Leveraged for Success
By Numer de Guia
Archimedes claimed that with a long enough lever, he could move the world. As many corporate-finance types would tell you, the ancient mathematician was onto something: The right degree of leverage means everything. That's especially true when it comes to companies' balance sheets.
Properly applied, financial leverage can boost returns to company shareholders. That's the idea behind taking on risk -- putting up assets as collateral -- in exchange for additional capital (i.e., debt). Debt financing often winds up being a cheaper alternative to selling equity, since the inducements a company makes to lenders -- offering collateral, debt covenants, and claim-seniority of debt -- prompt the lenders to agree to lower returns. And there's one other huge plus: Interest payments on debt are tax-deductible.
One potential side benefit of a healthy degree of leverage is that it forces management to impose fiscal discipline on operations. Companies attempt to stay in sound financial shape to maintain their high credit ratings, which holds down financing costs. To some extent, a company's willingness to take on debt could imply that management is confident about the success of its undertakings. However, too much debt reduces financial flexibility and increases the risk of bankruptcy.
The trick, then, is to find the right balance. Companies that can successfully use leverage to boost their business while keeping a close eye on financial health may be good candidates for further investment research.
That's the thought behind this week's screen. The selection was limited to companies with Standard & Poor's credit ratings of AA or better, indicating they have a superior ability to repay their principal and interest obligations. That's a sign of well-above-average financial strength.
Then, we took it a step further. From the list of names that emerged, we selected the two companies with the highest debt-to-equity ratios in their respective sectors under S&P's Global Industry Classification Standard. These companies, then, are deploying the highest degree of leverage within the universe of those with top credit ratings. They're more aggressive than their rivals, perhaps, but still well within the relative safety zone of a rating agency's top credit scores.
After we ran the numbers, 13 companies emerged:
• Bristol-Myers (BMY )
• ChevronTexaco (CVX )
• General Electric (GE )
• Home Depot (HD )
• Imperial Oil (IMO )
• Kimberly-Clark (KMB )
• Madison Gas & Electric (MDSN )
• MBIA (MBI )
• Microsoft (MSFT )
• Nicor (GAS )
• Pitney-Bowes (PBI )
• UBS (UBS )
• Wal-Mart (WMT )
De Guia is a portfolio services analyst for Standard & Poor's