Is This Company About to Fail?

The credit market remains exceptionally tight these days. In spite of (or perhaps because of) Uncle Sam's help, almost no company that actually needs a loan is able to get one from a private lender at decent rates.

In fact, those that can get money at all are forced to pay outrageous interest for the privilege. General Electric, for instance, is paying Berkshire Hathaway 10% on its preferred shares, and GE had to sweeten the pot with warrants to get its rate that low.

And GE is a profitable industrial titan -- once the world's largest company -- that even after its recent downgrade still sports an impressive AA+ debt rating. When a company like that needs to dilute its shares in order to get money loaned to it at double-digit rates, you know the credit market is tight.

Although it's difficult and expensive, GE can borrow the cash it needs to operate. But not everyone is so lucky.

Who's at the biggest risk?
In a credit environment this tight, firms that can't either roll over their debt, or pay their debt and operate with what they have, are in danger of going under.

But with the possible exception of law firms that handle bankruptcies, nearly every company is feeling the pain of this economic downturn. So how can you tell if a company is struggling just like everyone else -- or about to fail?

These three signs should make you sit up and take notice:

  • A substantial amount of debt -- given this credit market, a company with significant debt that it can't pay off is a huge risk for shareholders.
  • A negative tangible book value -- which means that its total worth is tied up in its brands, its goodwill, and its ability to generate cash, leaving nothing to borrow against.
  • Negative free cash flows -- which means that it's actively shelling out more cash to maintain the business than it's receiving from its customers.

When you put all three of those high-risk signs together, you get companies like these:

Company

Tangible Book Value
(in millions)

Levered Free Cash Flow

(in millions)

Total Debt
(in millions)

American International Group (NYSE: AIG  )

($44)

($131,617)

$198,465

Ford (NYSE: F  )

($18,904)

($15,368)

$154,196

UAL (Nasdaq: UAUA  )

($5,340)

($1,159)

$8,149

Ingersoll-Rand (NYSE: IR  )

($5,173)

($457)

$5,124

Cheniere Energy (AMEX: LNG  )

($688)

($869)

$3,165

Data from Capital IQ, a division of Standard & Poor's.

And that combination can be deadly, indeed. AIG has already repeatedly gone begging to Uncle Sam for bailouts, while Ford is barely staying ahead of the need to access government cash.

If a company is in debt, doesn't have sufficient assets to borrow against, and it isn't generating cash, then it's really only a matter of time before its debt holders get tired of financing its business. That's especially true now.

Buy smarter
In general, companies that hemorrhage cash, have weak balance sheets, and are drowning in debt make lousy investments. On the flip side, those that gush cash, are smart with their use of debt, and have solid balance sheets backing up their businesses can be tremendous companies to own.

That's especially true during times like these where virtually every company has been knocked down off its peak, and even the strongest ones are available at bargain-basement prices.

At Motley Fool Inside Value, we're actively scouring the market to find the solid firms whose shares have been left to rot alongside the truly damaged ones. When we find those diamonds in the rough, we share them with our members, who then have the opportunity to buy some of the world's greatest companies at bargain prices.

If you're ready to avoid the companies teetering on the edge of failure, and instead focus on those with the fundamental strength to thrive in the long run, then join us at Inside Value. Simply click here to learn more or start your 30-day free trial.

This article was originally published March 8, 2009. It has been updated.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of General Electric. The Motley Fool owns shares of Berkshire Hathaway, which is both a Motley Fool Stock Advisor selection and an Inside Value pick. The Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (33)

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 April 07, 2009, at 4:10 PM, bondnut wrote:

    Maybe a lousy equity investment. For those you believe the Feds will continue to bail out firms like AIG regardless of their poor business model than their bonds at 30% can be a good investment. Historically stocks return 10% a year, but at 30% a year you only need AIG to stay in business 3 and 1/3 years to get all your principal back. If it is a 20 year bond you are getting free checks for the next 17 years and at maturity getting back triple your original investment when uncle sam pays out at par. The stock paying no dividend can be a dead dog for years but unless uncle sam has the guts to pull if off life support the bond holders will come out ok.

  • Report this Comment On April 08, 2009, at 2:17 PM, AGCAPS wrote:

    If Ford lose this battle, which US auto maker will left?

    Also none of the automakers do well on this market. Then we should see which of the automakers show any increase in sales and ether or not they profit from it. Between all of them I believe Ford is the one with more chances. US auto market still in love with SUV and trucks.

    Why?

    The reason in my view is commuting and work. Most of the Americans like me which commuting long distances to working need a vehicle that can handle that and believe me it is not a small car.

    I commuting every day 60 miles (each way) and like me I see many people that are doing the same. A small car will last 1 to 2 years. People already realize that. We not a small country like most those in Europe and most of our life is in side of a car “unfortunate” so if you commuting you will know that.

  • Report this Comment On April 09, 2009, at 5:29 PM, paultaut wrote:

    Just on a contrarian basis...that's just being nice... LNG is on its way to $7.50 short term.

    They have been funding CQP's payout and will continue to do so until the end of this year. Thereafter, CQP will stand on its own.

    LNG itself is the next phase for Natural Gas distribution worldwide. Short Chienere at your own risk.

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