Stop following rules.
“Invest only in companies without debt. Low risk.”
“Never invest in companies with negative equity. Too risky.”
Rules like these will get you into trouble.
Here’s why.
“Debt-free = risk-free.” Wrong!
A company with no net debt is rated junk. Another with 6x net debt/EBITDA is investment grade.
Athabasca Oil Corporation (ATH CN). USD 206 mn cash against USD 148 mn debt. Operating profits of USD 215 mn.
Yet, S&P Global rated its notes junk.1
Enbridge Inc. (ENB CN). USD 78 bn net debt. Only USD 8 bn of operating profits.
That same credit rating agency blessed its bonds with BBB+. Investment grade.2
What gives?
Cyclicality.
ATH swings between losses and profits. It is an oil exploration and production company. Profits depend on oil prices.
ENB never reported an operating loss. It owns oil pipelines and storage terminals. Profits roll in no matter the oil price.
Next time you hear, "You must only invest in debt-free companies. Low-risk!", remember ATH and ENB.
“Negative equity = high risk.” Wrong again!
This company has negative equity, but is still investment-grade.
Altria Group, Inc. (MO US). Maker of Marlboro. 40% market share in the US. It owns USD 33 bn of assets. But it owes USD 36 bn. Negative equity of USD 3 bn.
Yet, Moody's, S&P Global and Fitch all rated it investment grade.
What gives?
Superior cash generation.
Altria generates ~ USD 9 bn of free cash flow every year. Consistent. Stable.
Altria structured annual debt maturities below USD 2 bn over the next five years.
Fitch praised this "Conservative Financial Policy".3
Similar stories at McDonald's Corporation (MCD US), Philip Morris International Inc. (PM US) and other consumer staples.
Next time someone tells you, "Never invest in companies with negative equity! Too risky!" or "The debt/equity ratio is too high!", remember Altria.
A company goes bankrupt when it cannot pay its debt, not purely because of accounting.
Afterword
Regular readers already know I don’t like blindly following rules. It can be very frustrating to have stock pitches shot down because of blind rules.
Always understand the business.
Accounting is a business map. But it is not the business.
Experienced readers already know this.
If you’re one of them, great. Here’s your reward. The funniest meme I’ve seen this year:
Source: wallstreetbets (2022)
Coming up next
Next week, I’ll be back with 2 to 3 more interesting ideas.
I’ll then analyse the most voted idea from my last post.
Right now, that’s Siltronic AG (WAF GR). Tuas Limited (TUA AU) is the runner-up.
Haven’t voted yet? Check out my last post: 2 Attractive Ideas
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Disclaimer
This publication is for informational, educational, and entertainment purposes only and does not constitute financial, investment, legal, or tax advice. The content herein is a record of my personal research and investment process, and all analysis, forecasts, and opinions expressed are solely my own.
I make no representation or warranty, express or implied, as to the accuracy, completeness, or timeliness of the information provided. The stock market is highly volatile, and my forecasts, estimates, and assumptions may prove incorrect.
I am not acting as your financial advisor or fiduciary. You should not rely on any information in this publication to make investment decisions. Under no circumstances will I be held liable for any direct, indirect, or consequential losses or damages arising from your reliance on the content of this publication.
At the time of publication, I do not hold any positions in the companies mentioned in this article, either long or short. I may change my views, predictions, or personal portfolio positioning at any time without notice.