A Plea for Better Balance (Sheets)

Banks were taken to the woodshed because they were overleveraged. Simply put, they took on way too much risk with weak underlying capital and assets. Some non-financial companies are also lacking necessary fiscal responsibility. Many of America's "blue chip" companies have scary balance sheets. Over the years, they have been living on "robust" cash flow while ignoring their balance sheets. It would seem that whenever possible they gobble up companies but lose sight of maintaining equity.

1. Verizon (VZ): At first glance, equity doesn't look bad at $42 billion. However, factoring out a whopping $100 billion in goodwill and other intangibles, investors are left with a $58 billion equity deficit. Their $47 billion in long term debt looks formidable. Cash flow dominates this company: operating cash came in at $27 billion for 2008 and $6 billion last quarter but, between acquisitions, capex, and dividends, that money gets eaten away. Please, management, build some tangible equity.
2. Macy's (M): Its $4.6 billion in equity gets swept away by the remaining $4.5 billion in goodwill and other intangibles left on its balance sheet (Macy's marked down two quarters ago about $5 billion in goodwill). The company has $8.7 billion in debt. True, the company made strides in reducing their debt last $800 million Q1 2009. Then, it had been an even more egregious $9.7 billion. This is a company that has been overly dependent on its cash flow at the expense of its balance sheets. It overpaid for Filene's, Marshall Field's and the rest of May's Department Stores. Can it tighten its belt and continue to pay down a debt that is twice its market cap? Will it resort to secondary stock offerings to manage debt? Will cash flow hold up in a tough retail environment? Will Macy's continue to pay down debt? With a total of 155 million square feet of space, Macy's is almost a third the size of Manhattan. Can Macy's continue to expand in the face of so little tangible equity and so much debt? My message to management: trim footage, cut costs and put every bit of cash into paying off debt.
3. Boeing (BA): The company has a negative 662 million equity position. Factor out goodwill and other intangibles and that figure drops to a negative $6.9 billion. tangible equity. Debt is something it definitely has: $8.7 billion in long term debt. The company has been stressed in its cash flow. In previous years, its cash flow could be used to pay down debt. With its recent strike and production woes, that cash flow has been hobbled. Last quarter, Boeing borrowed another $1.85 billion Unfortunately for Boeing, this money is already spoken for: $1.22 billion in dividends, $493 million in interest from its old debt, and $108 million in interest on the new bonds. Even with the new cash, Boeing is stuck in a hole. I would suggest Boeing cut its dividend, something the company can ill afford.

Mature publicly traded companies need to pay close attention to their balance sheets and build tangible equity.

Disclosure: (short M)

Comments

[Pj568:]

Can't buy into your premise that all intangibles are worthless.

Sure intangibles reflect acquisition activity but not all acquisitions are bad. Those with recent acquisitions are more at risk than older one, especially if they purchased financial assets during the last three or four years.

One should first consider it as a fixed asset cost and analyze from there. Yes, investment in fixed assets has an affect on firm structure and intangibles are subject to write downs. There are big differences in structure between service companies, banks and manufacturers. Liquidity, profitability and leverage are more the issue today.

Jun 21 01:24 PM

[Deehena:]

Goodwill is neither an intangible or a fixed asset cost - it is vapor.

Jun 21 02:35 PM

[Stephen Ros...:]

The lack of solid equity in companies is widespread. I chose M, BA, and VZ for the discussion. They are not unusual. Even "stalwarts" like IBM have negative tangible equity. What is worrisome is that many of these mature companies have deepening tangible equity holes. For example, VZ has dropped from a negative $13 billion to a negative $59 billion in a little over 2 years. It seems prudent to me that mature large companies would build their equity: cash, stock, property, factories. I have no problem with "paying up" for an acquisition. Once accomplished the acquirer should turn its attention to turning new business into real equity. Too often, companies merely to keep acquiring with total disregard of their balance sheets. You or I would be cut off. These companies instead are rewarded with renewed credit lines.

Jun 21 07:54 PM

[20smoney:]

Good article. I too am short Macy's (M).

20smoney.com

Jun 23 09:39 AM