"Discipline of Debt" is Punishing These Stocks
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For a long period, the "Discipline of Debt" has been preached by investment bankers thumping the bible of leveraged buyouts and other forms of corporate transactions. The sermon was that high debt would, by its very presence, force a company to "be lean and mean" and rid itself of wasteful spending and inefficient operations. That the debt was also tax deductible and did not dilute shareholder equity added to its appeal. A very painful lesson from this has been taught by the "Discipline of Debt" to the shareholders of SuperValu (NYSE: SVU), Sprint-Nextel (NYSE: S), Alcatel-Lucent (NYSE: ALU) and ArcelorMittal (NYSE: MT).
In his autobiography, "My Cross to Bear," legendary rocker Greg Allman of the Hall of Fame group "The Allman Brothers" noted, in a rare moment of introspection, that "After about my fifth wife, I realized that maybe I shouldn't be married." Despite disaster after disaster, corporations continue to pile on massive quantities of debt in ill-fated marriages. Like Greg Allman, it is soon realized just how truly expensive and draining such an event can be after tremendous costs and lost opportunities.
The latest victim is SuperValu, a grocery store based in Eden Prairie, Minnesota. In 2006, SuperValu acquired about 1100 stores from the Alberton's portfolio for a total cost of $11.3 billion. This week, SuperValu shares fell more than 55% after a disappointing quarter. SuperValu has a debt-to-equity ratio of 297.90-to-1 and a profit margin of a negative 2.88%. The debt-to-equity ratio of SuperValu means that it required almost $300 of borrowing to create every $1 in equity value. While the Alberton's purchase cost more than $11 billion six years ago, the present market capitalization for SuperValu is $497 million.
ArcelorMittal is the world's largest steel company, created by a series of very expensive and counter-productive mergers and acquisitions when times were better. Now trading around $15 a share, ArcelorMittal was trading around $100 in 2008. The profit margin for ArcelorMittal is low at 1.26% and its debt-to-equity ratio is high at 0.50. By contrast, Posco (NYSE: PKX), a South Korean steel firm pretty much the same size in terms of market capitalization, has a profit margin of 15.23% and a debt-to-equity ratio of just 0.16. As a result, its shareholders benefit from much more rewarding valuations.
After its disastrous acquisition of Lucent in 2006, Alcatel-Lucent finally starting making money. Alcatel-Lucent now has a profit margin of 3.19%. The debt-to-equity ratio is now 1.04. Now trading around $1.43 a share, Alcatell-Lucent is off more than 70% for the last year of market action. In 2004, Alcatel-Lucent was trading around $18 a share.
Sprint bought Nextel in 2004 for $35 billion. The present market capitalization of Sprint-Nextel is around $10 billion. Sprint-Nextel has a negative profit margin of 9.72% with a debt-to-equity ratio of 2.10. Sprint-Nextel is betting heavily that the iPhone 5 from Apple will revitalize the stock price.
Interestingly enough, the "Discipline of Debt" was obviously never learned at Apple. The debt-to-equity ratio for Apple is 0.00. That is the same debt-to-equity ratio for Microsoft and Mastercard Incorporated. Each of these companies has profit margins of over 20% and no debt, despite being mega-caps.
Excessive debt has a very corrosive, debilitating effect on the borrowing entity, be it a consumer, company or a country. Funds better utilized for growth are sent to the creditors instead. Constraints are put on operations and there are many missed opportunities due to the burden of the debt load. Alexander Hamilton, the former Secretary of Treasury, once stated that "A national debt, if it is not excessive, will be to us a national blessing." That holds true for a consumer or a company, too.
As with Greg Allman and his ex-wives, maybe there is a lesson to be learned about the "Discipline of Debt" after many painful, costly failed experiences in corporate excess.
jonathanyates13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Microsoft, ArcelorMittal, and SUPERVALU INC. Motley Fool newsletter services recommend Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.