US Corporate Debt: The Next Crisis?

  • Post the implosion of banks in the Great Financial Crisis the Federal Reserve stated that non-financial firms with debt/EBITDA >6x were a cause for concern regardless of industry
  • Below is the percentage of total non-financial firms’ market cap that have Debt/EBITDA > 6x
  • We have been relentless hammering home the alarming growth of financially fragile firms in today’s euphoric market in charts like this, this and this
  • With interest rates at record lows, junk bonds at record low yields, and the national debt spiraling higher, the United States has never had more risk on non-financial balance sheets than today
  • Firms with debt levels the government has deemed high risk has hit 2000 levels once again.

The difference is, today, bonds offer investors negligible income vs. 6% risk-free rates in 2000. Today there are few places to hide.

The Percentage of Firms with Dangerous Levels of Debt to EBITDA is Above the Dot Com Peak

The Debt Bomb in the US

In next week’s White Paper, we will discuss the magnitude and investment implications of the crisis among firms that may lack the ability to pay off their debt. The market mania underway has investors focused almost entirely on the revenue line at the top of income statements and not much else.

We believe the explosion in debt to EBITDA ratios during a period of soaring economic growth, an optimistic Wall Street sell-side community, and the heavy involvement of retail via apps like Robinhood augurs poorly for future returns. What is remarkable to us, and something we will expand on in upcoming research, is that earnings before interest taxes and depreciation is not even a GAAP defined term.

Warren Buffett and Charlie Munger have long expressed their dislike for this “rule of thumb” measure. Post the bubble when emphasis on this metric had become common, Wharton published a thoughtful rebuke of using EBITDA when building a ratio measuring a firms’ valuation. We provide the link above as a healthy reminder of just how wrong things can go when markets become complacent like we believe they are today.

Ultimately, taxes, depreciation, and amortization are often real and ongoing costs of a business. This is particularly true in frothy periods like today where intangibles are plentiful on corporate balance sheets. In many ways, the KCR research team believes there are few analysts focused on net income much less cash flows. Instead, we see an ever-growing amount of “research” based on future price to sales multiples discounted back at near-zero.

As we have documented rigorously in our Charts for the Curious, Quick Takes and White Papers, the KCR team believes that the obsession with novel and often loss-making stocks is creating terrific opportunities. If you are willing to avoid the herd, focus on the fundamentals, and put safety first, we believe some of the most proven and profitable firms are often some of the least expensive.

We also believe this is important from an income perspective. As we have outlined in pieces like A Preference for Getting Paid and our piece on “Fort Knox” dividend payers, there are terrific stocks with long histories of providing yield in a world where income is scarce in fixed income.

There is no denying that KCR is out of touch with today’s euphoria and staggering multiple expansion. We believe charts like this one show that patient investors focused on finding solid fundamental values will come out with a great deal more money in the future like those that remained disciplined during the mania. For investors looking to preserve and grow capital responsibly, we look forward to hearing from you :)

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra for anyone seeking out more information related to the topics above.


The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

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October 15, 2021 |

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