Seeking Alpha
Profile| Send Message| ()  

By David Sterman

During the past generation, a reasonable level of debt has always been seen as appropriate, because balance sheets were able to withstand a typical recession. Yet all that changed in 2008. GM's (GM) debt load crashed the company, forcing it into bankruptcy, while many other companies such as GE (GE), Ford Motor (F), Hertz (HTZ) and Domino's Pizza (DPZ) saw their stocks plunge on fears a bankruptcy filing would be necessary if economic conditions worsened.

Thankfully, many companies wizened up and have been taking many steps to strengthen their balance sheets. But not everyone got the message. Some companies still carry too much debt and might run into trouble if the U.S. economy slips into recession in coming quarters. These companies will need to make large payments to handle their debt in coming periods, and right now they lack the cash to meet potential obligations. Typically, a company can simply roll over that debt and push out the time frame when debts come due. But a weak economy would make this task much harder as lenders grow skittish.

That's why it's so important to pay attention to balance sheets during earnings season. Lots of debt is only a problem if the debts are soon coming due. For example, mattress maker Sealy Corp. (ZZ) has a very weak balance sheet, with almost $800 million in debt and less than $100 million in cash. But management wisely sought to roll over debt while it could, and now the company faces no major repayments until 2014.

Yet if a company's "current portion of long-term debt," that is, debts due within the next 12 months, exceeds cash on hand, you need to listen to how management plans to address the problem. I went in search of companies that may have just such a problem (less cash than near-term loan obligations) and added Canadian media firm Thomson Reuters (TRI) to the mix (its weak balance sheet is just above that threshold). The table below highlights a group of companies that might need to declare bankruptcy in 2012 if their lenders are in no mood to extend them more loans. Take a look...


(Click to enlarge)

This is just a short list. These stocks had red flags on the balance sheet as of June 30. The current earnings season may bring more troubled companies into this group. And if the economy slips into recession, as some -- but not all -- economists anticipate, then the list will only grow when year-end results are reported.

Some companies may be hard-pressed to avoid a date with a bankruptcy judge. Take American Apparel (APP) as an example. The retailer's founder, Dov Charney, has shown much more interest in generating buzz than actually watching the company's financials. As a result, the company is now saddled with more than $100 million in debt, much of which is slated for repayment in the next few quarters, but less than $10 million in cash on hand. American Apparel generates roughly $70 million in gross profits every quarter, but has $80 million in quarterly overhead. And as the losses pile up, the balance sheet weakens further.

American Apparel has already raised $22 million in fresh cash this year, but that's not enough to keep the wolves at bay. Billionaire investor Ron Burkle is one of several investors said to be looking at acquiring some of the company's debt -- not equity. That's often a precursor to eventual hostile moves to take control of the company by calling in debts, wiping out existing shareholders in the process. Short sellers may be anticipating an eventual bankruptcy filing, because they hold more than 5 million shares in short accounts.

Even seemingly healthy companies can get tripped up by a lousy economy. Right now, Thomson Reuters carries a hefty, but manageable, $7.5 billion in debt. This shouldn't be a problem, as noted by EBIT coverage of about 8 (which means Thomson Reuter's quarterly cash flow is eight times higher than its interest payments). But what if the economy stumbles and demand for the company's professional-grade subscription services starts to slump? EBIT coverage would quickly shrink, forcing the company to meet with lenders to make sure Thomson Reuters doesn't run out of cash. This scenario is quite unlikely in the next quarter or two, but bears close scrutiny in a worsening economic environment.

Risks to Consider: Some of these stocks already trade at levels that suggest imminent financial distress. If they're able to shore up their weak balance sheets, then short sellers may boost the stocks by short covering.

If you own any of these stocks, then consider selling them now, because all of them could tumble in a hurry. Instead, a much better bet for your money right now is what we call "Forever" stocks. These are the only stocks we know of that you can buy today and hold for the rest of your life. For example, one of these stocks has plowed through eight bear markets and has returned nearly 170,000% since 1972. This means every $725 you invested back then would be worth nearly $1 million right now. Today, the company is raising its dividends, spending billions to buy back its own shares, making smart acquisitions and is the dominant leader in a $30-billion market.

Disclosure: Neither D. Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

Original Post

Source: 12 Companies That Could Go Bankrupt Very Soon