Calpine Corporation (CPN), Brookdale Senior Living, Inc. (BKD): These Companies Are Finding It Hard to Handle Debt

“When you combine ignorance and leverage, you get some pretty interesting results.”- Warren Buffett

Leverage has many definitions and the quote above relates to the investors and speculators who bet more than they could afford on the housing bubble back in 2008. However, this saying can be applied to companies that use leverage in the form of borrowing, to borrow more that they can afford, gearing up balance sheets in an attempt to try and increase business performance.

Sometimes, this strategy can work well, especially when utility companies are concerned. On the other hand, this strategy can go terribly wrong and the business landscape is littered with corpses of firms that borrowed too much, increased their leverage to unsustainable levels, and then got hit hard when their business plans failed, income fell short of covering debt costs and a restructuring or even default soon followed.

How much is too much?

Well, according to various investing text books, notably the
Intelligent Investor
and
Security Analysis,
for debt to be considered safe and its repayments secure, the issuing company should be able to cover its interest payments at least two-and-a-half times by earnings, so, for this analysis, I shall be using that benchmark.

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 grocery chain SUPERVALU INC. (NYSE:SVU), which has been working to bring down its debt during the past few years but earnings have fallen faster.

Figures in $US million, except for ratios

During 2012, the company’s interest cover fell below the threshold of 2.5 times, which sends up a red flag about the company’s debt position.

However, taken over a three year time frame, debt and interest costs appear to be sustainable.

Figures in $US million, except for ratios

The ability of SUPERVALU to sustain its debt depends on its ability to double its revenue this year. Having said that, Q1 revenue has already come in 50% lower than the same period last year, so the company and its investors could be sailing into dangerous waters.