What a shock – the Fed didn’t raise interest rates yesterday. Their next chance is in December – we’ll see if they chicken out then, too.
Markets continue to obsess over whether Janet Yellen will raise interest rates this year. But when it comes to corporate credit quality, they are missing the big picture. Corporations are in bad shape. They are far more leveraged than they were on the cusp of the financial crisis. Their precarious condition is disguised by 8 years of zero interest rates. Now that the Fed is contemplating raising interest rates, their disguise could be ripped off.
But that isn’t their biggest problem. Because if the Fed chickens out and doesn’t raise rates, they are still in big trouble – maybe even bigger trouble. Because if the Fed doesn’t raise rates, it means that it believes the economy is too weak to handle even a tiny 25 basis point rate increase. And that’s downright pathetic.
Right now, there are a number of zombie companies that are still haunting the landscape solely because of low interest rates. These companies carry huge debt loads but the cost of servicing that debt is very low due to the fecklessness of the Federal Reserve. They are losing tons of money in their businesses but have been able to borrow (or extend their existing borrowings) due to complacent financial markets. Remember – bond and bank loan investors don’t want to report defaults to their investors if they don’t have to. So they are perfectly content to allow borrowers to “extend and pretend” their loans until some time in the future when they are forced to face the music.
Thus far in 2016, 122 companies have defaulted around the world. The tally would be much higher if interest rates were anywhere near normalized. Here is a short list of companies that will join this list if interest rates begin to rise, either because the Fed gets aggressive (which is highly unlikely) or because investors wake up to the fact that their businesses are weak and incapable of repaying these debts.
No matter how you slice it, these four companies are headed for disaster…
Sears Holdings Corp. (NASDAQ: SHLD)
Sears reported net losses of $398 million in Q2 and is set to close 64 more Kmarts within the next year (in addition to the 68 that they announced they were closing back in April). Sears Holdings has about $3.5 billion in long-term debt, more than $2 billion of pension obligations, and is limping along propped up by loans from CEO Eddie Lampert’s hedge fund, ESL Investments. As Kmart employees follow orders to move all merchandise onto the sales floor, it would seem that their parent company is preparing for liquidation. The question is whether Sears will even live to see Christmas. If it does, it could be seeing its last visit from Santa Claus.
As a whole, the retail industry is in crisis. Buffeted by structural changes such as the explosion of ecommerce, weak consumers and an increasingly selective consumer base, there’s been an epidemic of mall-based retailer bankruptcies lately (Sports Authority, RadioShack, Aeropostale, American Apparel, Pacific Sunwear…) and it’s only going to get worse. I’ve recommended some profit opportunities here.
iHeartMedia Inc. (OTCMKTS: IHRT)
iHeartMedia Inc., formerly called Clear Channel Communications Inc., is the largest traditional radio station operator in America. The company was taken private in an ill-advised LBO by Bain Capital Partners LLC and Thomas H. Lee Partners LP in 2008 and has paid down no debt while paying huge fees to its private equity sponsors and investment bankers to keep it alive. (The way private equity firms loot these companies, as I’ve written before, is shameful). It has $20.6 billion of debt that it can never hope to repay and is struggling to keep its head above water in an era of streaming media. It hasn’t reported a profit since 2007, hemorrhaging between $219.5 million and $4 billion every year. iHeart has been holding on by a string: refinancing, restructuring, pushing back payments, and cannibalizing its healthier divisions to create more cash (a move Bloomberg Intelligence described as “burning up your sofa to heat your house”). But if rates go up, the jig will be up.
Valeant Pharmaceuticals International Inc. (NYSE: VRX)
Fund manager Bill Miller recently recommended VRX stock. Miller famously beat the S&P for the 15 years heading into the financial crisis by taking huge risks. Then he blew up and lost most of the money he made over the previous 15 years because he ignored the value of risk-adjusted returns. VRX is heavily leveraged, has negative tangible net worth, is under investigation by multiple government agencies, and offers far more risk than reward. The stock is overvalued and the company is not out of the woods. Ignore Bill Miller and go short. With $30 billion of debt, VRX can’t afford to pay higher interest costs and will suffer if rates rise.
Tesla Motors (NASDAQ: TSLA)
It’s been well documented why I think Tesla is a giant Ponzi scheme. In the last quarter, the company lost $19,059 for every car it sold despite a starting selling price of over $70,000. Its negative net margin was -24.6% compared to -16.4% a year ago. It promised to produce 200,000 cars in 2017, but only expects to manufacture 17,000 in the second quarter of this year. In order to boost cash, the company just sold $1.4 billion in new stock. And it routinely reports non-GAAP earnings numbers to create a false picture of financial health. I could go on, but my blood pressure is rising.
Suffice it to say that each of these stocks is toxic and headed for disaster no matter when (or if) Janet Yellen raises rates. But when (or if) she does, that day of reckoning may come a little sooner.