Drip Portfolio Report
Friday, August 29, 1997
Randy Befumo (TMF [email protected])

ALEXANDRIA, VA (Aug. 29, 1997) -- Yesterday we took a closer look at OWENS CORNING's (NYSE: OWC) debt relative to its market capitalization, shareholder's equity, and revenues, and discussed the pros and cons of each approach. We concluded that although the company's debt is on the high-side for a corporation, it is by no means extreme, and the crucial decision on whether or not it was "too much" would need to be determined by looking at the company's interest coverage ratio.

Interest coverage takes interest costs and compares this with the amount of cash the company is bringing in. If interest expense for a year is $10 million and the company has an operating cash flow of $60 million, the interest coverage is $60 million-to-$10 million or 6:1. The higher the number, the better off a company is. The lower the number, the more dangerous things become. Interest coverage is often a better way to look at long-term debt than simply looking at the aggregate amount of debt because in the end it really matters what the company has to pay, not how much debt it has.

Think about it this way for a moment: say we have two companies, Company Good and Company Bad. Company Good has $100 million in debt financed at a 5% interest rate, recently refinanced. It is a good credit risk, has ample assets to back up its debt, and enjoys high ratings from all of the major credit rating services. Company Bad only has $60 million in debt, but it is financed at 15% because this debt was issued in the late 1980s to fund a leveraged buyout. Although Company Bad has $40 million less in debt than Company Good, its actual interest expense is much, much higher because its debt is financed at three times what Company Good has to pay.

Interest coverage is measured with the following equation: 

                Earnings before Interest and Taxes (EBIT)
Interest Cov. =------------------------------------------
                          Interest Expense

Why earnings before interest and taxes? Well, when you are measuring how much interest a company has to pay against how much money it could use to pay that interest, you cannot deduct the interest before the comparison or you double count it. As for the tax issue, if a company pays interest, it is tax deductible and therefore you get to reduce your taxable income by the interest expense. This means that both of these figures are irrelevant.

Looking on the last quarterly press release, we get the following important numbers: 

                               June 30,  June 30,
                                1997       1996     
INCOME (LOSS) FROM OPERATIONS   $105       $113 
  Cost of borrowed funds          23         18

Here we have the approximate income before taxes and interest, which is income from operations, and the cost of the borrowed funds, also known as interest expense. I am purposefully ignoring the income or losses from affiliates, because even though Owens Corning has to book them as part of their earnings, they do not necessarily affect its own cash flow and the ability to handle its debt. With $1.2 billion in debt last quarter, we can see that interest coverage at Owens Corning is 4.7 times this quarter, or $105 to $23, down from 14.1 times a year ago. The interest coverage decreased because of acquisitions that were not fully in the quarter, which might mean even more EBIT is available than is reflected on the income statement. If we assume that the interest for the new debt is financed at the same rate as the current interest, then the interest jumps tp $33.3 million and coverage drops to 3.2.

If the interest coverage were below 2.0 to 2.5, we might fret a bit about potential hazard if EBIT went down. For right now, given this interest coverage, I think it might behoove us to wait and see how Owens Corning's next quarter shakes out and see what kind of extra dollars can be brought to the bottom line. While I am not eliminating the company as an investment possibility, I do want to get a better read on the affordability of the debt as it is close to the range where I would not invest based on the interest coverage as a result of the $500 million in debt it took on for the recent Fibreboard acquisition. If it can find operating synergies with Fibreboard and increase EBIT, we may revisit Owens Corning again.

FOOLS ON THE RADIO. Your earnest Drip Portfolio management team, namely Jeff Fischer and myself, would like to drum up support for "America's Portfolio" by doing the local radio talk show tour. Unfortunately, we have no clue what local radio shows are out there in this great land of ours and need your suggestions. Do you listen to a radio talk show that might have us on as guests to talk about Dividend Reinvestment Plans, Direct Investment Plans, and other Foolery? If you do, please send the show name, host name, producer name, and the station's phone and fax number to [email protected]. If you don't know any of those, just call up the station and ask -- they will be happy to supply you with the necessary information. Or just get us whatever sketchy details you can! We're sure they want us... they just don't know it yet.

Have a great holiday weekend...

--Randy Befumo