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