For Companies, Rising Cash - And Rising Debt, Too

By Stephen D. Simpson, CFA | September 24, 2010 AAA
For Companies, Rising Cash - And Rising Debt, Too

Context is everything - without seeing the big picture, it is easy to get distracted and misled by a little nugget of information. That would appear to be the case when contemplating the balance sheet of "Corporate America". While there has been a fair bit of attention to the rising cash levels of the balance sheets of public companies, there is critical detail that goes missing in many of these stories. Debt is also climbing.

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More and More Cash
A recent article in Bloomberg Businessweek pointed out a significant increase in cash for the S&P industrials. For the second quarter, cash holdings stood at more than $842 billion, up from nearly $837 billion in the first quarter and representing more than 11% of current market value. The information technology sector likewise appears flush with cash, with holdings equivalent to 18% of market value and more than two years' worth of operating income.

Doing some spot-checking here and there would seem to confirm this trend. Cisco (Nasdaq:CSCO) and Apple (Nasdaq:AAPL) have huge amounts of cash on hand, as do Microsoft (Nasdaq:MSFT), Google (Nasdaq:GOOG), Pfizer (NYSE:PFE) and Wal-Mart (NYSE:WMT).

This should be a positive sign, right? If companies have large piles of cash, they can pay their workers more, invest in capital equipment and expansion, or at the very least weather any more ups and downs in the business cycle. And maybe, just maybe, they can return some of that cash to shareholders as dividends or stock buybacks.

Well, not so fast. The devil here really is in the details.

And More and More Debt
There are two sides to every balance sheet and you cannot talk about cash without also talking about debt. In the case of those companies, adding debt to the picture changes the view significantly. Pfizer and Wal-Mart both have more debt than cash (by a large margin), and Cisco's nearly $40 billion in cash looks less impressive after backing out the $15 billion in debt that the company carries. That still leaves four companies with substantial cash piles, but those are pretty much the top four non-bank cash-holders in America.

While cash balances tick higher, corporate debt is moving to record levels. Non-bank companies borrowed $289 billion in the first quarter of 2010, and corporate debt outstanding was above $7.2 trillion. In fact, during the same week in which that Bloomberg article was published, corporations issued another $34 billion in debt, led by the likes of Hewlett-Packard (NYSE:HPQ). According to an analysis from Smithers & Co, net debt as a percentage of net worth is at the highest levels in at least 60 years.

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So What is Going On?
It is entirely possible that there are relatively benign explanations for the rising levels of corporate debt. First, there may well be a mismatch in comparing the cash balances of large publicly-traded companies to the indebtedness of the entire corporate sector. The IPO market has been in critical condition for years now and that has cut off a major source of corporate funding - forcing many companies to go to the debt markets instead of the equity markets for new funds. Assuming that the market for new stock offerings can rebound, some of the debt will go away in place of equity capital.

Second, many companies may simply be buying money while it is cheap. Rates are eerily low right now and it makes quite a bit of sense to take on debt when the cost is so appealing. Whatever assumptions academics want to make about the cost of equity, the number usually falls in a range of 8-12%; certainly more than the after-tax cost of corporate debt these days (10-year Single-A corporate debt yields about 4.1% right now).

If corporate leaders expect rates to rise, and anecdotally most of them seem to, then it probably makes sense to pay a few years' worth of "unnecessary" interest payments and not have to tap the capital markets after rates begin to rise. Of course, that line of thought is not all that much different than the thinking that got countries like Greece and Ireland into so much trouble - cheap debt is still debt and borrowers always need to be careful not to get sucked into a downward spiral of indebtedness.

Consumers and Corporations Heading in Different Directions
If the U.S. and Western Europe really are in for a long stretch of economic malaise reminiscent of Japan's "lost decade", then this debt really could be a millstone around many companies' necks. On the other hand, the overall rising levels of cash suggest it could just be a case of timing and of companies taking a good deal (i.e., low rates) while the getting is good. (For more on the "lost decade", take a look at The Lost Decade: Lessons From Japan's Crisis)

Whatever the case may be, the cash situation of Corporate America is more complicated than a lot of journalists have suggested and investors should make sure to study both sides of the balance sheet before getting too excited about any particular trend.

For the latest financial news, see Water Cooler Finance: Poverty Rates Increase - And So Do Millionaires.

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