Record high levels of U.S. corporate debt have been a matter of growing concern in recent years, having grown to about $9 trillion and representing roughly 45% of U.S. GDP, per CNBC. Former Federal Reserve chair Janet Yellen is among those who have expressed alarm, warning that this debt overhang threatens to set off a wave of bankruptcies that could worsen the next recession. Stephanie Pomboy, founder of economic consulting firm MacroMavens, voiced similar concerns recently in a lengthy interview with Barron's.
Addressing these concerns, several major corporations have announced plans to reduce their debt burdens. “They’re in credit repair mode and going full force at this,” as Brian Kennedy, a senior portfolio manager at Loomis Sayles & Co., told Bloomberg. Noting that equity and bond investors alike are welcoming corporate debt reduction, Tom Murphy, the head of investment grade credit at Columbia Threadneedle Investments, had this to say: “Now the interests are much more aligned. t’s about generating profitable growth, not growth for growth’s sake.”
5 Blue Chip Companies That Are Paying Down Debt
(Total Debt Loads)
Sources: Bloomberg, Barron's, Yahoo Finance; data as of most recent financial reports for each company.
Significance for Investors
Companies such as those listed above are taking different routes to debt reduction. Kraft Heinz is using a combination of asset sales and a dividend cut to raise the funds. GE is selling its biopharmaceutical division to Danaher Corp. (DHR) for $21 billion and indicated that it will retire debt with the proceeds. The news spurred a rally in GE stock and its bonds alike, as risk premiums on its bonds fell.
Meanwhile, AT&T CEO Randall Stephenson asserts that debt reduction is his top priority for 2019, but has not offered a specific plan. The company's huge debt burden is making it difficult to compete with price cuts, creating customer retention issues in highly contested markets such as cellular service, Bloomberg observes.
"Telecom is the poster child right now for balance sheet religion," as Michael Temple, director of U.S. credit research at asset management firm Amundi Pioneer, told Bloomberg. AT&T's top rival, Verizon Communications Inc. (VZ), has $113 billion of debt.
Regarding debt-laden department store chains Macy's and Kohl's, debt buybacks offer the prospect of generating as much excitement among equity investors as do stock buybacks by other companies. Macy's debt is rated BBB-, or one level above junk bond status, while Kohl's is rated BBB, or two levels better than junk, per Barron's. The article notes that both retailers "are responding to market pressure by buying back debt."
Peter Tchir, head of macro strategy at investment banking firm Academy Securities, has written, as quoted by Barron's: "Corporate behavior is changing...[in a] response to how markets are pricing debt, and how equity markets are treating companies that are perceived to have too much debt." He indicates that a "material" number of investment grade companies can strengthen their balance sheets quickly by reducing or eliminating share repurchases, which he calls a "luxury item." That is, while dividend cuts often provoke negative reactions among investors, cuts to buyback programs rarely do.
Merger and acquisition (M&A) activity has been a significant source of the corporate debt buildup. Acquirers often raise the funds needed for cash transactions by issuing new bonds, a move that can hurt existing bondholders if the company is perceived as becoming riskier, pushing its bond prices down and their yields up.
However, independent credit research firm Gimme Credit says, per another Barron's article, that five big acquirers "have made pretty dramatic leveraging transactions, but most of them have plenty of free cash flow and have laid out specific plans and targets for getting their leverage back down." They are Altria Group Inc. (MO), Cigna Corp. (CI), Comcast Corp. (CMCSA), CVS Health Corp. (CVS), and the Interpublic Group of Companies Inc. (IPG).
In the context of $9 trillion of total U.S. corporate debt, the moves by the individual companies mentioned above are small, and significant systemic risk remains. However, reducing the number of weak links in credit markets is a welcome development.