Do rising interest rates affect companies with high debt-to-equity ratio?If you know what a debt-to-equity ratio is, you would likely say Yes, as it increases the cost of the capital you use to finance your business. If your business uses debt to pay its current obligations, then uses next month's/quarter's/etc. revenue & profit to pay down that debt, you are pretty much:
- Operating on a month-to-month basis, where a bad month could really hurt, and
- Exemplifying the ancient Chinese proverb "Americans spend tomorrow's money today" (well, if you're not in America, it's still a dangerous game to play).
A measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets.Now, most smart businesses only use debt to finance aggressive growth and expansion, and taking on more debt might be a sign of really good things to come. I can imagine lots of gun and ammunition factories looking to take on additional debt in order to expand their factories in the wake of the shortages (read: run on ammo by the Feds). However, should something backfire along the way and revenue doesn't meet expectations, or a company begins operating on a month-to-month basis, rising interest rates will eat into whatever margins the company has left, negatively affecting earnings.
As interest rates have started to rise, I decided to take a look at the 25 publicly-traded companies with the highest debt-to-equity ratios in the United States. They come from a variety of industries and include names you've heard of such as Orbitz, United-Continental Airlines, and DISH Network. Some of these names have stayed on this list since last time I looked well over a year ago, and others have rotated on & off. At first, one might think the prospect of rising rates would negatively affect the outlook of these companies and (by proxy) their prices, but the stock market doesn't seem to think so just yet. I ran an analysis on 22 companies (as 3 of the 25 were in the pink sheets or otherwise not trading) comparing today's closing price with that of April 30, since 4/30 is where the TBT exchange-traded fund (tracking the yield on 20+ year Treasuries) had a recent bottom. Here is the specific data:
|Ticker||Company Name||Total D/E||4/30 Close||Last|
|CCK||Crown Holdings I||2500||42.67||42.5|
|CSUN||China Sunergy Co.||10260||1.55||1.98|
|DISH||DISH Network Corp||3710||39.19||38.47|
|EDG||Edgen Group Inc.||7750||6.86||6.97|
|FUN||Cedar Fair L.P.||7360||42||40.4|
|GTIV||Gentiva Health Se||3070||10.44||11.5|
|IMH||Impac Mortgage Ho||19370||10.3201||11.11|
|LBTYA||Liberty Global pl||2100||72.34||73.62|
|MNTG||MTR Gaming Group||4170||3.45||3.71|
|OXF||Oxford Resource P||2920||3.268||2.55|
|RRD||R.R. Donnelley &||7010||12.3||13.25|
|USG||USG Corporation C||5790||26||26.05|
|WYNN||Wynn Resorts Lim||2110||137.21||136.52|
Correlations are near & dear to my heart, as you might have realized from previous posts, so here are some I'll present from this data (and others I didn't choose to paste in):
|% Move to D/E||0.0447016|
|% Move to (Return on Equity / Market cap)||0.2689635|
|% Move to (Return on Assets / Market cap)||-0.232323|
As you can see, these are not very compelling. Since 4/30, the debt-to-equity ratio has not proven to be a useful indicator of stock performance at all, as the percent change for each asset in this group seems to basically be random. Comparing the moves to various returns on equity or assets is a bit more correlated, but I wouldn't advise making any bets solely on any of these metrics nonetheless.
My final note pertains to the return on this basket: assuming you had one share in each company, you made 2.34% between 4/30 and now, or $15.01. Coincidentally, in the same period, the Dow Jones Industrial Average has gone up 341 points, or 2.30%. How long will this collection of stocks track the Dow so closely? Will these start to crumble if & when interest rates on corporate bonds start to feel the same push as US Treasuries? Only time will tell. For now, don't buy any puts on any of these at random; some of these still would make great buys, but those who are squandering their debt will cease to exist, as 3 already have in recent memory. To find out which ones will do what, I'll utter your favorite three words: "Do your research." (Right up there with "Lose weight with proper diet & exercise.") Hopefully this provided you with an interesting idea for how to play rising rates, even though nothing here is worth acting on just yet.