One can gauge the likelihood of a recession by assessing the number of companies classified as high risk. Investors tend to withdraw from a company with imminent credit risk, ultimately contributing to its downfall. An increase in the number of bankruptcies can eventually lead to a recession. In today’s FA Alpha Daily, we will analyze the amount of cash that U.S. companies have in relation to their short-term obligations to determine their current level of risk.
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Is there going to be a corporate bloodbath?
Along with looking at Credit Cash Flow Prime (“CCFP”) analysis, there are a few other ways we gauge corporate health. One is looking at how much cash companies have on hand relative to near-term obligations.
Right now, the Federal Reserve is trying to push more companies into the “high risk” category. It’s raising interest rates to make it harder to borrow more money and to refinance. It’s trying to slow down the economy.
But if companies have cash on hand to meet their debt maturities, the Fed’s efforts will cool down the economy without doing serious damage.
We can look at how many companies have more cash than they have debt coming due in each of the next three years to see what kind of shape they’re in.
Take a look.
From 2019 to 2021, many companies scrambled to build enough cash to handle their near-term obligations. They didn’t want a cash crunch. In 2020, nine out of every 10 S&P 500 Index companies had more cash on hand than debt coming due in the next 12 months.
For most of the past 15 years, roughly three out of every four companies carried more cash on hand than they had debt maturities. The number of companies that had more cash than debt maturing in the next three years tended to peak at roughly seven out of every 10.
Right now, companies aren’t holding as much cash as they were at pandemic highs, but levels are still above average.
Almost four out of every five companies have more cash than debt for the next year. And those with enough cash for the next three years are near those normal peak levels.
That’s great news. It means that the economy isn’t about to get slammed with very sick corporate patients.
The Fed’s actions the past year or so have definitely hurt a lot of weaker companies. Some companies won’t be able to refinance their debts with high interest rates and slowing demand.
But thanks to how healthy corporate balance sheets are as a whole, those sick corporations are going to be fewer and farther between than they normally would be as the Fed cranks up the rates.
With this choppy market, there will be buying opportunities. Take advantage of companies that will be able to weather the storm.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
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