Credit Crunch Puts Some Companies on S&P Watch List
By MATT KRANTZ, USA Today
Homeowners aren't alone in struggling to keep up with their interest payments. As Bear Stearns' near-brush with bankruptcy shows, some companies also are dodging the repo man. Already this year, 24 public companies with assets worth $9.9 billion have filed for bankruptcy protection, BankruptcyData.com says. That's two-thirds higher than the defaults during the same periods in 2007 and 2006.
Things will likely get much worse. Bond watchers are braced for many more blowups as companies struggle with their debt loads and consumers cut back on their spending. Debt-rating agency Standard & Poor's expects at least 4.6% of speculative-graded companies to default by the end of the year, up from the 25-year low of 1.1% in January and above the historical 4.4% average, says Diane Vazza, managing director at S&P.
If S&P is right, that could mean as many as 74 additional defaulting companies within the next 12 months.
While nobody knows exactly which companies will default and which will turn themselves around, S&P's latest list of its "weakest links" shows companies that have the lowest credit ratings and face a strong possibility of additional downgrades.
Worldwide, there are 114 companies on the weakest-link list, the highest number in 16 months. And there are now 93 U.S. companies on the list, including some household names, such as Eddie Bauer, Sbarro, Guitar Center, Blockbuster, Six Flags and Linens 'n Things. The number of U.S. weakest-link companies jumped 13% from February through March, showing just how much strain some companies are under.
"We're on the first leg in the up-cycle of defaults," Vazza says. "The second half and in 2009, we're going to see a lot more deterioration. This is just the beginning."
There are some clear-cut trends among companies that are struggling the most, including those that:
Rely on consumer discretionary spending
Companies that depend on consumers spending money for non-essential items are most at risk as the economy slows, S&P says. Industries with the most "weak links" include entertainment, consumer products and restaurants.
One industry that really stands out is retailing. Consider Linens 'n Things, which sells home products. It is not publicly held and declined to comment for this story. But industry leader Bed Bath & Beyond cut its forecast for its fiscal fourth quarter ended in February. Bed Bath & Beyond has no long-term debt, unlike Linens 'n Things, which has $650 million, S&P says.
Another well-known retailer, Eddie Bauer, is on S&P's list. Last year, the seller of outdoor apparel lost $102 million on top of a $212 million loss in 2006. Eddie Bauer also carries heavy debt — more than $260 million, exceeding the $256 million of equity in the company, says S&P's Capital IQ.
Eddie Bauer is part of a trend that saw retailers boost debt by 31% the past year, says research from Marti Kopacz of Grant Thornton. Eddie Bauer did not return calls for comment. High debt is a heavy load for firms when shoppers are in a sluggish economy.
"You can buy fewer pillows and not eat out as many times," Vazza says.
But Robert Friedman, CEO of retailer Loehmann's, says being in a challenging business and having heavy debt shouldn't land his company on S&P's list. It's "uncalled for," he says. "We are not delinquent with any payments."
Carry heavy debt loads
Borrowing might have seemed like a sound idea when financing was cheap and easy to get, but companies that loaded up on debt now know it can bite hard when the economy slows and credit dries up.
When debt comes due, shakier companies that can't afford to pay it off may have trouble replacing it with new debt now that lenders have tightened up, says Jing Zhang, head of research at Moody's KMV. About $6.8 trillion in corporate loans and bonds come due this year, he says.
Just making payments on existing loans can be more onerous as business slows down.
Six Flags, the operator of amusement parks across the country, is attempting to turn around its business while carrying debt of $2.7 billion. "The debt is a problem," says David Miller, analyst at SMH Capital.
The suggestion Six Flags may be a candidate for bankruptcy any time soon is "silly," he says. The company has had a string of "biblically bad luck," including bad weather in many of its markets last year. While the company's debt load is large, it doesn't come due until 2010, Miller says.
Analysts expect the company's earnings to double in the third quarter, says Reuters Estimates. The company didn't return calls.
Heavy debt is also an issue at Blockbuster. The video rental chain's former parent company loaded it up with more than $1 billion in debt, says Michael Pachter, analyst at Wedbush Morgan.
But he thinks bankruptcy isn't a risk. The company's debt is down to $758 million, with just $44.7 million due this year and $56.5 million due next year, he says. Blockbuster is expected to generate at least $100 million in cash flow, more than enough to service the debt, so "The risk of default is nil in 2008 or 2009," he says.
Blockbuster also doesn't see imminent danger. "We expect to generate meaningful cash flow to return Blockbuster to profitability and be in full compliance with debt covenants," says spokesman Randy Hargrove.
Some blame private-equity firms for loading too much debt on companies they bought.
IAP Worldwide, a defense contractor owned by private-equity firm Cerberus, has $535 million in debt and is on S&P's list. But in an e-mailed response, Cerberus said IAP has been able to restructure its debt.
Face operational issues
Krispy Kreme is an example of companies on S&P's list that have had persistent problems in managing themselves profitably. Ever since the doughnut chain's accounting scandal in 2004 and 2005, it has been trying to turn itself around.
Aftereffects of the accounting mess coupled with too many new stores have put the company in a tight spot. It has lost money for 13-consecutive quarters, and Thomson Financial says analysts expect the company to lose money again when it reports fiscal fourth-quarter results April 7. Its stock has fallen more than 90% the past five years. Krispy Kreme has had a revolving door of executives and in January named a new CEO. A few months earlier, it said it would realign operations. Krispy Kreme declined to comment for this story.
But while some companies and industries face serious challenges both internally and externally, Moody's Zhang doesn't expect a serious default epidemic. "Default risk has been increasing," he says. "But the relative level is very low."