Corporate Balance Sheets Show Surprising Strength

U.S. large-cap companies have survived the recession without taking on loads of new debt. According to an analysis of Bloomberg data on nonfinancial companies in the Standard & Poor's 500-stock index, the average large-cap company has shrunk liabilities on its balance sheet by 8.2%. The liabilities on a company's balance sheet include its debts, as well as any other financial obligations, such as those toward pension plans.

"It's a mixed bag, [as] some institutions have been able to pay down debt quite a bit," says Michael Yoshikami, president and chief investment strategist at Ycmnet Advisor.

Stronger corporate balance sheets stand out at a time when government and consumer finances remain shaky. Bond markets have revealed concerns about the U.S. government's fiscal status. The federal government had $11.9 trillion in debt outstanding at the end of the 2009 fiscal year, up 19% from 2008.

Since the recession began, Americans have cut back on spending and paid off some of their debt. Yet, according to Federal Reserve data released on Mar. 5, U.S. consumers still owed $2.46 trillion in consumer credit in January, down 4.1% since the end of 2008.

The large-cap S&P 500 is split almost evenly between companies that have reduced their liabilities and those that have increased them. Over the past 12 months, 218 companies have used a variety of methods to slash a total of $265 billion from balance sheet liabilities. Cutting the most—in dollar and percentage terms—was Time Warner (TWX), which reduced its liabilities by $36.4 billion, or 53.2%.

best to slash debt or amass cash?

A further 194 companies have increased their balance sheet liabilities over the past year, by a total of $309 billion. The leading company was Pfizer (PFE), which boosted its liabilities $69.1 billion in a year. The pharmaceutical giant borrowed $22.5 billion to finance its acquisition of Wyeth.

Even in the same industries, companies have taken opposite stances. Some have paid off debts so as to maintain maximum financial flexibility while competitors have borrowed to raise extra cash at a time of record-low interest rates. In the past year, King Pharmaceuticals (KG) cut 52% of its liabilities, a total of $1 billion. Biotechnology company Amgen (AMGN) added $1.4 billion, or 9.1%, to its liabilities.

Though many of the patents are expiring soon, King's pain drugs generate strong cash flow, enabling the company to slash liabilities, Morningstar (MORN) analyst Debbie Wang notes. "They want to clean up their balance sheet and [store] away cash so that they can make an acquisition," she says.

Possibly hunting for acquisitions, too, are Amgen and other health care companies, but Wang notes they've decided to raise extra cash now, by borrowing. Amgen and other health care companies "have decided the current rates are so attractive that they've taken on more debt," Wang says.

Overall, nonfinancial S&P 500 companies had liabilities of $5.8 trillion in their most recent quarter, a $44 billion increase—0.75%—from 12 months ago. Companies used a variety of methods to strengthen balance sheets, even though in many cases sales were falling because of the recession.

A Smaller Time Warner can spend more

Among the most aggressive was Time Warner, which has raised cash by spinning off both its AOL (AOL) division and Time Warner Cable (TWC). The parent company ended up increasing its share count 190% during the year, a way of raising money that dilutes current shareholders' stakes.

"Time Warner today is a much smaller company than it was just a short time ago," Chief Financial Officer John K. Martin told an investors' conference on Mar. 2. The results are worth it, he said, as the smaller company can now spend more on new TV and film production while also considering acquisitions. The diminished Time Warner generated $2.9 billion in free cash flow in 2009, Standard & Poor's says.

"We feel very, very good about the balance sheet that we have," Martin said, calling the company's financial flexibility a "strategic asset."

Alternative approaches to strengthening balance sheets are demonstrated by Ford (F), the second-largest cutter of liabilities, and General Electric (GE), No. 3.

By slashing $33 billion, or 13.9%, of its liabilities in one year, Ford demonstrated the benefits of cost cutting. From 2006 to 2009, Ford reduced expenses by $13.4 billion, slashed worldwide employment by 35%, and improved the terms of union contracts, according to Soleil Securities analyst Michael Ward. A deal to offload health-care costs to an independent Voluntary Employment Beneficiary Association, which took effect on Jan. 1, improved the balance sheet. Ford also boosted its share count by 38%.

GE: "We're going to be more focused"

With its balance sheet wounded by the financial crisis, General Electric cut costs and sold off divisions to raise cash. Last year, GE shed $27.5 billion in liabilities, or 4% of its total, without significantly increasing its share count. In December, GE announced a deal to sell its NBC Universal division to Comcast (CMCSA), a transaction which the company said should net $8 billion in cash.

"We're going to be smaller," GE Chief Financial Officer Keith S. Sherin told an investors conference on Mar. 16. "We're going to be more focused."

With interest rates low, taking on more debt has never been cheaper for many blue-chip companies. Still, a lot are doing everything they can to reduce liabilities. A company's approach to debt these days often will depend on how executives foresee the economic recovery playing out.

"Companies are making a strategic decision," Yoshikami says. A strong recovery in sales can make paying off debts much easier. Alternatively, he says: "If the economy remains weak, it's far more important to have a strong balance sheet on hand."

Company balance sheets may have improved in the past year, but don't expect them to shed debt at the same rate in 2010, says Dave Novosel, senior analyst at research firm Gimme Credit. Many companies will instead turn extra cash into dividends and stock buybacks, Novosel says, adding: "A lot of companies are now feeling the pressure to return cash to shareholders."

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