More and more companies are burning through cash as the pandemic moves closer to being a year old.
A growing number of junk-rated corporations including Delta Air Lines Inc. and Royal Caribbean Cruises Ltd. are losing money even before they pay interest and other necessary expenses like taxes. They’re covering those costs with cash they still have and with more borrowing in the bond and loan markets, where investors are willing to bet that companies will recover relatively fast after Covid-19 vaccines arrive.
In the latest quarter, the number of junk-rated corporations that borrow in U.S. dollars and lost money before paying interest and other required expenses, known as having negative Ebitda, reached an eye-popping 47, according to a Bloomberg Intelligence analysis. That’s nearly double the level in the second quarter, out of a universe of about 600 borrowers.
These companies are doing worse than many other zombies, or corporations that have losses after covering interest expenses. In this case, the businesses are losing money even before servicing their debt. If they don’t turn themselves around, some could be part of another wave of bankruptcies next year.
For now, the Federal Reserve is helping these companies limp along by keeping interest rates near zero and forcing investors that want decent returns to consider financing struggling businesses. But money managers won’t be willing to lend to weak corporations forever. Companies are trying to just hang on until life returns to normal.
Debt markets may not be paying enough attention to the risk of cash and financing running out, said Noel Hebert, director of credit research at Bloomberg Intelligence who did the analysis. And even if the pandemic ends sometime next year, businesses will have to deal with their growing debt levels and an economy that may look very different after Covid-19, he said.
“We’ve got companies where we don’t know if they’re functionally okay or not because we don’t know what the economy looks like on the other side of Covid,” Hebert said. “You’ve got companies that need a fast solution to figure out how to make their debt levels work, and absent that, those are companies that over the course of the next year may need to file for bankruptcy.”
Companies that came out of the last big downturn with higher debt loads ended up performing worse than their peers, economists at the New York Fed wrote this week. In this cycle, firms in industries like tourism, travel and hospitality could grow as much as 10% slower than in ordinary times, based on figures seen after the financial crisis and companies’ debt levels coming into this downturn, among other factors, the economists found. Junk bonds meanwhile have gained around 5.5% this year, after returning more than 14% last year, according to Bloomberg Barclays index data.
“Debt investors are willing to cross their fingers and go, ‘OK you’re not profitable, but we think someday you can be again,’ which is a tricky way to invest,” Hebert said.
Corporations including Delta, Royal Caribbean and United Airlines Holdings Inc. are among those that have seen trailing-twelve-month Ebitda turn negative in the third quarter. Many of these are in industries hit hard by Covid-19, including tourism and live entertainment. And some of those companies may be eligible for government aid. The bipartisan stimulus proposal that Congressional lawmakers released this week would give $45 billion of funding for transportation, including $17 billion for four months of payroll support to airlines.
Representatives for Royal Caribbean and Delta declined to comment, while a spokesperson for United did not return a request for comment.
Cash Flow Proxy
Ebitda represents a company’s income before it pays taxes or interest on its debt, and ignores some expenses like depreciation and amortization, where the cash expenditure often came in prior periods. It can be used as a proxy for cash flow or earnings from the company’s main operating businesses. Bloomberg Intelligence looked at companies with negative Ebitda over the last 12 months.
The 47 companies in the Bloomberg Barclays U.S. Corporate High Yield Bond index that posted negative adjusted Ebitda for the 12 months ended in September compares with just 26 in the second quarter. And they reflect only a portion of the firms currently burning cash, given that the analysis excludes most companies that aren’t public and corporations in the financial sector. By other, more stringent definitions, such as subtracting expenses including interest and capital expenditure from Ebitda, even more firms are turning in a less-than-zero performance.
Normally, corporations with negative Ebitda are on the road to bankruptcy, because they aren’t earning enough to make even partial debt payments. But in this downturn, some troubled companies have been able to raise equity. And many have successfully borrowed billions of dollars from investors betting that companies will rebound when the pandemic is over, probably around the second half of 2021.
For example, Carnival Corp. borrowed about $2 billion in November in the corporate bond market, paying an interest rate of just 7.625% on unsecured notes in U.S. dollars and euros. That compared with the hefty 11.9% yield it had to pay on debt secured by its ships in April, when investors were less confident in the timing of a return to normality.
“What these companies are going through is temporary, that’s the bottom line,” said Kevin Mathews, global head of high yield at Aviva Investors. “If they’ve raised enough money in the market to survive until their business comes back, then those default rates aren’t going to be as bad as we thought.”
By one measure, high-yield companies were able to cut their aggregate debt burdens in the third quarter. The ratio of total debt to Ebitda on average for high-yield companies ticked down slightly to 5.27 times in the most recent quarter from the historic high of 5.57 times in the three months ended June 30.
But that improvement is largely because of quirks in how aggregate leverage is measured. Any company with negative Ebitda was removed from the figures because leverage becomes meaningless when that occurs, making the average look better. Also, a handful of companies left the index in the third quarter after filing for bankruptcy.
There was also some improvement from a few companies that benefited from the pandemic and showed real financial gains, such as the strong quarter from consumer staples company the Kraft Heinz Co.
While high-yield companies are struggling, investment-grade corporations are generally managing to tread water or even improve their situation slightly. Average total leverage ticked down to 3.5 times in the third quarter for the investment-grade Bloomberg Barclays U.S. Corporate Bond index, from 3.54 times in the second quarter. The gains came from stronger earnings in the technology, utilities, and consumer staples spaces, some of the biggest sectors in the index, according to data compiled by Bloomberg.
Many companies have borrowed in recent months and kept the cash on their books as a back up in case their situation gets worse. That money can be used to pay down debt in the future, unless it gets spent first. Those funds are partly why net leverage, which compares total debt levels minus cash to Ebitda, is lower than total leverage. For junk-rated companies, that ratio dropped to 4.17 times in the third quarter, from 4.39 times three months earlier.
Large corporate debt loads will be a drag on the economy in the years to come and weigh on growth, said Michael Collins, senior multi-sector portfolio manager at PGIM Fixed Income. Companies hard-hit by the pandemic have been laying off workers and cutting back on investments to cut costs.
“They really focus on survival rather than growth,” Collins said.
Many companies should benefit when the global economy sees an expected rebound in the second half of 2021, but that won’t necessarily extend to businesses that might be facing long-term reductions in revenues as consumer habits change, according to Collins.
“If you thought the last decade coming out of the financial crisis was a poor or weak recovery, which it was by historic standards, I think the recovery this cycle is going to be worse than that because of all the debt overhang,” Collins said.
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