Coverage Ratios: What We Can Uncover in the S&P

Credit markets are still fairly frozen, making it difficult for companies to issue new debt. With earnings estimates seemingly in freefall, I thought it might be interesting to run a screen that identifies those companies who are expected to be well positioned to avoid problems related to carrying their current total debt load.

This screen is based on the Cash Flow to Debt Coverage Ratio. This compares a company's operating cash flow to its total debt, which, for purposes of this ratio, is defined as the sum of short-term borrowings, the current portion of long-term debt, and long-term debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt.

In our screen, we looked for companies whose debt coverage ratio is 0.75 or more. In scanning 7400 stocks, we came up with a list of 251 companies. We then cross-referenced this list with the S&P 500. The result is the following list of 23 stocks (prices as of the close on 2/10/09):

Symbol	Name	Sector	Last Price
AFL	AFLAC Inc.	Financials	$22.13
BCR	Bard (C.R.) Inc.	Health Care	$85.00
CF	CF Industries Holdings Inc	Materials	$53.60
COH	Coach Inc.	Consumer Discretionary	$14.31
GPS	Gap (The)	Consumer Discretionary	$11.50
JEC	Jacobs Engineering Group	Industrials	$40.68
MO	Altria Group Inc.	Consumer Staples	$16.47
OXY	Occidental Petroleum	Energy	$55.44
RHI	Robert Half International	Industrials	$17.38
SWN	Southwestern Energy	Energy	$32.18
SYK	Stryker Corp.	Health Care	$41.33
TIE	Titanium Metals Corp	Materials	$7.68
WFR	MEMC Electronic Materials	Information Technology	$14.57
XOM	Exxon Mobil Corp.	Energy	$76.14
ADBE	Adobe Systems	Information Technology	$20.48
AMZN	Amazon Corp.	Consumer Discretionary	$63.31
APOL	Apollo Group	Consumer Discretionary	$81.57
ADSK	Autodesk Inc.	Information Technology	$17.20
CTXS	Citrix Systems	Information Technology	$22.88
JNPR	Juniper Networks	Information Technology	$15.65
MSFT	Microsoft Corp.	Information Technology	$18.80
QCOM	QUALCOMM Inc.	Information Technology	$35.02
YHOO	Yahoo Inc.	Information Technology	$12.75

It's no surprise that the Financial sector has few representatives on this list, as companies in this sector tend to issue large quantities of debt as a matter of course.

It's interesting to see that the majority of stocks in this list are tech stocks (ie: in the Information Technology sector). I am surprised to see Yahoo, though; there must be more value in the company than meets the eye. Or maybe they are smart enough to manage their debt load well and lucky enough to maintain reasonable cash flow despite the fall-off in earnings the company has experienced recently.

Another surprise is the presence of some of the beaten down retail stocks like Coach and Gap in the Consumer Discretionary sector. I wouldn't have expected to see them in this strong a financial situation given how consumers seem to have gone on strike lately. On the other hand, Amazon is firing on all cylinders lately and this is a confirmation of that company's health. Note that Amazon is one of the stocks that was recently identified as a BUY in our Alert HQ.

In any case, an investor can use this list as a guide to companies that are not only conservative in taking on debt but that are also cash flow positive. Those are two characteristics that are always valuable in any investment.

Disclosure: none

Comments

[Jolly_Rancher:]

Excellent article. This is the way to uncover bargains!

Feb 12 12:58 PM

[Vox Rationalis:]

You need to go back to your data to include companies with zero debt. Apple and Google should clearly be on this list.

Feb 12 01:38 PM

[3201JQ:]

In a perfect world, this would become the era of the self-financiers. Companies that through attention to growth within self-financed limits were now able to expand into growth areas previously dominated by debt-steroid addicts, now gasping for a fix at the government-funded community methadone clinic.

But it is far from a perfect world.

JQ

Feb 12 09:13 PM

[Moon Kil Woong:]

Debt is not a bad thing in modest proportions. Without it we wouldn't have any money for one thing.

Business debt is fundamental to the healthy growth and expansion of the economy. Essentially, it is applying utilization of current resources to derive value add in the future. What do I mean by that? It is using assets to create goods and services in the future. Only this allows assets to be used for something called consumption of new things. Without allowing healthy business debt, we would most likely only be able to buy used clothes and other people's unwanted goods on e-bay.

Sure, a few rich companies can make some goods and services without debt. But prosperous the world would not be if every business didn't use debt. Nor would the world be as rich or efficient as it is today.

Feb 12 10:12 PM

[mac.barron:]

constructe makes a very good point. Taking it a tiny bit further I'll expand the thought by saying:

Taking on debt is borrowing assets from others to create goods and services that sell at a premium in the future. So long as that premium exceeds costs AND interest this leverage is the engine that drives a huge part of our economy.

The best run companies will be shrewd enough to get that premium, the real trick will be keeping out of the way of the falling U.S. Dollar if things start to go sideways.

Over the past quarter I've looked seriously at the balance sheets of 90 per cent of these companies (not AFL, COH, GPS, MO or YHOO) and this is a very strong group. N.B.: CF has been looking to buy Terra Industries, if the succeed my guess is that their balance sheet will probably tip and take them off of this list.


On Feb 12 10:12 PM constructe wrote:

> Debt is not a bad thing in modest proportions. Without it we wouldn't
> have any money for one thing.
>
> Business debt is fundamental to the healthy growth and expansion
> of the economy. Essentially, it is applying utilization of current
> resources to derive value add in the future. What do I mean by that?
> It is using assets to create goods and services in the future. Only
> this allows assets to be used for something called consumption of
> new things. Without allowing healthy business debt, we would most
> likely only be able to buy used clothes and other people's unwanted
> goods on e-bay.
>
> Sure, a few rich companies can make some goods and services without
> debt. But prosperous the world would not be if every business didn't
> use debt. Nor would the world be as rich or efficient as it is today.

Feb 13 02:55 AM

[Vox Rationalis:]

"CF has been looking to buy Terra Industries, if the succeed my guess is that their balance sheet will probably tip and take them off of this list."

I don't think so - a glance at their recent financials indicates TRA would be close to making this list if it was bigger.

What this does show is they advantage these companies have in the current environment because of their solid balance sheets. Yes, their stocks have been hit just like everybody else's, but they are in a position where they can take advantage of lower asset values. CF is a perfect example, where it is trying to take advantage of the reduced value of a solid company. All of these companies are likely to be considering acquisitions - for us the trick is to get ahead of them.

Feb 13 02:07 PM

[mkreisel:]

There is no excuse that AAPL and GOOG are missing from this list.

AAPL's net cash alone makes up for 30% of its market cap.

Feb 16 03:05 AM