As Finney puts it, “I would rather have too much cash than be highly leveraged any day.”
Truth be told, the dramatic efforts undertaken in the past few years to improve balance sheets, whether through asset disposals or debt reduction, have created a comforting cushion at present for bondholders. As of March 31, the 374 industrial companies in the Standard & Poor’s 500 stock index collectively had $555.6 billion in cash and short-term investments on their balance sheets. That’s up some $56 billion, or 11 percent, since the end of 2003, and more than double what they had at the end of 1999.
How does that compare with debt levels? The top 100 investment-grade issuers at the end of 2003 collectively had cash on hand equal to 20 percent of their debt, up from 11 percent in 2000 (see “The Dough Rises,” at the end of this article). Hussain says investors in high-grade corporate bonds are unlikely to grow nervous until that percentage falls back to 14 or 15 percent. He expects that cushion to shrink to such a level within a year or so.
Some companies have so much cash that they don’t know what to do with it. Sears, Roebuck and Co., for instance, has bought back more than 40 percent of its shares outstanding since 1999. And in June, it announced it would pay $621 million in cash for 54 stores from bankrupt Kmart Corp. Yet the troubled retailer is still awash in cash. With its retailing business lagging, Sears’s huge cash hoard makes it a likely candidate for a buyout, according to Hussain.
Not every company has such problems, of course. Memphis-based AutoZone Inc., an auto-parts retailer, has repurchased so much stock during the past five years — almost 40 percent of the total outstanding — that it has virtually no cash on its balance sheet. That has helped produce a five-year return of 200 percent for equity investors. Bond investors have less reason to be pleased, since AutoZone’s leverage has climbed in the past two years, with debt now accounting for 81 percent of total capital. At year’s end, the company’s cash covered the interest on less than 9 percent of that.
Yet AutoZone CFO Michael Archbold has no doubt the company is doing the right thing. Its debt costs an average of 5.3 percent, and Archbold estimates the cost of its equity at roughly 15 percent; thus, he says it makes sense to buy in stock rather than pay down debt. At the same time, however, the company is determined to grow cash flow rapidly enough to maintain its target leverage ratio of 2.1 times, and with it an investment-grade rating that is rare in its industry.
Varian, too, has been actively repurchasing stock, spending some $75 million in the past three years on the effort (net of the proceeds it has received from employee stock-option exercise). But Finney didn’t have the option to pay down some of Varian’s $59 million in long-term debt, which carries a hefty 6.8 percent interest rate, because the company faces a 14 percent prepayment penalty for doing so. “We weren’t in a favorable negotiating position with the banks” when the company went public in 1999, she explains.