Debt can be useful for expansion, capital spending, or leverage returns. However, too much debt can rapidly lead to stagnating returns, poor cash flows, and a rapid descent into zombie state.
There are some signs that suggest we could be standing at the foot of a debt crisis as companies that have borrowed heavily in this period of low interest rates will have to refinance at higher rates in the future, which will lead to poor performance for those companies that have borrowed heavily.
Having said that, even now there are several companies that are finding it hard to finance their debt as sales have been slow during the past few years, leading to increasing levels of borrowing, deteriorating credit ratings, and higher rates of interest.
The culprits
Surprisingly, there are not that many companies that fail the above debt test, however, there are some and the results are listed below.
First up is producer of construction aggregates, such as crushed stone and gravel, Vulcan Materials Company (NYSE:VMC), which has seen net debt remain constant while interest costs have risen over the last few years.
| Metric | 2010 | 2011 | 2012 |
|---|---|---|---|
| Financial costs | -$162 | -$209 | -$207 |
| EBITDA | $355 | $344 | $404 |
| Net debt | $2,670 | $2,660 | $2,402 |
| Interest cover | 2.2 | 1.7 | 2 |
| Net Debt to EBITDA | 7.5 | 7.7 | 6 |
Figures in $US millions except for ratios
During each of the last three years, Vulcan Materials Company (NYSE:VMC) has not been able to cover its interest costs the required 2.5 times by EBITDA, indicating that the company’s debt could be too much for it to handle.
Furthermore, viewed over a three-year time frame, debt and interest costs still do not appear to be sustainable:
| Metric | Value |
|---|---|
| 3-yr Average Interest Costs | -$193 |
| 3-yr Average EBITDA | $368 |
| 3-yr average Net Debt | $2,577 |
| Interest cover | 1.9 |
| Net Debt to EBITDA | 7.0 |
Figures in $US millions except for ratios
Vulcan Materials Company (NYSE:VMC)’s net debt position has averaged seven times the size of its EBITDA during the past three years, a very high level. Additionally, the company has only been able to cover the interest on its debt 1.9 times on average, below the minimum requirement of 2.5 times that, for the purpose of this piece, signifies financial security.
Next up
Next up is oil tanker supplier and leasing company Scorpio Tankers Inc. (NYSE:STNG). Scorpio Tankers Inc. (NYSE:STNG) has been wrestling with overcapacity and low leasing rates in the tanker industry during the past few years. As a result, the company’s finances are not as strong as they should be.
| Metric | 2010 | 2011 | 2012 |
|---|---|---|---|
| Financial costs | -$3 | -$7 | -$9 |
| EBITDA | $11 | $9 | $8 |
| Net debt | $127 | $143 | $135 |
| Interest cover | 3.7 | 1.3 | 0.9 |
| Net Debt to EBITDA | 11.6 | 15.9 | 16.9 |
Figures in $US millions except for ratios
