Companies aren’t saving their pennies as markets turn bubbly4 min read . Updated: 20 Feb 2021, 02:46 PM IST
- Thrift is in a bear market as even the riskiest borrowers rush to issue new debt. That world may not last forever
When money is readily available and almost free, why bother saving for a rainy day?
For corporations, the question is worth asking at a time when dollars might as well be falling from the sky. The average rate on so-called “high yield" bonds recently fell below 4% to a record low. In the late 1990s, even corporate borrowers with the best reputations paid average interest rates on the order of 7%. There is so much money looking for a place to go that companies are being contacted by investors asking if they would like to issue bonds rated below investment grade rather than the other way around.
It is a seller’s market for all manner of risk. While the 10 year U.S. Treasury Note yield has been edging higher since the summer, interest rates have mostly been in decline for decades. Policy makers at the Federal Reserve and other major central banks have indicated that major changes are unlikely anytime soon. Government rescue of private enterprises facing insolvency, once an unthinkable intervention, has become somewhat commonplace. As the Clovers once sang, though not about monetary policy, “your cash ain’t nothin but trash."
The sentiment isn’t quite universal, though.
“We take a lot of pride in the Triple-A credit rating, and we see it as a potential competitive differentiator," says Joseph Wolk, chief financial officer at Johnson & Johnson, which is one of only two U.S. firms remaining with that sterling designation. Prudence helped the company, founded in 1886, survive two world wars, the Great Depression and other calamities.
Yet the most recent catastrophe to befall big business saw the federal government ride to the rescue as never before. Companies facing major pandemic-related challenges such as hospital systems, movie theaters and sit-down restaurant chains have had little trouble accessing capital. Airlines, no strangers in bankruptcy court over the decades, have successfully navigated nearly a full year of badly hobbled travel demand. Even newspaper chains have been able to sell debt.
It is about a lot more than survival, though. This environment has opened the door for management teams to get creative and ultimately take more risk. In this kind of low-rate world, paying out debt-financed dividends to investors or investing in risky growth opportunities has beaten a frugal mentality hands down. In certain industries a large cash pile can actually result in a lower valuation because investors perceive that future opportunities for good investments are dwindling.
Prudence, meanwhile, has been downright costly. Take an index of “high quality" U.S. stocks selected by financial return and borrowing levels, of which Johnson & Johnson is a major constituent. A $10,000 investment five years ago in an Invesco exchange-traded fund tracking the index in the five years through last week would have turned into about $21,500 compared with $24,100 invested in large U.S. companies generally.
Meanwhile, those executives taking chances are reaping the biggest rewards in their stock prices and for themselves personally. In an alarming trend to traditionalists, companies like Tesla and Square have chosen to speculate on bitcoin with their corporate cash. Earlier this week, business intelligence firm MicroStrategy sold $900 million in convertible bonds that pay zero interest for a bitcoin purchase; high investor demand boosted the offering from a planned $600 million. While Tesla CEO Elon Musk allowed Thursday on Twitter that Tesla’s bitcoin purchase is“adventurous," he also said Bitcoin “is simply a less dumb form of liquidity than cash." The cryptocurrency’s price has more than quadrupled since Square first announced its purchase last fall.
Thrift is unmistakably in a bear market.
But this sentiment is underpinned by the belief that conditions in the bond market will remain stable. Even with central banks being so friendly recently, speculative grade bond yields have spiked from time-to-time, cracking 10% in 2016 when several energy firms went bust and nearly that high again last March amid nationwide lockdowns.
Continuing to roll the dice also assumes money remains cheap in general. While a world in which interest rates march ever higher seems otherworldly to most contemporary executives and market participants, it shouldn’t be: A multidecade bear market in bonds preceded the current go-go era.
An end of the bear market in thrift could sting even companies with the fattest wallets. When rates are falling, refinancing debt is easy. In a weak market, rolling over maturing debt with new bonds and loans is costly and limits a company’s set of investment opportunities. For instance, splashy acquisitions of the sort that dazzle Wall Street would happen less often. More marginal borrowers would struggle to get by altogether. In that scenario, a large cash pile might regain its appeal to investors.
Even for a blue chip like Johnson & Johnson, flexibility can pay off. The company’s drug development business already is risky enough without financial engineering. Consider that only three in 10 early-stage candidates actually reach the market, making some bad investments unavoidable. As for the general responsibility of a CFO to plan for unlikely, unpleasant scenarios, Mr. Wolk channels William DeVasher, the security chief played by Wilford Brimley in “The Firm."
“I get paid to be suspicious when I’ve got nothing to be suspicious about," he says.
Imagining an eventual end to the easy money era could help spare the C-Suite a big headache down the road.
Write to Charley Grant at firstname.lastname@example.org