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Market Intellect: Could U.S. Corporate Cash And Debt Levels Foreshadow A European Shopping Spree?

Publication date: 14-Jun-2010 09:21:31 EST

The Market, Credit and Risk Strategies group (MCRS) is a separate and independent research team at Standard & Poor's. The objective of this group is to provide unique financial intelligence by analyzing relationships across multiple asset classes and markets. Enabled with cutting-edge S&P and third-party applications and data, the group offers investors valuable new sources for alpha discovery and "out-of-the-box" thinking through robust data exploration and analysis. The research is delivered through the Market Intellect series that provides investors with actionable and topical market perspectives that can offer innovative ways to leverage credit and risk intelligence.

Observations

The average probability of default (PD) for nonfinancial S&P 500 companies has decreased significantly as the economy gradually rebounds from the recent recession (see "Probability Of Default For S&P 500 Index Debt Plummets With Growing Corporate And Economic Stability," published May 26, 2010). Market, Credit, and Risk Strategies (MCRS) believes that increasing cash levels and consistent debt levels on balance sheets of U.S. S&P 500 corporations have largely spurred this improvement in overall credit quality. Furthermore, this recent phenomenon has not been limited to large-cap corporations: Similar trends have emerged for S&P MidCap 400 and S&P SmallCap 600 Index constituent companies.

The collective U.S. corporate response to the credit crunch, to raise cash and cut debt, is quite understandable considering the magnitude of the financial crisis that followed. As economic recovery takes hold, however, companies may not want to keep such large, unproductive cash holdings on the balance sheet. Given the ongoing sovereign debt crisis in Europe, U.S. corporations might look across the Atlantic for growth options.

Key Findings

  • Total cash and short-term investments have risen 42.6%, 35.9%, and 30.8%, respectively, for nonfinancial companies in the S&P 500, S&P 400, and S&P 600 indices in the past two years.
  • Total debt rose by only 5.6% and 3.4% for nonfinancial S&P 500 and S&P 400 companies, respectively, and fell by 8.5% for nonfinancial S&P 600 companies over the same time period.
  • As a percentage of debt, cash and short-term investments have risen to 36.6% from 27.1% for nonfinancial S&P 500 companies, to 40.1% from 30.5% for non-financial S&P 400 companies, and to 61.2% from 42.8% for non-financial S&P 600 companies in the past two years.
  • Large U.S. corporate cash balances, combined with currently low European and U.K. equity forward price-to-earnings ratios and the euro's 16% year-to-date fall against the U.S. dollar, leave U.S. corporations well positioned to pursue European target company acquisitions.

Research Output And Analysis

Cash and short-term investments remained relatively flat until about 18 months ago, when it rose substantially for all three indexes. The amount currently totals well over $1 trillion for the S&P 1500 corporations, excluding financials (see chart 1). Conversely, debt rose until mid-2008, after which it flattened out for the S&P 500 and dropped slightly for the other two indices (see chart 2).

Chart 1

Chart 2

Cash and short-term investments relative to debt peaked for nonfinancials between late 2006 and early 2007 and then fell in late 2008 due to the recession. Since then, the ratio has risen substantially to well over prerecession levels (see chart 3).

Chart 3

Economic Implications

With soaring levels of cash and short-term investments and flat debt levels, U.S. corporations have substantial capacity to increase dividends and stock repurchases, increase internal investments in capital spending, and pursue acquisitions of other firms. The current global macroeconomic backdrop, which includes a sharp decline in the value of the euro against the U.S. dollar as well as the steep drops in European and U.K. equity markets in response to the sovereign debt crisis in Europe. The average forward price-to-earnings ratio for stocks included in the FTSE 100, CAC 40, and DAX equity indices is currently in the neighborhood of 10x for 12-month forward earnings. This represents a significant discount to the forward ratio's 15x average since January 2000. Current European and U.K. stock values remain consistent with levels recorded at mid-year 2008 and first-quarter 2009, during the recent financial crisis. Given the stocks' very low valuations compared with historical levels, cash-rich U.S. corporations may consider overseas acquisition target companies to be "on sale" from both a foreign exchange and equity price perspective.

Although U.S. nonfinancial acquisitions of European nonfinancial target companies have been extremely quiet in recent months (see chart 4), current market valuations may entice U.S. corporations back to the mergers and acquisitions market despite ongoing volatility in the global financial markets.

Chart 4

Underlying Data And Resources

Quarterly cash and short-term investments and total debt levels for all companies currently in the S&P 500, S&P 400, and S&P 600 came from Capital IQ. The data was then aggregated by quarter for all nonfinancial companies. First-quarter 2010 (ended February, March, or April) is the most recent quarter included; the earliest is first-quarter 2007.

This report was prepared by S&P's Market, Credit and Risk Strategies group. This group is analytically and editorially independent from any other analytical group at S&P, including Standard & Poor's Ratings Services.

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Market, Credit, and Risk Strategies:Michael Thompson, Managing Director, New York (1) 212-438-3480;
michael_thompson@standardandpoors.com
Robert Keiser, Senior Director, New York (1) 212-438-3540;
robert_keiser@standardandpoors.com
Steven Krull, Ph.D., Senior Research Advisor, New York (1) 212-438-1767;
steven_krull@standardandpoors.com

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Credit-related analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact or recommendations to purchase, hold, or sell any securities or to make any investment decisions. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P?s opinions and analyses do not address the suitability of any security. S&P does not act as a fiduciary or an investment advisor. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives.

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