You wouldn't imagine it from newspaper headlines, but by one measure at least, Corporate America is in relatively good financial shape. Going into the current economic storm, companies had more cash on their balance sheets than before the last four recessions. And, through September at least, their pretax profits were more than enough to pay interest on all their debt nearly four times over. "The story of Corporate America is better than people think," says James W. Paulsen, chief investment strategist at Wells Capital Management.
How can that be? Corporate executives took heed of the bankruptcies and credit crunch of the 1990-91 recession and built themselves a financial safety net. Many used the subsequent long expansion to replenish their cash even as Internet startups squandered their funds. As a result, liquid assets held by companies shot up to 28.8% of their short-term liabilities last September--the most recent month for which data are available--compared with 20.7% right before the 1990 recession, according to the Federal Reserve.
Of course, that hardly means they're home free. "In recessions, people typically burn cash faster than they realize," says Richard B. Berner, chief U.S. economist at Morgan Stanley Dean Witter. Just how quickly the crunch can come is shown by Hewlett-Packard Co. (HWP ): In the quarter that ended in January, its cash plummeted to $2.8 billion from $4 billion as sales slipped and inventories rose. Besides, the aggregate numbers gloss over problem companies that can quickly infect their healthy suppliers by delaying payments.
So with the economy stalling and fears of recession rising, executives are becoming more concerned about protecting the cash they've got. "People are more conservative than they were a year ago," says Charles G. Ward III, co-head of investment banking at Credit Suisse First Boston. "CEOs and CFOs are making sure they have bank lines and cash, and they want to make sure capital expenditures don't outstrip their cash-raising capability." Adds Richard H. Brown, CEO of technology-services giant Electronic Data Systems Corp. (EDS ): "Cash is king now."
HARMFUL HOARDING. The ample cash cushions should mean that more companies will survive the storm than might otherwise. But in the short run, hoarding cash will impose more acute pain on the economy. Executives worried about cash are quicker to close factories and stores, lay off employees, postpone capital spending, and abort research and development. Just look at the big auto companies, which have the most experience with cash burn during recessions. They are cutting back. General Motors Corp. (GM ), for example, is pruning European production 15%, trimming 10% of its white-collar workforce, and vowing to cut $2 billion in costs. Ford Motor Co. (F ) is cutting $1 billion in costs, though it is still shelling out $2.3 billion to complete acquisitions of Volvo and Hertz interests and says it still plans to buy back $4 billion worth of stock this year.
Even so, the auto makers may have to do more. In the last recession, GM burned through more than $12 billion in cash and Ford spent more than $8 billion, according to analyst Stephen J. Girsky of Morgan Stanley Dean Witter. GM has $11.8 billion in cash, but it wants to raise that to $13 billion, and Ford has $8.1 billion. Those levels and the companies' possible burn rates were among the factors prompting debt analysts at Standard & Poor's Corp., like BusinessWeek, a part of The McGraw-Hill Companies, to downgrade the outlook for the industry recently. Only time will tell if auto makers should have stashed more cash during the good times and held back on share buybacks. S&P downgraded DaimlerChrysler (DCX ) debt on Feb. 26, questioning whether it, too, is keeping enough cash and noting that the carmaker is choosing to maintain its high dividend.
Retailers, from department stores to grocery chains, are closing stores and trying to conserve cash before it's too late. At Ames Department Stores Inc. (AMES ), Chief Financial Officer Rolando de Aguiar is out to shrink inventories and quickly close 32 stores that were picked up in an acquisition of Hills Stores. "If the economy hadn't slowed as fast as it did, those stores would have been O.K.," he says, adding: "It's best to close those stores rather than divert cash."
The same fateful choice now faces telecom outfits, from giants such as AT&T (T ) to startup local carriers. These companies have been burning through cash, much of it borrowed, to build their networks quickly. A handful of well-funded new entrants, such as XO, McLeod USA, and WinStar Communications, have enough money to last until 2002, analysts say, but dozens of others will run out of cash this year. WinStar CEO William J. Rouhana Jr. says his budget is getting tighter because the company has only $1.3 billion in cash but owes $300 million in interest this year and needs to invest $700 million in capital projects. Meanwhile, Lucent Technologies Inc. (LU ), which announced 16,000 layoffs in January, had to scramble to negotiate a $6.5 billion short-term bank credit on Feb. 23 after it was shut out of the commercial-paper market.
That market, which is extremely sensitive to cash positions, is anticipating more trouble for issuers in other industries, says Michael Cloherty, vice-president and senior market economist at Credit Suisse First Boston. Power generation, electrical equipment, and retailing could be hit. And second-tier companies are being forced to pay higher interest rates relative to other issuers than at any time since the last recession.
So just as severe storms demonstrate the need for homeowners' insurance, business slowdowns show executives why they shouldn't skimp on cash reserves. Periodically, it's good that they're reminded.
By David Henry, with Steve Rosenbush, in New York, Dean Foust in Atlanta, Joann Muller in Detroit, and bureau reports