American companies currently have a total of $6.3 trillion in debt — more than they ever have before. To a certain extent, taking on large loads of debt can be normal during periods of economic recovery.
But, it isn’t wise for companies to keep this debt, and it’s even riskier for companies to continue leveraging themselves. CEOs may be over-leveraging companies, especially in the retail industry, in the interest of securing profit now — even though this could lead to a weakened position in the event of a recession.
Setting New Records
Interest rates have been extremely low for some time, which has prompted companies to continue borrowing. Borrowing responsibly is key to creating a strong business, and it isn’t a negative thing in and of itself. Through borrowing, businesses are able to grow and expand. Though interest rates have gone up recently — and borrowing has consequently become less attractive — many companies still owe extraordinary amounts of debt.
Debt becomes dangerous when an economy goes through a recession or depression. Every country goes through periods of recession, and when the United States goes through its next recession, these companies may find it difficult to recover. Some companies are already feeling the strain as their own industries go through downturns.
Many individual businesses have never been more leveraged than they are now, with some of the debtors having as much as 8 times the debt as their cash. Increases in interest rates may also ultimately lead to tightened purse strings for companies, as they will not be able to leverage themselves further. A total of four interest rates are expected to occur throughout the year; two of them have already happened.
Retail Most at Risk
Retail appears to be the most vulnerable sector, with large companies such as Toys R Us going out of business just this year — and Payless ShoeSource declaring bankruptcy last year. Energy and utilities industries are also high risk industries, with a debt ratio that increased by three times during 2016.
Energy and utilities companies have raced to capitalize on the United recent energy boom, leveraging themselves in hopes of future revenue and expansion. This over-leveraging could cause issues should there be a setback regarding energy prices, such as the previous oil crash.
The United States Remains in Flux Regarding Trade
While debt continues to rise, trade issues with China are also intensifying. Trade issues could have a dramatic impact on the United States economy, making many raw resources, supplies and technologies more expensive for American businesses and manufacturers. At the same time, businesses may have limited access to the more affordable manufacturing and developing capabilities of China. This could prompt critical issues with businesses that are over-leveraged, as they may not be able to survive their debts.
China has a few different options when it comes to trade-war retaliation, such as targeting American companies, or using America’s debt as financial leverage. China currently has $1.2 trillion holdings of U.S. government debt, which it could sell off if it becomes necessary. China may also attempt to alter the trading value of their dollar against the US dollar, which would ultimately serve to make U.S. importing more expensive.
Companies now should be looking to reduce their debt and therefore increase their flexibility moving forward. Many analysts do believe that a recession will be coming, and when a recession does hit, it is the companies that are over-leveraged that will suffer first. The China-US trade war that is looming could make this situation much worse, depending on how it pans out. For investors, looking at debt and debt management plans may become an even more important aspect of analyzing a company’s fundamentals.
Regards,
Ethan Warrick
Editor
Wealth Authority
