The Economist Warns "A Reckoning Looms" For America's Debt-Binged Companies

Via The Economist,

The total debt of American non-financial corporations as a percentage of GDP has reached a record high of 73.3%.

America’s companies have been powering ahead for years. Amid growing profits, the recession that began in 2007 seems an increasingly distant memory. Yet the situation has a dark side: companies have binged on debt. For now, as the good times have coincided with a period of record-low interest rates, markets have been untroubled. But a shock could put corporate America into trouble.

No matter how it is measured, the debt load looks worrying. When calculated as a percentage of GDP, the total debt of America’s non-financial corporations reached 73.3% in the second quarter of 2017 (the latest available data). This is a record high. Measured against earnings before interest, tax, depreciation and amortisation (EBITDA), the net debt of non-financial companies in the S&P500 hit a ratio of 1.5 at of the end of 2016, a level not seen since 2003. And it remained nearly as high in 2017 (see chart).

To be sure, things are less worrying than they were before the financial crisis. According to a recent analysis by S&P Global Ratings, a ratings agency, for example, debt is now more evenly distributed. Only 27% of American firms in 2017 were highly levered (defined as a debt-to-earnings ratio higher than five), down from 42% of firms in 2007, meaning that fewer firms are immediately at risk.

The use of the extra debt was also somewhat different. Bob Michele of J.P. Morgan reckons that in recent years much of it was used by companies to finance share buy-backs, essentially for purposes of balance-sheet management (rather than, say, big expansions or acquisitions).

Even so, certain industries look particularly vulnerable under their debt loads. David Tesher of S&P Global Ratings says that retail is the sector in America most at risk. Such companies accumulated high levels of debt after more than a decade of private-equity-sponsored activity. They must also cope with tough competition from e-commerce. Around 50 American retailers filed for bankruptcy in 2017 alone, many due to the debt piled on by their private-equity owners. The most prominent example is Toys R Us, which was acquired by a consortium of private-equity firms in 2005. In the case of Payless ShoeSource, a retailer that also went bankrupt last year, creditors argued in court filings that its private-equity owners should share the blame for its collapse; after much argument, the owners agreed to put more than $20m back into the company.

Energy and utilities are two other industries at risk from their levels of indebtedness. The net debt-to-EBITDA ratio of the energy industry rose to three times by 2016, largely because of the shale-oil boom. But firms then issued a substantial amount of new equity. As earnings recovered with the rise in oil prices, their debt ratio improved to two times by last year. Utilities, meanwhile, which have always borrowed heavily, saw their debt rise to a 14-year high of 4.5 times earnings in 2017.

America’s new tax reforms add extra complications. Despite being welcomed by most businesses, the impact on firms’ willingness and ability to take on debt is uneven. For many, the lowering of the headline corporate-tax rate from 35% to 21%, as well as provisions such as the ability to expense capital spending up front, will boost profits and thus reduce the need to take on new debt (unless bosses go on a buying spree). But the new law also caps the (previously unlimited) tax deductibility of interest payments at 30% of EBITDA until 2021, falling to a more restrictive 30% of earnings before interest and taxes (but after depreciation and amortisation) from 2022. This provision will hit the most indebted firms hard, notably those owned by private equity, as well as industries such as utilities.

How quickly debt levels turn into a problem depends on monetary policy and how the economy fares.

In a benign scenario, in which corporate earnings rise across the board, and the Federal Reserve raises interest rates at a slow and predictable pace, companies’ debt ratios may even fall, for now.

But if more worrying scenarios—say, a trade war, or significantly faster-than-expected monetary tightening—come to pass, more indebted companies may find their luck running out. A binge, after all, never lasts forever.

 

Comments

El Vaquero Tue, 03/13/2018 - 18:12 Permalink

But if more worrying scenarios—say, a trade war, or significantly faster-than-expected monetary tightening—come to pass, more indebted companies may find their luck running out. A binge, after all, never lasts forever.

Uh, China dumping steel on the world and the US responding with tariffs after years of so much goddamned monetary manipulation that I can't keep it all straight kinda implies that we are in the middle of a trade war.

Buckaroo Banzai Four Star Tue, 03/13/2018 - 18:25 Permalink

Oh yay, the (((Economist))) weighed in, now I know what to think.

But seriously, let's strip away the bullshit and boil this down to the essentials. A private equity firm bought Toys R Us out a decade ago, leveraged it up, looted it, and busted it out. Now the bondholders are going to open the empty bag they've been handed, and come to terms with the fact that, for the umpteenth time, the Red Sea Pedestrians of Wall Street have royally fucked them yet again.

In reply to by Four Star

ejmoosa sixsigma cygnu… Tue, 03/13/2018 - 18:24 Permalink

One can only pay debt back out of earnings after taxes.  Not GDP.

 

Corporate debt stands at 6.1 Trillion Dollars. Corporate profits after taxes are 1.644.Trillion Dollars

 

That's a factor of 3.71 dollars of debt for every dollar of profit after taxes that is available to pay back that debt.

 

And that makes the ratio of corporate debt to profits after taxes much much more dire than the ratio of corporate debt to GDP makes it sound.

 

As rates rise, profits decline, and the picture gets exponentially worse.

 

https://fred.stlouisfed.org/series/NCBDBIQ027S

 

 

 

In reply to by sixsigma cygnu…

squid ejmoosa Tue, 03/13/2018 - 20:46 Permalink

Yup!

You issue bonds at 1%, say 1 billion worth to make the arithmetic simple. You take the billion, with a carry cost of 10 million and buy back your over valued shares. The entire C suite gets huge bonuses.

5 years later, you don't have a billion in the bank to pay out the principle on that original bond, which has been costing you 10 million a year in carry costs, so you roll it. Problem is, not rates are at 4%. Your carry costs are now 40 million, not 10. That is a 300% rise is carry costs.

 

I've worked my whole life in the private sector and companies go down when costs rise by 20%. I just can't foresee a company surviving a spike in debt carry costs of 200-400%.

 

This is a train wreck in slow motion.

 

Squid

In reply to by ejmoosa

TeethVillage88s Seasmoke Tue, 03/13/2018 - 21:06 Permalink

Did they pay in 2008 Global Crisis while protected by State Capitalism Bitchez?

- economist-warns-reckoning-looms-americas-debt-binged-companies

- Main Street Paid

- Economic Rights Granted by UN or International Law? Naw, we must be too rich, the jobs from our nation flow to low wage labor overseas... and result in struggle for us morality/us labor/us debtors/us careerist/us youth/us whistleblowers... against black balling of their career

- National Law Protections take Decades or Centuries according to History. 

- Inflation, Planned FISCAL & Monetary Inflation fucks Republics & Federations & Fixed Income Families as well as Youth, old, Infirm Students, Sabatticals, Independent Science (which gave us much and which we owe much)

- Even well paid govt agents commit crimes for career or political career (due to Debt & Inflation) ... journalist are cucked... sometime LEOs are Cucked... Crimes in DC Politics & Wall Street FIREs are put under special authority which seems to act as protector... perhaps like FISA or FBI or SEC

In reply to by Seasmoke

pippi68 Tue, 03/13/2018 - 18:17 Permalink

Hahaha! The Rothschild's magazine is issuing another warning that the whole world is going to go to hell if we can't turn it into the globalist totalitarian socialist paradise they have in mind for us. LdR even threatened to poison the Potomac to help the effort so we could watch our kids slowly die. These are such wonderful people. We should really heed their advice!

karenm Tue, 03/13/2018 - 18:22 Permalink

Bubble is already bursting, or has anyone not noticed the almost daily bankruptcy of retailers? 

 

So now they have to come out with the scapegoat for their misdeeds, lending recklessly to cause the problem in the first place. 

silverer Tue, 03/13/2018 - 18:23 Permalink

The Economist. Now most of you know they are a bullshit magazine. They really are. So for them to print something that sounds actually real is pretty scary. When the dipshits start spieling the truth, things have got to be near critical mass, and even these unrealists are unsettled by it.

pitz Tue, 03/13/2018 - 18:23 Permalink

Utilities usually will take out long-term financing.  But a lot of companies borrowed short, or did the same through swaps to create the allusion of higher profitability.

analyser Tue, 03/13/2018 - 18:26 Permalink

Short Amazon in Trumpdepression. In deflation , amazons weak margins will get hit. Currently the highly profitable AWS division is subsidizing the lossmaking package business. Higher sales, higher losses and this before the big deflation. The stock is worth 0 if we get 30 percent deflation

 

Hereby some comments from my dead canary website www.canarydeath.com

 

11/02:

FY figures. Basically failliet, eh basic fit. You have to believe in the growth nrs otherwise way to expensive. Forfarmers ok, good cash generation. But Brexit posing challenges. ( For all of us ).RWEwith 4 billion cash drain. Bad.E.onalso messy. Veolia : weak balance sheet like many old utilities.Iliadtoo expensive. Econocom : can someone pls call they company, there are big errors in their reporting. KBC : credit bubble in belgium. Volkswagen : cash flow from operating activities for the group negative by  around 2 billion Euro, we have never seen that doing that before. Cash flow from investing activities - 16.5 billion. In debt and leasing we trust.

10/02:

Spring is in the air and we have a new couple E.ON, RWE, actually crossing assets and stakes, mainly concerning Innogy. Two difficult assets Rwe andE.on, Rwe had almost a cash burn of Eur 4 billion in 9M. Oeps.  Difficult to value these two but highly  capital intensive and weakened balance sheets. Salzgitter, cash flows much weaker then P/L , lot off one offs and like many german companies ( pension charges not in the P/L).FNG bond placing, company is draining cash

09/02

Exxon : around 30 billion $ capex in 2019, operating cash flow 2017 of 30 billion $. The plan is not without risk in trump/demography misery. More importantly,  might it not be wiser to spend this 30 billion a year $ in solar and related infrastructure ? There are not many companies or even governments  that can spend so much money, GE not he :-).  Cleaner and less pollution. You are one of the biggest reference companies in the US and you invest so little in the real future. We are increasingly dying from CO2.The sun gives us enough energy on 1 day for the whole  year. Wise strategy Exxon to spend the money like this ? Bed Bath & Beyond is looking cheap here. Jardine Strategic and Jardine Mathesonlook too expensive on 30 times underlying earnings.

ejmoosa analyser Tue, 03/13/2018 - 19:04 Permalink

BBBY?  They are being Amazonned....that's why they look cheap.  Look around.  If what they sell can be delivered, they better start innovating yesterday, not tomorrow.

 

Amazon has and will cut the businesses that are losing if things get tough. Others are not in the same position to do so.  

Amazon is just starting to get some major economies of scale.  They deliver what they sell and even now they have just started 2 hour delivery from Whole Foods for free.  Publix has joined the fray.

Who already has the logistics mastered between those two for home delivery?

In reply to by analyser

thegreatsleuth Tue, 03/13/2018 - 18:27 Permalink

The corps are willing to go over since they can spend a few ten thousand dollars lobbying/buying ALL politicians and get the people to give them trillions in bailinout.

Easier when the hill is for sale and cheap! PAY TO PLAY

Why spend trillions when you can throw the dogs a bone in the house/senate/wh for a thousand and get it all for free.

Even easier, just give the israel lobbies freebies and you get a bailout just for supporting israel the money printers.

Billj1972 Tue, 03/13/2018 - 19:04 Permalink

 When you raise the debt ratio you create a one time wealth transfer to the equity owners at the expense of the existing debt owners.  You increase beta and increase the systemic default risk of the company.  But the existing debt owners get increased default risk with no extra return.  Wealth transfer from creditors to owners.   Finance 101.  

peippe Tue, 03/13/2018 - 19:50 Permalink

so we can still light 26.7% of the GDP on fire?

okay-good to know.

might want to update you stock photo, toyserus is toysergone.