It was supposed to be a temporary buffer—more than $1 trillion of debt taken on by U.S. companies last year to ride out the economic devastation caused by Covid-19.
But with the economy rebounding and interest rates still near all-time lows, it’s becoming increasingly tempting for corporations including Home Depot Inc. and Verizon Communications Inc. to spend those cash cushions on acquisitions and dividend hikes. In many cases, they’re now borrowing more.
The risk is that unfettered access to cheap debt—even for less creditworthy companies—will ease the pressure on executives to pay down their liabilities. That could extend a decade-long trend of swelling corporate debt levels, increasing the chances of a greater reckoning once interest rates rise or the next time capital markets seize up.
“Today’s liquidity becoming tomorrow’s leverage is going to be the story of 2021 for at least some companies,” said David Brown, co-head of global investment grade fixed income at Neuberger Berman, which has $405 billion in assets.
Rising Cash
Total debt loads for U.S. companies outside the financial industry rose 10% in 2020 to $11.1 trillion, according to the Federal Reserve, in part because lower interest rates have made it less burdensome for many companies to shoulder more debt. So far, corporations have largely been hoarding the money rather than spending it. Non-financial companies in the S&P 500 index that reported results before March 31 had about $2.13 trillion of cash and marketable securities on their books in the most recent quarter, up more than 25% from a year earlier, according to data compiled by Bloomberg.
But that’s likely to change, according to strategists at Barclays Plc. With the U.S. giving Covid-19 jabs to more than 3 million people a day now, and the economy showing signs of a resurgence as more consumers feel safe to go out and spend, companies are likely to be more aggressive in deploying cash.
That’s likely to show up in the form of dividends, share buybacks, acquisitions, capital expenditure, and debt repayments, Barclays strategists led by Shobhit Gupta wrote in a report on Friday. Their analysis of comments on company conference calls shows that more management teams have been talking about making one-time dividend payments in recent months, and have been discussing buying back shares. The volume of acquisitions has also been growing.
Generally, companies with higher credit ratings, in particular those at least four steps above junk, are likely to feel comfortable maintaining higher debt levels, the strategists said. Those with lower grades are more likely to pay down obligations.
Home Depot sold $5 billion of bonds in March 2020, saying soon after that it wanted to make sure it had enough cash to tide it over during the pandemic. Then in January it borrowed $3 billion more for its acquisition of HD Supply Holdings Inc., its former subsidiary serving professional contractors. In February, the retailer said it was increasing its quarterly dividend by 10%. Meanwhile, total debt jumped by about $5.8 billion over the company’s fiscal year.
Higher Earnings
Investors don’t always get hurt when a company boosts its borrowings. In the case of Home Depot, its earnings have risen alongside its liabilities, as the pandemic has spurred house-bound people to fix up their properties.
The retailer prepaid $1.35 billion of bonds in March, and credit-rating firms aren’t looking at downgrading the company, which is ranked five steps above junk by Moody’s Investors Service and S&P Global Ratings. But analysts have said the boom in home improvement may fade in the coming year as people finish their projects and spend more time outside the home as the pandemic eases.
Still, most money managers viewed companies’ extra debt as being short-term. Verizon said in April 2020 that it was issuing notes to boost its cash levels, describing the move on a call with investors as a step to help it “manage through the impacts of the Covid pandemic.”