11-30-2018, 11:55 AM
I thought this comment from Ted Fischer on one of Chowder's threads on Seeking Alpha was worth sharing. Ted talks about the debt/cash flow metrics for a few popular consumer staples stocks.
Quote:One of the problems in analyzing stocks is that people tend to focus on principle rather than the numbers, and can easily end up applying the principles at the wrong times to the wrong examples.
I pulled EBITDA (TTM) and Debt (ST + LT) numbers from Morningstar for six different Consumer Staples companies to illustrate this principle. Four of the six carry a BBB credit rating. People have raised questions about five of the six. The last is considered the "gold standard" for stability.
Keep in mind that this is a superficial analysis. Because I am working from TTM EBITDA, any recent acquisitions that shift the needle will affect the results. Finding solid EBITDA projections is a little trickier to do on a consistent basis, so I will leave that exercise to your own due diligence rather than attempting to get it right here...
PG is the gold standard of quality in the sector. It carries an Aa3 credit rating, and has not used leverage to nearly the same extent as its peers. It has $16.8B EBITDA vs. $31.3B total debt, for a 1.86 Debt/EBITDA ratio. This is very strong. In fact anything under 3x is strong!
GIS is at the other extreme, with a Baa2 credit rating and $15.6B debt vs. $3.1B EBITDA for a 4.97 ratio. The Blue Buffalo acquisition may boost that EBITDA a little going forward (I believe only the latest quarter includes the acquisition), but it isn't immediately going to move the needle by much. They are going to need growth to dig out of this debt hole, especially since their dividend eats up 37% of EBITDA. I am comfortable with GIS only as long as I anticipate 5% forward growth. If that stalls again for an substantial period of time, they are in trouble. I consider this speculative quality, because they don't have much margin for error.
KHC has 4.83 Debt/EBITDA and a dividend representing 46% of EBITDA. The debt is not significantly different from GIS (keep in mind that this is a superficial analysis) but the higher dividend leaves them even less wiggle room. I do not follow KHC closely, as it fails my quality checks.
MKC has 4.85 Debt/EBITDA, but a dividend that is just 26% of EBITDA. The difference between this and the two previous is that the dividend is lower -- and thus EVEN WITHOUT GROWTH they have the cash flow to aggressively address the debt burden. Of course it doesn't hurt that their projected EPS growth is a solid 8%. They may presently hold a similar credit rating, but I have a very high degree of confidence that they will resolve this within the next 1-2 years and return to A-grade credit.
SJM actually has a little less debt than the others, just 4.33x EBITDA. Moreover, the dividend is just 27% of TTM EBITDA. The concern there isn't so much the debt (which is admittedly substantial) but the deteriorating outlook. FCF is projected to drop by 15%-20% from FY18 to FY19, and while the impact on earnings may be smaller, a DECLINE in earnings can start to push the debt ratios into the danger zone. I want to emphasize that the major concern isn't the debt. It is the debt combined with operational weakness. They could survive operational weakness if they had less debt, or they could survive the debt if they had stronger results. It is the combination that is potentially deadly.
People often cite "debt concerns" at KMB, but that is in my opinion foolishness. If you are looking at debt metrics for KMB that cause you concern, then toss those debt metrics because they are meaningless in this situation. KMB has a Debt/EBITDA ratio of 2.37, thus despite a 44% Div/EBITDA they EASILY have the financial flexibility to manage that debt. They do carry a little more leverage than PG, but the other four listed have literally TWICE the debt burden that KMB does.
Similarly, T has debt of just 3.5x EBITDA, much of it with very long maturities. Their debt is not a concern. The concern is that FCF is only half of EBITDA, and thus the payout ratio is pretty high. Because their debt is not unreasonable, they don't actually need much growth to manage this. They do need to avoid shrinking earnings. A risk, but not a concern at this time.
If you want scary numbers, check out CVS -- Debt/EBITDA of 7.12!!! Of course they just closed the Aetna deal, so that will bring the ratio down immediately. I would put them in a similar category with MKC -- elevated debt but the financial flexibility to bring that down quickly as long as they don't hit too many road bumps.
Chowder talks about good debt and bad debt. I don't like that characterization, preferring instead to think in terms of manageable debt and dangerous debt. The difference between the two often comes down to operational strength. In each of these cases, if you are confident that revenues and earnings will grow, the debt will not be a problem.