The Federal Reserve's quantitative easing efforts combined with its zero interest rate policy of the past few years have created extraordinarily cheap external financing options for corporations. Indeed, the corporate debt market has witnessed a boom in new issues at record low rates since the financial crisis subsided. This has enticed many companies to take advantage of record low rates and issue new debt "while the gettin' is good," as they say down South. This article will take a look at three such companies that may have issued a little bit too much in relation to their respective abilities to service the debt.
First up, United Technologies (UTX) is a 218,000 employee provider of various technology products and services to the aerospace and building systems industries. The company sells everything from elevators to aircraft engines to landing gear. The company has been steadily growing its earnings over the past few years, with net income increasing by 16% between 2010 and 2011. However, the company has taken on an additional $12 billion worth of debt as of the end of fiscal 2012, moving the total owed up to $21.6 billion in long-term debt alone at the end of last year. Of course, this new debt was taken on to fund the 2012 purchase of rival Goodrich.
Obviously, UTX is a very profitable company that has shown a propensity for growing earnings at a very respectable rate. However, the balance sheet now shows $63 billion worth of total liabilities, or roughly 12 times the amount of money UTX made in 2012. In addition, the company now sports a tangible book value of negative $17 billion. The combined company is expected to make $5.6 billion this year, but for now, it looks like UTX may have taken on more debt than it can reasonably service.
With the stock trading within a breath of its 52 week highs right now, it is still reasonably valued at about 13.5 times this year's earnings. In addition, a PEG ratio of 1.1 means you aren't paying too much for future growth. However, investors would do well to monitor the firm's ability to generate enough cash to pay down its enormous liabilities, which now stand at a staggering 73% of market cap. The company pays a decent 2.3% dividend, but that is not enough income to compensate me for the risks that the debt load will prove to be overwhelming. UTX is a terrific company, but it is getting ahead of itself with its liabilities, in my opinion.
Hologic (HOLX), founded in 1985, develops, manufactures and supplies medical imaging, surgical products and diagnostic equipment for women's health needs. In the last three years, the company's operations have combined for a dismal $52 million loss. To add to the pain, the company took on an additional $3 billion in debt in 2012. This brings the long-term debt total to a staggering $5 billion. Keep in mind that this company has produced net income of negative $52 million for the past three years combined.
Even with Hologic's expected $423 million profit this year, the total long-term debt load represents roughly 12 years' worth of earnings for the company. In addition, Hologic's tangible book value is negative $5.3 billion, so any hopes of repaying the company's debt with existing assets is futile.
Since Hologic is a company that hasn't shown the ability to actually make money, the fact that debt investors were willing to buy more debt than the entire market cap of the company is astounding to me. The company pays no dividend, but the stock does trade for a reasonable forward PE of 11. However, I'm skeptical of the earnings estimates given the dreadful performances of the past three years. With markets at all-time highs and HOLX trading within 18% its 52 week highs, I would stay away from this company as its prospects for growth and profitability may not be enough to eventually pay off its substantial debts. Even if HOLX can actually return to sustainable profitability, the hole the company has dug itself into may prove to be too much. I think Hologic will need to execute perfectly in order to justify its current price and I'm not willing to take that chance.
Eastman Chemical (EMN) is a specialty chemical company that manufactures and sells plastics, chemicals and fibers in the U.S. and abroad. The company was founded in 1920 and currently has more than 13,000 employees. After growing earnings nicely from $425 million in 2010 to $626 million in 2011, earnings were markedly lower last year at $437 million as SG&A, R&D and non-recurring expenses more than devoured additional gross margin dollars. In addition, the company issued $3.3 billion in additional debt in 2012 to bring the depressing total up to $4.8 billion at the end of last year.
With Eastman expected to earn less than $1 billion in 2013, its overwhelming debt load represents right at five years' worth of income. The company's balance sheet sports shareholders' equity of $2.9 billion, but a closer look reveals $4.5 billion in intangible assets, bringing tangible book value to negative $1.6 billion. Again, any hopes of potentially paying off its debt load with existing assets are nothing but a pipe dream.
Eastman is set to have an earnings yield of just over 10% this year, based on its current $69 price. This is impressive, as the company sports a forward PE of less than 10 and a PEG ratio of about 1.1. With the stock trading off of its highs of $75, it still looks cheap. The company pays a dividend, but it isn't great at 1.8%. In having to compete with the likes of Dow (DOW), BASF (BASFY.PK) and others, any missteps along the way could prove too much for Eastman's ability to refinance its debt when it comes due. This is a good company trading for a cheap valuation, and I suspect it is so cheap because of the very debt we've discussed here. If Eastman can execute in the coming years and eventually pay off its debt, the stock should trade up in sympathy. However, if Eastman can't figure out a way to grow earnings again, its debt may prove too costly and shareholders will suffer as a result.