Excerpt from our One Page Annotated Wall Street Journal Summary (which you can get emailed to you every morning by signing up here):
Corporate Debt Begins to Worry Bond Investors
Summary: Companies are using debt to buy back stock and issue special dividends rather than invest in cash-generating growth, and that's starting to worry some bondholders. In Q1 the volume of investment grade debt raised by companies rose 72% year over year, junk bond issuance was up 25% and bank lending "soared". Yet in the first half of this year companies repurchased $200 billion of stock and paid out $108 billion of dividends. As a result, S&P reports, there were 2.7 debt rating downgrades this year for every upgrade, compared to 1.5 to 1 last year. Cisco's acquisition of Scientific Atlanta this year, for example, was funded by issuance of $6.5 billion of bonds, despite the fact that Cisco had $15 billion of cash. It then announced that it would increase its stock buy-back by $5 billion in addition to the previously announced $35 million. Cisco's stock is up 11% year to date, while the bonds are down 4% since issuance. Tribune Co announced in May that it would use bank debt and bonds to repurchase up to 25% of its stock. Moody's then cut the credit rating on its bonds to junk and their price dropped. Heinz said it would raise its dividend by 17% and repurchase $1 billion of stock, prompting S&P to cut its debt rating and outlook.
Comment on related stocks/ETFs: Although increased leverage raises risk, this phenomenon is positive for equity investors. Cisco's (NASDAQ:CSCO) decision to repurchase stock is a strong positive as the company generates enough cash flow from operations to repay the debt. Tribune (TRB) and Heinz (HNZ) are less clear since their core growth is in question.