Within the average company, there are two kinds of investors: those who hold its stock, and those who hold its debt. But many Foolish investors may not realize that these two factions don't always get along. Stockholders want the company to invest in growing its business, increasing its intrinsic value. Bondholders would rather see that money spent to repay the money they originally lent the company, and the interest it has accrued. The latest developments at Heinz
As fellow Fool Nathan Parmelee mentioned in his article on Heinz's grand plan, the company recently announced plans to increase its dividend 16.7% to $1.40 per common share, and to undertake a $1 billion share repurchase over the next two years. The move should benefit shareholders by nearly $2 billion; they'll reap more cash from a higher dividend yield, and the lower share count will boost their earnings per share. But what does this mean for the company's debtholders?
Bondholder blues
Largely in response to Heinz's June 1 announcement, Moody's
For one thing, Heinz's action shifts capital from the company itself to its shareholders, giving the company less cash with which to pay its obligations. Moody's debt rating is essentially its estimation of the likelihood that a company will default on its debt or be unable to make interest payments. The rating is based on many factors, including a company's financial condition, growth prospects, and market conditions, just to name a few.
The three main ratings agencies, including Moody's, Standard & Poor's, and Fitch, all use similar methods to make these distinctions. For example, Moody's rating for Heinz's senior unsecured debt is the lowest rating still considered "Investment Grade." Anything below a Baa rating is considered "junk" or "speculative," signaling a high risk that the company will default on paying its debt or interest.
A debt downgrade primarily increases a company's cost of borrowing. Downgrading Heinz's existing $4.4 billion in debt won't hurt the company directly, but it will cause the already-issued bonds to trade lower, leaving current holders with an realized loss on their principal investment. A downgrade does hurt future debt issued by Heinz, since it hikes the company's interest rates and makes borrowing more expensive.
Why should you care?
Shareholders and debtholders alike should keep an eye on company developments, though they affect each group in different and sometimes opposite ways. For example, debt sits higher than equity in the capital-structure totem pole; if a company declares bankruptcy, the debtholders become its owners, at shareholders' expense. Stockholders clearly don't want this to happen, and it's a last resort for the owners of the debt, too; they just want to collect on their coupon payments.
It's just another reminder that a company's financial decisions can ultimately affect its stockholders as well. Your best Foolish defense against a nasty investing surprise is to stay alert and stay educated.
Heinz is a Motley Fool Income Investor pick. Find out why it made Mathew Emmert's list, and discover all his other dividend-paying picks, with a free 30-day guest pass.
Moody's is a Motley Fool Stock Advisor recommendation.
Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss the company further.
