: Beware the ides of debt.

Commercial Vehicle Group
This might seem a bit confusing because Commercial Vehicle's fourth-quarter report signaled a return to growth. Sales for the quarter rose 43% and operating income tripled. So why am I skeptical? Mainly because of the industry that Commercial Vehicle is in and the aggressive manner in which it has been adding debt.

As the company is a supplier of various vehicle parts to the heavy-duty and industrial vehicle sector, higher fuel prices and even the slightest pullback in the economy could cripple its earnings potential. Since just last year, its debt level is up by more than $70 million, and management has made it clear that it could be looking for additional buyout opportunities. Considering that it only produced $7 million in free cash flow in 2010, I'm not confident that it'll be able to cover its debt obligations in a protracted economic downturn if it keeps shopping like it's in a 99-cent store.

Newcastle Investment
Given my dislike for the housing sector, it's not really a surprise that a mortgage-backed securities and CDO purchaser wound up on this list.

Newcastle has been doing its best to get back on its feet after the housing bubble and financial crisis nearly put it out of business. Its portfolio of products personally doesn't inspire a lot of faith from me, as it has very few A-rated securities. Newcastle's riskier portfolio of products could pay big dividends (no pun intended), but it also carries inherent risks that you won't see with other MBS investment portfolios. Following its many years of negative free cash flow, I see no reason to believe that Newcastle is in the clear just yet.

Halcon Resources
In February, the former RAM Energy received a recapitalization that will save it from being swallowed by debt, but that by no means puts this company in the safe zone over the long-run.

The company's proven reserves of 21.1 million barrels of oil equivalent only give the company a run life of 13.7 years. Over the past decade it has not managed more than $4 million in annual free cash flow in any given year. Now if you can explain how it's going to pay back more than $200 million in debt when it can't turn a profit and is producing less than 2% of its outstanding debt total per year in free cash, then perhaps you deserve a medal. I personally can't explain it, and that's enough reason for me to be skeptical about its prospects.

US Airways
The sad news for US Airways is that without American Airlines to pick on, I feel the former now falls into the "worst of breed" category for the airline sector. It did put together a string of good quarters in 2011 and grew passenger revenue per available seat mile by 8.5%. But a 38% rise in fuel costs and $4.57 billion in long-term debt says that US Airways has a long way to go before it gains my trust.

US Airways has had a free cash outflow in seven of the past 10 years -- and one of the positive years was so marginal ($2 million) we may as well call it flat. Consumers are opting more and more for the cheapness and timeliness of regional airlines, completely bypassing national carriers. With more than 100 bankruptcies on record in the airline sector since 1990 -- two of which go to US Airways (2002, 2004) -- it's quite possible a third time could be in the cards at some point down the road for US Airways.

Foolish roundup
Just because these five companies maintain a lot of debt doesn't necessarily mean they're doomed, but it raises a yellow flag. Sound off in the comments section below with your opinion on the above companies and consider adding them to your free and personalized watchlist.

To avoid the pitfalls of investing in companies with potential yellow flags, consider getting a copy of our latest special report, "3 Stocks That Will Help You Retire Rich." It's free and packed with info on three companies currently making profits hand-over-fist.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. Outside of a mortgage, he loathes carrying debt. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's interest-free but full of interesting things.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 13, 2012, at 1:14 PM, kovach267 wrote:

    You have had it in for US Airways for a long, long time.

    I don't know what that company did to you but you do seem to hold a grudge toward it.

    I admit, I am biased. I have worked for US Airways a bit longer than you have been spouting off about it. From an employees perspective we have had our ups and downs but overall, it has been a good employer and I look forward to a few more good years with the company that has done well by me.

    Regardless, your endless rants about US Airways' immenent doom have grown tiresome.

    Perhaps its time you spewed your bile at a new company you love to loathe.

  • Report this Comment On March 13, 2012, at 3:48 PM, cp757 wrote:

    Sean I think pointing out debt is a good thing to do to help investors. I am sure that its hard for the average investor to realize his beloved stock is drowning in dept and his investment will go down. I worked up some numbers on CZR to see about how long it will take them to sell just the IPO share and I did the calculations with 250,000 shares traded a day. They don't trade 250,000 shares a day but I thought just for a math problem I would use that. That gives me 125.34Million shares offered in the IPO divided by 250,000 shares traded per day and that equals 501 trading days.That's almost two years to sell the IPO if they can increase the volume. People love to own a name and an idea and I think they love to complain about how much they lost. They just don't understand that when they cry about how much they lost no one listens. That's just like they did not listen when you told them about the amount of dept the company has. You said that it doesn't necessarily mean they're doomed, but it raises a yellow flag. I think the flag is red.

  • Report this Comment On March 14, 2012, at 3:18 PM, cp757 wrote:

    WOW CZR just jumped big time lets look at these numbers.

    Caesars raised a very modest $16 million when it sold less than 2 percent of the business in an initial public stock offering early this month. The company had previously planned to raise $500 million in an IPO that never got off the ground in 2010. The new Caesars shares jumped from $9 to $15.39 on their first day of trading but have since retreated, closing most recently at $12.56. If the IPO sold 125.34M and that's 2% of the shares that means the real number of shares is 6,267,000,000 billion shares. If you have a stock price of 12 dollars a share to figure your market cap you multiply 12 dollars a share times 6,267,000,000 billion for a total of 75,204,000,000 billion market cap. Can anyone tell me all the company's that have a market cap in the sector of over 50 billion?

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