I was listening to the Vulcan Materials (VMC) call yesterday wondering when someone might ask the question I wanted answered. The company executed a massive acquisition last year, piling goodwill onto its balance sheet. With business down so much, the company, in conducting its annual "impairment test", might find that it needs to write down the carrying cost.
The company stated that it didn't need to make an adjustment this year, though clearly this is purely management discretion. This is important, because a writedown can trigger a violation of bank covenants (as debt to equity rises after the equity is reduced). Further, it can hurt valuation ratios such as price to book value.
I described my major theme of "big bad balance sheets" in December. As I have been writing frequently about my concerns that many companies outside of the Financial sector will struggle immensely this year with balance sheet concerns, I want to continue the dialogue by identifying companies with high debt loads, high goodwill and deteriorating fundamentals. If you own these stocks, you should attempt to better understand how a potential company writedown might impact its ability to borrow, its cost to borrow and its likelihood to continue paying dividends. Here are the parameters I employed:
- Intangibles/Equity > 70%
- Debt/Cap > 40% (Net > 25%)
- EPS decline for 2009 >15%
- Market Cap > $600mm
The list yielded 74 names, but several are from different shares of stock for the same company. Also, I would point out that good things can happen to bad companies, as one of the stocks, Advanced Medical Optics (EYE), recently received an acquisition offer. (click on chart to enlarge)
The list encompasses candidates from many sectors and across all market capitalizations. I included a couple of columns on dividends to help highlight one of the risks (a dividend reduction). Note that many of these are high-yielding stocks, with several of them having very high payout ratios. Remember, there is no FDIC insurance on those dividends!
As I stated before, this list is a good starting place to identify companies that may be at risk of an impairment to their goodwill. The deal looked so good back when it was done, but the current economics might not support the original purchase price. The consequences of a write-down may not be signficant, but if the company has substantial debt it can lead to violations of its agreements with its lenders and require repayment of debt or higher borrowing costs.
Additionally, companies may be restricted in their ability to pay dividends. I believe that my thresholds are actually not low enough and would be concerned with companies that have goodwill representing 50% instead of the 70% I employed in order to keep the number of companies hitting the screen to below 75. Also, there are many companies that haven't reported and have stale earnings forecasts that kept them from meeting the "-15% EPS" parameter. One that comes to mind is Weight Watchers (WTW), which I recommended as a sale in Mid-January. Another caveat is that I was unable to include stocks with negative equity, but there are several of those that would meet the criteria otherwise. If I remove the down EPS parameter and change the goodwill ratio to 50%, the number of stocks rises to a stunning 294. While companies may avoid it for now, many of them will be taking the charges in early 2010 if this economic crisis persists. Don't get caught holding the bag!
Disclosure: No position in any stock mentioned or in the graphic.