Cash: Burn, Baby, Burn

A range of companies is overlooking ways to boost liquidity

If he wants to play, Toys 'R' Us Inc. (TOY ) Chief Executive John Eyler must pay. The No. 2 toy retailer has a pile of debt due soon, and mounting inventories to finance. But to regain the top spot from Wal-Mart Stores Inc., he says he will dig even deeper -- to beef up customer service and stock higher-ticket toys. "If you're struggling to compete...while you have to watch every penny, doesn't that place you at even more of a disadvantage?" asks Carol Levenson, research director at New York fixed-income research shop, Gimme Credit Publications Inc.

It certainly does. But Eyler isn't the only one in Corporate America who's having to spread his cash thin. Liquidity woes are plaguing whole industries and threatening venerable U.S. corporations. Under pressure from credit-rating agencies and investors, many finance execs are struggling to boost their cash flow. But it's like squeezing blood from a stone: Cutting costs isn't much of an option, because after three years of a tepid economy many companies are operating at bare-bones levels. Going to the equity market is no answer -- that well has run dry. And banks aren't lending. Worse, some need to plump up depleted pension funds from dwindling reserves.

As a result, many companies are now consuming more cash than they're generating. In a study for BusinessWeek, London's REL Consultancy Group Ltd., a cash-flow-management adviser, reviewed the largest 1,000 nonfinancial U.S. companies by revenue to identify outfits with cash strains. "The data reveal the deterioration in corporate liquidity," says Marc Loneux, REL's global financial analyst. "If companies do nothing to sort out this trend, they may be headed for trouble." REL developed its formula in 1975 and counts Nestlé (NSRGY ), DaimlerChrysler (DCX ), Gillette (G ), and J.P. Morgan Chase (JPM ) among its clients.

Some companies flagged by REL already have well-known problems. Best Buy Co. (BBY ), the nation's largest electronics retailer, is struggling with losses and the fallout from ill-conceived acquisitions. While it had $1.2 billion in cash on the books when it last reported, it has flirted with a high-risk rating for several quarters, REL says. Bookstore chain Borders Group (BGP ) gets a high-risk rating, but a company spokeswoman for the Ann Arbor (Mich.) company says free cash flow is now improving. And with the semiconductor industry's 15-month recovery sputtering, companies such as Advanced Micro Devices Inc. (AMD ) are in harm's way. AMD is burning through up to $250 million of cash a quarter, prompting a negative rating on its bonds from Moody's Investors Service in March. The Silicon Valley company declined to comment.

Companies that eat more cash than they churn out aren't necessarily headed for the scrap heap. Some are sitting on huge cash cushions but just aren't handling it as well as they should, REL says. One example is Corning Inc. (GLW ), which has $1.5 billion on hand, almost half of its annual sales. Still, the ratings do serve as a warning to top management to get their financial houses in order.

REL's formula doesn't appeal to everyone. Gimme Credit's Levenson objects that such corporate-finance models "lump together companies with very different seasonal and other cash-flow and working-capital patterns." Still, she concedes that REL's list "shows up a lot of baddies, nonetheless."

Like REL, much of Wall Street is following the money these days. That's no surprise: In a drooping economy, cash is quickly eroded by sluggish sales and the pressure to keep prices down. With now-you-see-it, now-you-don't earnings, tracking cash flow is a better way to value companies, say many analysts. "Earnings are an accounting fiction," says Jeffrey R. Bohn, head of research and analytics for KMV LLC, a San Francisco risk-assessment specialist, that Moody's bought last year. KMV uses a formula that aims to judge the risk that a company will default by crunching data such as stock prices, volatility, liabilities, and assets. "More cash equals more value," says Bohn. "Everything...including how much investors are willing to pay for a stock...ties back to expectations about cash."

For its part, Standard & Poor's, like BusinessWeek a unit of The McGraw-Hill Companies, added liquidity analytics to its ratings last year. It has since doled out four downgrades for each upgrade, owing primarily to cash concerns. "Investors are starting to ask about the quality of these [high-debt] companies' assets and their liquidity," says John Bilardello, managing director of global corporate ratings. "These questions weren't asked before all that debt was coming due."

How do companies get so cash poor? In some cases they are fighting a losing battle with competitors; in others, executives make bad strategic mistakes. But often they simply overlook cash trapped in their own books. For example, money is tied up when customers don't pay their invoices, suppliers are paid too quickly or not fast enough, and inventories sit unsold on warehouse shelves. It sounds simple, but it adds up to big bucks. "Managers are looking externally, when big internal cash opportunities are sitting right there in the balance sheet," says REL's Loneux. Corporate America, in fact, has more than $620 billion -- 35% of total sales -- blocked by inefficient cash-flow management, REL estimates. For example, REL figures that because Toys 'R' Us (TOY ) takes four-and-a-half months to pay its suppliers, it lost its edge against Wal-Mart (WMT ), which pays in about six weeks. With that kind of lag, suppliers tend to jack up their prices, eating away at profits, REL says. A Toys spokeswoman says while its "turnaround is longer than we expected," the company is content with progress on managing inventories and the earnings front.

Sound like Finance 101? It is. Still, top execs rarely worry about the nitty-gritty of internal cash management. Instead, chief executives often see winning new sales or installing a new IT system as the best way to boost margins. And when faced with a cash crunch, they pursue rampant cost-cutting and restructuring that may later aggravate growing cash woes. Slashing capital expenditure and research and development is a short-term fix that risks undermining future earnings. Likewise, selling profitable assets at depressed prices impairs future cash generation. And issuing debt is another stopgap measure. U.S. companies sold more than $100 billion in bonds in the first eight weeks of 2003, up 26% from the same period last year, but most of the proceeds went to refinancing older, short-term debt at a higher price. It all amounts to buying time without improving financial prospects, says Loneux.

Sometimes a company is left few options. Take American Greetings Corp. (AM ), the Cleveland-based maker of greeting cards, which recently lost a big contract with Winn-Dixie Stores Inc. (WIN ) to a rival. Sales in the fourth quarter, ended Feb. 28, dropped by 6.4%. Meanwhile, cash flow from operations has fallen 54% since 2000, to $77 million, in fiscal 2003. To compensate, the company said it would cut its workforce and the dividend. But the restructuring will require cash outlays that will consume a big chunk of the company's free cash flow, say analysts. The company declined to comment.

Cash is still king -- and more than ever in the post-bubble economy. Letting it slip away in any form is an oversight that investors won't easily forgive.

By Mara Der Hovanesian in New York

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