Amid rising interest rates and a tightening credit market, companies with weaker balance sheets are getting squeezed by higher borrowing costs.
Royal Caribbean Group
(ticker: RCL) is a case in point. The cruise operator had $5.5 billion in short-term debt at the end of June, but $2.1 billion in cash. Royal Caribbean just issued $1.15 billion worth of convertible notes to cover some of its current debt, pushing their maturity from 2023 to 2025. But it comes with a higher interest rate—6% instead of the retired debt’s rates of 4.25% and 2.875%.
However, the firm’s operating cash flow turned positive last quarter and CEO Jason Liberty said he plans to get the company’s balance sheet back to what it was prepandemic. The company couldn’t be reached after multiple requests for comment.
To fight inflation, the Federal Reserve has raised its benchmark interest rates by 2.25 percentage points since March. That could spell trouble for higher-risk issuers that need to refinance debt or borrow more.
“Not only do these issuers generally have fewer funding options, but growing risk aversion amid market volatility and rapidly shifting financing conditions could exacerbate their refinancing risk and funding costs,” wrote S&P Global Ratings analyst Evan Gunter in a recent report.
Already, bond issuance for junk-rated issuers has dropped 75% in the first half of 2022. The amount of distressed debt—junk-rated bonds trading at yields 10 percentage points above Treasuries—jumped to $116 billion in July from $26 billion just two months ago, according to S&P. That suggests that the credit market is growing uneasy about debt repayment.
If the economy worsens, companies could see earnings wilt, further straining their cash flow. Companies that have trouble getting loans might be forced to sell equity, diluting shareholders. In a worst-case scenario, a company could become insolvent.
To find companies at risk of a liquidity squeeze, Barron’s screened for those whose cash balance has shrunk by more than half from a year ago. Among those, we looked for companies with short-term obligations—including debt and fixed rent payments—that are higher than their cash balance and one-year earnings combined.
|Company / Ticker||YTD Change||Cash Balance (mil)||Cash Balance One Year Ago (mil)||Short-Term Obligations (mil)||Last-12-Month Ebitda (mil)||Data as of|
|Royal Caribbean Group / RCL||-45.7%||$2,102||$4,307||$5,538||-$1,884||06/30/2022|
|Bed Bath & Beyond / BBBY||-27.1||108||1,132||335||-121||05/28/2022|
|Party City / PRTY||-75.0||39||85||350||95||06/30/2022|
|Rite Aid / RAD||-28.0||56||119||579||411||05/28/2022|
|Wolverine World Wide / WWW||-21.2||149||346||533||290||07/02/2022|
|Caleres / CAL||31.2||34||98||424||310||04/30/2022|
|Express / EXPR||-31.8||37||84||200||96||04/30/2022|
Note: YTD change through Aug. 11.
Sources: FactSet; Bloomberg
After further narrowing, we identified seven companies worth watching: Royal Caribbean, party-supply seller
(PRTY), home-goods retailer
Bed Bath & Beyond
(BBBY), drugstore chain
(RAD), fashion retailer
(EXPR), and footwear companies
Wolverine World Wide
The retail sector is a sore spot. Retailers depend heavily on consumer demand and often don’t have enough pricing power to pass the higher costs on to consumers, says Neha Khoda, head of loan strategy at Bank of America Merrill Lynch.
Bed Bath & Beyond faces declining sales and is posting losses as consumers spend less amid rampant inflation. It doesn’t help that the company has spent more than $1 billion on share buybacks since 2020. Bed Bath had $108 million in cash as of May, down from $1.1 billion a year ago.
While most of Bed Bath’s debts don’t mature until 2024, it needs to pay $335 million in rent next year. Bank of America analyst Jason Haas warned that the retailer could face a liquidity pinch if vendors ask it to pay for the merchandise on shorter terms.
Bed Bath still has $1 billion available in its revolving credit facility, a company representative told Barron’s. “We have already taken actions on many fronts—including a reduction of at least $100 million of [capital expenditure] against the company’s original plan,” he noted in an email.
Party City has $39 million in cash as of June, with $350 million in debt and rent payments due in a year. The retailer’s earnings for the past 12 months were $95 million, down 20% from a year ago.
“Despite the continued macroeconomic factors impacting our business, we feel comfortable with our current liquidity and feel it is sufficient to run the business,” said CFO Todd Vogensen on the latest earnings call.
Party City has $157 million available in its revolver and other levers at its disposal, said Vogensen, such as cutting capital expenditures and delaying projects. It also intends to raise $22 million from current creditors.
Rite Aid has little debt due until 2025, but its short-term lease obligations, at $574 million, loom over the $56 million cash balance as of May. In the past four quarters, the company’s earnings slid 18% from a year ago.
“Paying down debt is a top priority for our company,” said CFO Matthew Schroeder in the recent earnings call. The company is exploring additional sale-leaseback options on its owned stores and expects to have proceeds from them later in the year.
Rite Aid also plans to use up to $150 million of its $1.7 billion in revolver availability to buy back outstanding bonds at a discount. The move will bring some interest savings in the future, according to the firm, as the revolver loans have a lower rate.
Express, Wolverine, and Caleres also have high short-term obligations and low cash on account, but all have seen improving earnings in recent quarters. The three companies either declined to comment or didn’t respond to a request for comment.
If the economy goes into recession, more companies will face pressures. Says S&P’s Gunter: “The longer conditions remain this tight, the greater the risk that vulnerable issuers, regions, or sectors could feel the squeeze.”
Write to Evie Liu at firstname.lastname@example.org
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