Screening For Opportunities In Debt-Laden Companies

Most analysts are pushing companies with rock-solid balance sheets to deal with the current global economic crisis. Thus, the contrarian might wonder if opportunity lurks in companies in disfavor due to high debt levels.

Of course, many companies will default under their heavy debt burden so I sought companies with high debt levels but strong free cash flow (FCF), recent Q4 revenue growth and strong competitive positions. Specifically, I screened for the following criteria:

  • debt-to-equity over 2.0 for the most recent quarter (MRQ)
  • revenue growth for Q4 YoY of at least 5%
  • trailing twelve months FCF greater than last fiscal year’s FCF
  • company has a narrow or wide economic moat as designated by Morningstar

This screen yielded seven stocks but I discarded Deutsche Bank (DB) for obvious reasons and Imperial Tobacco (IBYTY:OTC) due to its OTC status. The resulting five stocks are presented over two spreadsheets for readibility:

I prefer dividend-paying stocks, which turns me away from Alliance Data Systems (ADS) and Verisign (VRSN). The other three stocks, HJ Heinz (HNZ), Telefonica (TEF) and Oshkosh (OSK), all sport fairly high yields over 5%.

I dabbled in Telefonica a few years ago and its Latin American growth story still intrigues me.

From a pure financial numbers standpoint, HNZ and OSK pique my interest for different reasons. Heinz’s consistent cash generation over the last 5-6 years is notable and 3x debt-to-EBITDA isn’t a heavy load for such a reliable business. The company’s solid operating position should also comfort shareholders.

Just looking at the FCF numbers in the spreadsheet, OSK seems wildly undervalued. But they toil in the automotive sector, which is being shunned by investors. A bargain may be lurking there but I’d have to look long and hard to make sure OSK don’t deserve to be lumped in with the rest of the stocks in that sector.

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