Based on Leverage and Default Risk, Macquarie Research Picks Favorites

Market volatility, the decline in consumer spending, the speed of the economic slowdown, government and global stimulus, commodity price declines, the failure of brokers and investors, the lack of liquidity, and the flight from equities. There is clearly no shortage of events in the past months that can appropriately be labeled “unprecedented.”

In fact, according to analysts at Macquarie Research, the most unprecedented outcome has been the number of times that word has been used in market and economic commentary.

After 15 years of very easy credit, the cost of borrowing has soared. While many at the corporate level are still able to do so, refinancing is far from a simple process for those without solid businesses. At the same time, companies are being encouraged to take advantage of the low cost of debt relative to the cost of equity when structuring their balance sheets, Macquarie analysts said in a report.

They stressed the importance of recognizing that companies are facing two different issues: the uncertainty surrounding capital and balance sheet structure, and uncertainty about revenues as a result of the economy.

The analysts said:

At some point these intersect, though it will be different for each industry and each company. The decline in economic activity and corporate revenues, if it continues, will throw the liquidity issues to center stage for many companies.

If it turns out that the economy falls to the low end of expectations in 2009 and the debt markets remain difficult to access, which companies will need to act first and what will they do? Macquarie has identified what it considers the most and least risky companies based on leverage and default risk.

For example, the firm considers Exxon Mobil Corp. (XOM) the best-positioned defensive stock in the integrated oil space, while ConocoPhillips (COP) and BP plc appear most constrained from a liquidity perspective in a downside energy price scenario. “Integrated oil companies are likely to reduce share repurchase in a downside scenario and in some cases take on incremental debt,” the analysts said.

For rail companies, Macquarie noted that none face repayments of more than 15% of long-term debt plus capital leases between 2009 and 2010. It expects Norfolk Southern Corp. (NSC), Canadian National Railway Co. (CNI) and Burlington Northern Santa Fe Corp. (BNI) to perform best in a severe downturn, suggesting they would likely be able to buy back half as many shares as they would in a best case scenario.

Canadian Pacific Railway Ltd. (CP) would need to eliminate its share repurchases completely in a worst-case scenario, the analysts said, adding that it will probably need to do so in 2009-2010 even if things end up at the high end of expectations. “Its ability to meet its contractual obligations and its EBITDA to debt ratio would start to look somewhat under stress,” Macquarie said.

Meanwhile, the firm noted that telecom carriers learned from the painful dot-com bust and have kept their debt levels manageable, concerns about the liquidity of homebuilders is overdone and they face no refinancing needs through 2012, and it favours MasterCard Inc. (MA) and Visa Inc. (V) in the financials sector.