Low Debt and High Expectations

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The first things I look at in any potential investment - and especially young companies - are the company's debt/equity ratio and its quick ratio.  If debt/equity > 1, and/or if quick ratio < 1, the company had better have stellar figures elsewhere, or my money is going elsewhere.

If used right, debt can be an effective tool in growing one's business.  It can also be a way to immediately pursue one's perceived future interests.  If used, however, there are (at least) three ways in which debt can be detrimental to a company's success:

  1. Debt may enable an achievement that comes at the expense of future income and flexibility;

  2. Debt is a form of self-imposed inflation - the interest one pays becomes an addition to the cost of an expenditure while not necessarily increasing its value;

  3. The assumption of debt - and its repayment - creates an environment where more debt may need to be assumed.

I would like to discuss three companies that have impressed me with two things: the promise they offer in their particular industries, and the mature way in which they have approached their use of debt.  Data presented in the tables below reflect the status of each company as of September 30, 2012 (revenues are calculated from 10/1/2011 - 9/30/2012).

Diana Containerships (NASDAQ: DCIX)

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DCIX was founded and registered in the Marshall Islands in 2010 and operates out of Greece.  At its beginning, the company owned two Panamax containerships (ships with a capacity of 3000 - 4999 TEU) together valued at $92 million.  It has purchased both used ships and new builds to a current fleet size of 10 containerships having a total net book value of over $246 million, yet carries only approximately $98 million in total liabilities. 

In its Form 20-F filed in December 31, 2011, the company outlined its plan to utilize income and equity issuance as the primary source for purchases, with any debt incurred being on a short-term basis.  Its growth plans derive from its management: Diana Shipping Systems, a wholly owned subsidiary of Diana Shipping (NYSE: DSX), a dry-bulk carrier which itself currently boasts a total debt/equity ratio of 0.33 with a quick ratio of 7.80.  DCIX's ability to minimize debt has enabled the company to pay an annual dividend of $1.20, a yield of 17.9%.

Rhino Resource Partners (NYSE: RNO)

<img src="/media/images/user_15433/rno-data_large.jpg" />

Rhino is a coal producing company initially operating out of the Central and Northern Appalachian regions (Ohio, Kentucky and West Virginia).  Originally formed by Wexford Capital LP in 2003, Rhino held its IPO in September, 2010.  Rhino now has mining property in the the Illinois Basin region, as well as in Utah and Colorado.  It also recently increased its holdings in the Appalachians.  Rhino has also acquired oil and gas mineral rights to properties in Ohio and Oklahoma (the Ohio property - Utica Shale - has already brought in more than $7 million in lease bonus payments).

As a limited partnership dealing in natural resources Rhino is obligated to pay dividends in order to avoid certain tax liabilities.  Its actions are directed towards securing a consistent cash flow, and Rhino currently pays an annual dividend of $1.78 per common share, for a yield of over 11%.  To maximize revenues, Rhino has secured continuous contracts with power plants for its steam coal, and also maintains sufficient markets for its metallurgical coal.  Rhino also operates subsidiary businesses in mine engineering and reclamation, trucking, and oil-well platform construction.

Rentech (NASDAQ: RTK)

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Rentech, in operation since 1981 and public since 1996, specializes in the technology for producing synthetic fuels, lubricants, and specialty chemicals.  The company has developed its own proprietary technology based on the Fischer-Tropsch process (the Rentech Process), and has acquired additional technologies from ClearFuels Technology Inc. (2011) and SilvaGas Corporation (2009), which technologies complement the Rentech Process.  Its jet fuels have been certified by the U.S. Air Force and the Department of Defense for use in military aircraft and commercial aircraft as well.  Rentech also acquired controlling interest in Rentech Nitrogen Partners (NYSE: RNF), a producer of nitrogen-based fertilizers.

Rentech's aversion to debt has no doubt motivated some of its recent activities, such as abandoning three projected plant constructions despite resultant impairments of over $57 million in FY 2011, and the redemption of over $57 million in convertible senior notes in December, 2012.  

Credit-wise people - and companies - recognize that credit is a tool best used sparingly, and only when necessary.  In particular, companies that are just getting their start, or that are in the process of expansion, do well to recognize that misused debt is the one thing that can snuff out inspiration, aspiration and expectation in one fell swoop.

josephpporter owns shares of Diana Containerships Inc. - Common Shares, RHINO RESOURCE PARTNERS LP COM UNIT REPSTG LTD PARTNER, and Rentech, Inc.. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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