3 Companies Doing the Right Thing with Debthttp://www.fool.com/investing/general/2013/11/06/3-companies-doing-the-right-thing-with-debt.aspx Rupert Hargreaves
November 6, 2013
Many investors see debt as always being a bad thing. But when rates are low, taking on debt can be the smartest move a company can make.
Back in August, Credit Suisse analyst Kulbinder Garcha wrote in a research note that IBM (NYSE: IBM) had a cash flow problem and should be avoided. Since then, other Wall Street analysts have also jumped into the fray, raising concerns about IBM's high level of borrowing to support its growth and its buyback program. According to data from MarketWatch.com, at the end of the third quarter, IBM's net debt had exploded 160% since the end of 2009.
Wall Street is not always right, however. IBM has the backing of Warren Buffett, so the company can't be all bad. Indeed, it seems IBM is actually doing the right thing by binging on debt now while rates are low.
Since the end of 2008, IBM has acquired more than 40 smaller peers, each of which are specialists in their own fields. The total consideration of these deals is unknown, but using debt to purchase these bolt-ons seems a prudent decision by IBM.
According to data from Morningstar, nearly half of IBM's total debt has a rate of interest below 2%, which is below the United States' average inflation rate for the past 10 years. Put another way, IBM is borrowing at negative real interest rates after adjusting for inflation. What's more, although IBM's net-debt pile has expanded 160% to $36 billion during the last four years, its annual interest expense has only risen modestly, and its fiscal third-quarter interest costs actually fell by about 30% year on year. All in all, IBM does not need to be worried about the level of debt it is accumulating. Actually, if I were running IBM, I'd be tempted to borrow more, as it seems the market is actually rewarding IBM's borrowing with lower rates of interest.
Chevron CFO Patricia Yarrington replied that the company was taking a medium-term view on the matter and that with a 12% debt ratio, the company was not worried about its debt load. Indeed, it would appear that debt is almost of no concern to Chevron; according to the company's debt profile on Morningstar, approximately half of the company's $20 billion debt pile demands interest payments of less than 2.5% annually. Considering this, I'm not worried about the company's debt. In fact, borrowing to buy back stock while it is trading at such low levels will guarantee better returns for investors in the future. What's more, additional borrowing should allow Chevron to buy some smaller peers to boost its own flagging production.