Drip Portfolio Report
Thursday, August 28, 1997
Randy Befumo (TMF [email protected])

ALEXANDRIA, VA (Aug. 28, 1997) -- Yesterday we took a first pass at looking at OWENS CORNING's (NYSE: OWC) long-term debt. As part of my study, I immediately went to the company's last quarterly earnings press release to find the long-term debt number. Last night when doing further study for tonight's continuation, I discovered that since the end of the company's quarter, it had taken on approximately $468 million more in debt to complete the purchase of Fibreboard, a maker of vinyl siding. This would bring the total debt at Owens Corning up to around $1.7 billion, rounding up, instead of the $1.2 billion number I was working with yesterday.

Additionally, before I go on with the debt analysis, I want to make something else very clear. A lot of people have written me e-mail confusing Owens Corning with either CORNING (NYSE: GLW) or the now bankrupt Dow Corning, famous for breast implant litigation. Owens Corning is the product of a joint venture between former Dow Jones Industrial Average component OWENS-ILLINOIS (NYSE: OI) and Corning that went public in 1938. Corning still remains a separately traded company famous for its glassware, among other things. Dow Corning was a joint venture between Dow Chemical and Corning in the 1980s that went awry when its silicon gel breast implants apparently caused some medical problems. With the settlements pretty much in the bag here, given that Owens Corning has been a separate company since 1938, it does not seem any of that will splash on it.

A Lesson In Measuring Debt: Debt-to-Capitalization

Owens Corning has a lot of debt -- this much is certain. The company carries $1.72 billion in long-term debt on its balance sheet, up more than $900 million in the past twelve months due to a number of acquisitions. The question we will study here in the Drip Portfolio today is whether this level of debt is acceptable or poisonous. There are as many ways to analyze debt as there are Seattle-based alternative rock bands. The most common are debt-to-capitalization, debt-to-capital, debt-to-equity, and debt-to-revenues. I will describe each in turn, as well as illustrating the important numbers that you need to do the calculations.

Debt-to-capitalization is probably the most frequently used because it is the easiest to compute. You simply take the total market value of the company, including any long-term debt, and then see what portion of this value is made up of long-term debt. With 53.8 million shares outstanding and a stock price around $41 1/2, Owens Corning has a market capitalization of $2.2 billion. Adding the $1.2 billion in debt, the company's total capitalization (or enterprise value) is $3.4 billion. Of this total capitalization, 43.6% is made of debt, a high -- but not extraordinary -- number. By comparison, Disney Co. has 22% of its total capitalization in debt with the stock valued at a much higher price/earnings multiple.

This is the problem with the debt-to-capitalization ratio -- if the stock price goes down, the percentage of debt as a percentage of total capital goes up. This means that companies that become cheap actually become less attractive as they get cheaper, not necessarily the way that you want the logic to work. For instance, if the equity at Disney were valued at 9.4 times next year's earnings like Owens Corning, the company would have a debt-to-capitalization ratio of 39.9%, but it would be the steal of the decade.

Debt-to-Capital

An improvement on the debt-to-capitalization ratio is the debt-to-capital ratio, which looks at shareholder's equity instead of market capitalization and adds long-term debt to this. "Capital" refers to the cash that Owens Corning has after deducting all non long-term debt liabilities, with "shareholder's equity" plus any long-term debt viewed as the "total capital" at a company's disposal. If a company has a lot of debt relative to its capital, or shareholder's equity, it is called "leveraged." Owens Corning has a negative shareholder's equity of $353 million because of the write-downs for the asbestos litigation, so the debt-to-capital ratio for Owens Corning is actually very high. You deduct the negative equity from the $1.7 billion in long-term debt to get the total capital of $1.3 billion. Then you compare debt to the total capital and discover that debt is 130% of total capital, an awfully large amount.

However, considering this is distorted by the large reserves for what will end up being an extraordinarily long one-time event, this may not be the best way to look at things either. Additionally, because Owens Corning has a negative equity, ironically the higher the debt number becomes the lower the ratio of debt-to-total capital will become. We can see that the debt-to-capital ratio in this specific instance may be flawed, so the next step is to find some fundamental aspect about the company that we can compare to the debt in order to determine whether it is a reasonable amount.

Debt-to-Revenues

Although not very popular, my favorite quickie debt comparison is debt-to-revenues. Revenues, unlike capital or capitalization, are not really affected by the company's corporate finance policy or the company's current market valuation. Adding up the massive Fibreboard and AmeriMark acquisitions the company has made to expand its vinyl siding business, Owens Corning has around $4.8 billion in sales over the past twelve months, giving it a debt-to-sales ratio of 37.5%. Disney's debt-to-sales ratio, by comparison, is 52.1%. Coca-Cola, towards the other end of the spectrum, has a debt-to-sales ratio of 5.2%.

Depending on how you measure the debt, it becomes more or less relevant. Because the inflated values of Disney and Coca-Cola stock mask their debt relative to capitalization, most investors miss it. However, if we use a number like sales that is a little less influenced by external factors, the debt appears and becomes significant, although maybe not that significant in Coca-Cola's case. Certainly Owens Corning has a good-sized slug of debt, but that debt is not really extreme relative to its sales, especially considering that the debt has been used to acquire cash-making companies at valuations that are below what Owens Corning currently trades at. Additionally, the company is not even close to the top of the debt charts. For instance, it is not even close to Ford's debt that is 140% of revenues.

Tomorrow I will use something called the interest coverage ratio to figure out whether Owens Corning can afford its debt. Even if you are not interested in Owens Corning, it is a helpful ratio to know and I urge you to take a look.

--Randy Befumo