Will Higher Debt Hurt These Stocks?

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Two years after the financial crisis made everyone realize that debt was a four-letter word, investors have learned the value of cash. Yet despite the widespread perception that corporate balance sheets are getting healthier, many companies have increased their debt levels substantially in the past 12 months, citing a variety of reasons behind their moves. Will more debt help or hurt these companies and their shareholders?

Rich vs. poor
Before the market meltdown in 2008, investors saw great benefits from companies that used leverage. Incurring debt at reasonable interest rates helped companies increase their returns on equity, rewarding shareholders with greater profits. A company that had too much cash on its balance sheet was seen as wasting opportunities for corporate investment, and cash-rich investors like Warren Buffett took heat for not putting their cash to better use.

But the financial crisis made companies realize that having cash on the sidelines can be a valuable thing. Buffett and other opportunistic investors took advantage of the scarcity of cash to make outrageously favorable deals to desperate companies that needed capital at any cost. Meanwhile, debt-laden businesses made an effort to pay off their indebtedness in order to avoid the risk that they wouldn't be able to access credit markets in the future. And suddenly, cash-rich companies like Apple and Oracle were seen as smart capital allocators, and dividend-paying stocks became highly valued for the regular cash distributions they made to shareholders.

Is leverage back?
Now, the cycle appears to be turning back toward higher levels of debt. A recent report in the Wall Street Journal notes that despite some notable exceptions, overall corporate debt levels have risen to record levels, with $7.4 trillion outstanding among non-financial companies as of the end of the third quarter, according to figures from the Federal Reserve. That corresponds to 58% of the value of those companies, a big increase from 41% just five years ago.

Within the S&P 500, 17 companies have seen their outstanding long-term debt double or more in the past 12 months, and more than 100 have increased their debt levels by at least 10%. Although some of the companies among the biggest debt-raisers are financial stocks for which leverage is a natural element of their business model, more than a dozen of the debt-doubling companies are non-financial stocks. Let's take a look at the ones that have seen the biggest percentage increases in their outstanding debt:


Current Long-Term Debt

Increase From 4 Quarters Ago

Genzyme (Nasdaq: GENZ  ) $1.1 billion 832%
CONSOL Energy (NYSE: CNX  ) $3.1 billion 705%
Cliffs Natural Resources (NYSE: CLF  ) $1.7 billion 226%
Microsoft (Nasdaq: MSFT  ) $9.7 billion 158%
Stanley Black & Decker (NYSE: SWK  ) $2.8 billion 155%
PepsiCo (NYSE: PEP  ) $18.4 billion 149%
Xilinx (Nasdaq: XLNX  ) $884 million 147%

Source: Capital IQ, a division of Standard and Poor's.

It's not enough, though, just to look at debt levels. In addition, you have to understand why a company raises debt. For instance, Genzyme, Microsoft, and Xilinx took advantage of low interest rates to borrow money with the express purpose of returning it to shareholders via buybacks or dividends. The former Stanley Works and Black & Decker completed their merger and thereby combined their former debt into one entity. Strategic initiatives have also contributed to higher debt; witness the big increase in debt at ExxonMobil that came from its merger with XTO Energy this year.

But for many companies, the motivation appears to be a combination of seeking to refinance existing debt at favorable prices, as well as simply to releverage balance sheets. PepsiCo, for example, issued debt in January to help finance an acquisition, but returned to the credit markets again in recent months.

The mixed message of debt
With interest rates as low as they are, it's hard to criticize companies for raising their debt levels. Whether having more debt on their books will hurt them depends on their ability to service that debt. As long as companies remember that raising debt was an opportunistic move to lock in once-in-a-lifetime low rates rather than something to be counted on going forward, they should be fine. But if they forget and become reliant on debt, then eventually they'll get a rude awakening once credit terms stop being as favorable as they've been.

If you're trying to retire rich, debt can kill your dreams. Get back on track by clicking here to read the Fool's special report, "The 7 Secrets to Salvage Your Retirement Today."

Fool contributor Dan Caplinger keeps his debts to a minimum. He doesn't own shares of the companies mentioned in this article. Microsoft is a Motley Fool Inside Value selection. Apple is a Motley Fool Stock Advisor selection. PepsiCo is a Motley Fool Income Investor recommendation. Motley Fool Alpha has opened a short position on Xilinx, which is a Motley Fool Big Short short-sale choice. Motley Fool Options has recommended diagonal call positions on Microsoft and PepsiCo. The Fool owns shares of Apple, ExxonMobil, Microsoft, and Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy owes you the truth, the whole truth, and nothing but the truth.

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  • Report this Comment On January 13, 2011, at 1:42 PM, SoquelCreek wrote:

    From a 2009 Xilinx shareholders meeting, the question came up why Xilinx was borrowing money when they had significant cash reserves.

    The CFO's answer was a bit surprising. The U.S. government's uncompetitive tax policies. The U.S. has one of the highest corporate tax rates in the world. Meanwhile, many other competing nations are reducing their corporate tax load.

    Xilinx earns a good portion of its money overseas. If they repatriate that money to the U.S., then they are subject to something like a 30% federal tax plus whatever California will take. In other words, they immediately lose 30% of their cash value just brining the funds to the U.S. However, they can instead borrow the funds at low interest rates (<4%). U.S. tax law allows the company to deduct the interest expenses from their income. The CFO explained that if there was some sort of emergency, then company could fully cover the debt.

    In effect, U.S. tax policy ...

    * Encourages companies to take on debt even when it seems counterproductive.

    * Discourages companies to repatriate money to the U.S. in order to invest here.

    * Encourages companies to invest money overseas.

    It's important to understand the incentives to understand why corporations are moving jobs outside the U.S. It's not all about lower salaries overseas.

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