One of the hallmarks of a cyclical business is operating leverage. When revenues explode, and your cost structure remains relatively fixed, profitability kicks into overdrive. When boom turns to bust, that leverage cuts just as hard in the other direction, and losses pile up. Layering financial leverage (i.e., debt) on top of this natural operating leverage is often a recipe for disaster.
At the end of 2006, contract driller Hercules Offshore's
If Silgan Holdings
Other than a few fairly long-term engagements with the likes of Chevron
Hercules had over $950 million in total debt at the end of the quarter. Catching what I believe is the tail end of a monster junk bond rally, the firm recently sold $300 million of 2017 notes that were priced to yield 11%. This will help pay down Hercules' term loan, thus buying the company time to climb out of the hole it's drilled for itself over the past few years.
If bidding activity continues to pick up in the Gulf of Mexico, as it has since September, and the commodities complex avoids another sharp downturn over the next two to three years, Hercules could prove a rewarding speculation. I'm not personally willing to take those odds, however.