_(If you would like to use my code, you can find it here on my GitHub. Sorry, it hasn’t been cleaned/commented. Also, you will need a subscription to Sharadar US Fundamentals and a Quandl API key to run it)_
How healthy is the typical American Company? That’s an exceedingly relevant question right now. While there’s reason to be very cautiously optimistic that the COVID-19 situation is improving, that’s just step 1. What’s to come (reopening and righting the economy) will be just as hard or harder.
Many businesses both big and small will not be there anymore when we finally come out the other side of this economic tunnel. Today, we will study the underlying financial data to get a sense of what corporate America’s debt picture looks like and whether there are any obvious trouble spots.
Why Firms Default
The most frequent reason that companies go bankrupt is high fixed costs – in other words an inability to scale down costs when revenues plunge. Companies have fixed costs for multiple reasons:
- The business requires large upfront investments in high cost assets like factories in order to function. If sales collapse right after a firm finishes building a new factory, it would be disastrous for the company’s bottom line – it’s shelled out the cash with no way to make it back. High fixed costs of the functional type is known as operating leverage in financial parlance.
- The other reason for high fixed costs is debt. Any company, regardless of its cost structure, can juice up its returns during good times with debt. It’s kind of like buying stocks using margin extended by your broker. If stock prices keep going up, great, you’ve made more money because the debt allowed you to buy more stocks than you could otherwise have afforded. If the stock market crashes, then you are in big trouble. Not only have you lost most of your investment, you also still need to pay back your broker the original amount that you borrowed. Firms that borrow significantly run the same risk – if businesses collapse and cashflow dries up, then they may not be able to pay back their debts.
- A hybrid of the two is hidden debt like exposures such as being locked into long term leases or rental contracts (like leasing a plane or renting large amounts of commercial real estate).
Today we will focus on exploring the debt part of the equation as large amounts of debt is usually also a sign of high operating leverage (unless a company has massive cashflows like Apple, it will generally need to borrow to be able to afford its upfront infrastructure investments).
Who Holds All That Debt?
Let’s start by checking out which industries are most indebted. The competitive dynamics (profit margins, infrastructure needs, etc.) across companies in different industries differ greatly, so we should expect the use of debt to vary as well. I’ve plotted total balance sheet debt (both long and short term) by sector below. A few observations:
- The financial services sector (banks, etc.) employs the most debt. That doesn’t necessarily mean that they are the most at risk of default though. Banks use debt as a tool (or a raw input) to make money. At a high level, they convert money borrowed via deposits (like checking and savings accounts) into cash producing loans – so they basically serve to funnel money around the economy. As long as these loans produce more interest income (and don’t default en masse) than the interest expense the banks pay on their deposits, the banks will make money. A financial analysis of banks should focus more on their equity cushions (total assets less total liabilities) and the riskiness of loans made. When assessing a bank, it’s less about how much it’s borrowed in absolute dollar terms and much more about where it’s invested the borrowed money. For these reasons, in some of the plots and analysis to follow, I will omit financial services firms.
- Sectors that borrow a lot of money are generally the ones with high upfront investment needs like communication services (Comcast, AT&T), energy (Exxon Mobil), utilities, and real estate.

Total debt levels are interesting but it’s more important to look at debt levels relative to income, which factors in a company’s ability to service its debt. We can do this by dividing debt by EBITDA and plotting average debt/EBITDA by sector (below). EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBITDA is a reasonable proxy for the cashflow a company has on hand to service its debt.
- While the communication services sector issues a lot of debt (number 2 behind financial services in our previous plot), it also generates substantial profits as it includes massively profitable companies like Google and Facebook (so in debt/EBITDA terms it looks pretty healthy, and that’s before factoring in their substantial cash hoards). Comcast and AT&T also both generate substantial profits thanks to their oligopoly on home internet.
- In this plot, the one that really jumps out is real estate. The sector on average has borrowed a lot of money against not that much income (it’s got $17 of debt for each $1 of EBITDA). Off the top of my head, I’m not sure what the commercial real estate exposure of this sector is (remote work trends and the continuing shift to online retail do not bode well for the owners of office buildings and malls). But looking at the larger companies (by market cap) in this sector, there are names like American Tower and Crown Castle which own and lease cell towers as well as Equinix which does the same with data centers – already essential services today and perhaps even more so in a work from home tomorrow. So while the high indebtedness relative to incomes will prove challenging as economic conditions decline, these firms are not as COVID exposed as they appear to be at first glance.

Slicing By Sector And Market Cap
Let’s focus our lens a bit and include market cap as well in our analysis. We can use a heat map to visualize average debt/EBITDA levels by sector and market cap (market cap is a decent proxy for the size and scale of the firm).

Before we dive into the numbers, note that there is not correct answer for what a firm’s debt/EBITDA ratio should be. It depends on management’s ability to manage liquidity, the interest rate paid on debt, the cyclicality of cashflows (if your company’s cashflows plunge in a recession, then it should watch how much it borrows), and the return on projects financed with that debt. Obviously these variables change from company to company. And they also change depending on economic conditions or specific industry conditions – you can bet that if the recession deepens, EBITDA will decline severely and debts that previously looked manageable will become massive burdens.
It’s important to realize that debt is not necessarily a bad thing. If a company has large and consistent cashflows, can access debt at a low interest rate (thanks to today’s super low rate environment), and can earn a return on that debt in excess of the interest paid, then it should borrow at least a little bit. As long as management doesn’t overestimate the magnitude and stability of its cashflows, super low rate debt for companies like Google, Apple, and Berkshire Hathaway are almost akin to free money.
OK, back to our heat map. Overall, I notice the following:
- Small real estate firms and mega-cap industrial firms have huge debts relative to their incomes. We should definitely take a look at the companies in these two buckets.
- As we previously observed real estate firms in general have high debts relative to their ability to pay. We also see that it’s the smaller companies in the sector (with less diversified real estate portfolios) that are the most indebted.
- Mid sized energy firms (I wonder how many frackers are in there) and large basic materials firms also look over indebted relative to their sector peers. Commodity companies loaded with debt make me nervous – they have zero control over the price of what they sell so they are always one price crash away from being wiped out.
Another thing that I noticed is that, with the exception of industrials, large-cap firms are on average more indebted than their mega-cap peers in the same sector (see bar chart below). I would guess that this is because mega-cap firms dominate their respective industries and enjoy the competitive advantages of scale and therefore higher profit margins. So while they might borrow more on an absolute dollar basis, relative to incomes (thanks to their higher profitability), mega-cap firms actually look less indebted. Still, I’m surprised to see such a stark difference in indebtedness in commoditized sectors like basic materials.

Individual Companies That Are Highly Indebted
Below is a plot of the 30 most indebted companies in the energy, real estate, and industrials sectors (I include only companies with at minimum $5 billion in debt as I want to focus on the whales).
Looking at the top few, they are predominantly mortgage REITS (like Capstead and AGNC). Similar to banks, these firms borrow in order to invest in a portfolio of mortgage bonds (so debt is more or less a basic input into their business). So a high level of debt is to be expected and is not necessarily a bad thing – as long as the mortgage REIT astutely manages the default risk in its portfolio (across the entire business cycle) and properly matches the duration of its assets and liabilities (a.k.a. debts). So we should look past real estate companies and focus on energy and industrials (an exception in our list is Brookfield Property Partners, which manages office buildings, hotels, malls, etc. and may come into trouble in the months ahead).
After the mortgage REITs, you have financially mismanaged companies like Boeing (too many share repurchases) and General Electric as well as energy firms fallen on hard times like Transocean and Apache. Transocean is an interesting one. Pre-2014 when oil prices still hovered around $100, Transocean’s fleet of offshore drilling ships and rigs were in huge demand. Each ship (or rig) cost a lot but earned even more – so as long as oil prices stayed high, it made sense to borrow and invest in an ever larger fleet. Obviously, with oil hitting 20 year lows and the surge in onshore shale oil production, Transocean’s expensive fleet has, over the past 5 years, become a huge financial drag.

Below is the list for all sectors besides financial services and real estate (only companies with at minimum $5 billion in debt). It’s not a pretty list. Most of the companies below are severely impacted by the pandemic and even as the economy reopens, they will continue to feel the pain:
- Boeing and Latam Airlines Group are hit hard by the dramatic decline in air travel.
- Transocean, Apache, Cheniere Energy, and Noble Energy will find it next to impossible to make money at current oil prices.
- Caesars Entertainment and AMC Entertainment will have a hard time enticing people back into casinos and theaters respectively (and will have to bear the cost of enforcing strict social distancing and capacity rules when they do reopen).
- Ford and Clear Channel Outdoor Holdings (billboards) will be hard hit for years by the accelerated trend to remote work. Less drivers means less cars sold and less commuters to view outdoor ads.
Keep in mind that business performance often doesn’t equate to stock performance, especially in the short-term. Stock performance is all about what transpires relative to what was expected to transpire. And just as even the stocks of great companies can sell off significantly in a market downturn, the stocks of mismanaged and uncompetitive companies can do great in a bull market when animal spirits abound.

Conclusion
This is just the first layer of the onion. I plan to dig more into debt structures and business models as well as other areas of companies’ financial statements in the not so distant future.
Lastly, before we go, let’s check whether overall debt levels have increased over the past 5 years. They have! Besides basic materials, every other sector has seen an increase in debt. This is, of course, a byproduct of the long economic boom (that just ended) – as firms’ sales, profits, and assets grew, they were able to borrow more and did so. But this type of behavior is also what raises the risk of default in an economic downturn – debt levels hit all time highs just as declining economic conditions reduce profits and ability to pay.

Hopefully, this was insightful. I didn’t have a story in mind when I started analyzing this data and wanted to just see what I could find. I am still analyzing so there will be much more to come. Cheers, stay safe, and happy Investing!