Last week, I published an overview of the only four companies that currently have a perfect AAA credit rating.
It’s not surprising that all of those financially secure companies are also companies that have had long consistent stretches of dividend growth, ranging from the better part of a decade to almost half a century.
They are not, however, the only four businesses that have great balance sheets. Several other businesses have extremely secure financial positions, and in this article, I’ll provide an overview of five excellent balance sheets. Some of them have balance sheets that rival or exceed their AAA counterparts.
Apple Inc. (AAPL, Financial)
Apple doesn’t have an AAA rating because it has no debt to rate. If it did, however, the Apple balance sheet would arguably be considered the strongest balance sheet of any business. It’s so strong actually, that one of the biggest financial complaints towards Apple was that it was hoarding too much cash instead of returning it to shareholders, and so CEO Tim Cook finally announced a dividend. The yield will be under 2%, but in terms of total payout, it’s one of the biggest quarterly dividend payments of any company in the world.
The company has approximately $100 billion in liquid money on its books. The company’s dividend may slow down cash accumulation, but shouldn’t draw into the cash reserves, because the current free cash flow covers the proposed dividend payout several times over. And because Apple sticks to only small, strategic acquisitions, the free cash isn’t reduced by any major acquisition expenditure.
The question for investment purposes is whether Apple can maintain their current innovation, or whether they’ll eventually fall behind. Unlike businesses that produce reliable cash flows with an economic moat, Apple is dependent on being able to release trendy market-beating products each year.
Chevron Corporation (CVX, Financial)
A few months ago, I posted an analysis of Chevron where I discussed how the company could absorb even a multi-billion-dollar litigation penalty if it had to, with regards to current media reports at the time.
Chevron’s total debt/equity ratio is around 8%, and their interest coverage ratio is very high. The company has approximately 10% worth of its market capitalization worth of cash equivalents on hand.
Due to heavy capital expenditure, free cash flow is fairly weak compared to net income ($14.5 billion in FCF vs. $27 billion in net income for 2011), but free cash flow still covers the dividend payout twice over in most years.
Intel Corporation (INTC, Financial)
Microsoft made it onto the AAA list, but Intel did not. Intel, however, has a current ratio of over 2, a total debt/equity ratio of around 16%, and an interest coverage ratio that is considerably above 100. The company has more cash on hand than their current liabilities are worth.
Intel, like Apple, is dependent on its ability to produce the best products every year. But unlike Apple, Intel gets design wins based almost strictly on performance rather than a combination of consumer preference and specs, and supports this performance with an R&D budget and a capital expenditure budget that vastly outmatches its rivals.
Here’s the recent analysis: Intel: Where are their Growth Opportunities?
Canadian National Railway (CNI, Financial)
Canadian National Railway may not have quite as low of a total debt/equity ratio as some of the others on this list, but what constitutes a good balance sheet varies by industry. When a company has a large base of assets and reliable cash flows, and still rather conservative balance sheet metrics, then it be considered as financially sturdy as a fast paced business with a leaner balance sheet.
This railroad system has tracks extending from the Atlantic Ocean to Pacific Ocean through Canada, and also has tracks extending down to the Gulf of Mexico. Railways, based on their position once developed, and based on their energy efficiency compared to other forms of transportation, have solid economic moats.
With a debt/equity ratio of around 60% and an interest coverage ratio of almost 10, CNI’s balance sheet is robust. Their dividend, which has increaed every year since the mid-1990”²s, is comfortably covered by free cash flows.
National Presto (NPK, Financial)
National Presto has some troubles with its cooking appliances segment, and while their defense segment is strong, there is uncertainty regarding how much of it can be maintained with a reduction in military activity. But one problem that National Presto doesn’t have, is a poor balance sheet.
This company, like Apple, has tons of cash and no debt. The company has $133 million in cash on their books, which is equal to approximately 25% of their total market capitalization. So, this small cap has a higher cash/market cap percentage than Apple or any other company on this list.
Their dividend policy differs from many others; rather than pay a set dividend that grows each year, they pay a large annual special dividend that is equal to approximately 90% of earnings. So their dividend scales with their performance, which has advantages and disadvantages.
The recent analysis: National Presto: Value Play or Value Trap?
Importance of Balance Sheet Strength
The importance of a strong balance sheet goes far beyond credit risk and liquidity risk. A company that has tons of cash and little debt is a company that’s flexible. Given the right opportunity, their balance sheet can absorb a big change by taking on debt, if need be.
If, for example, you have a company with $1 billion in assets, $500 million in debt, and $200 million in net income, then you have a fairly leveraged company. On the other hand, if a company with $1 billion in assets, no debt, and $200 million in net income existed at the same valuation, it would be a much better bargain, all else being equal. This second company could, for instance, make a targeted acquisition to come up to the same debt/assets ratio as the first company, but could then have tens of millions more in income. Emerson Electric, for instance, acquired companies to enhance its data center business during the recent recession. They had the balance strength to absorb a slightly higher degree of debt for a good opportunity.
Overall, it’s good to look for companies with above average balance sheets, as they can weather storms, and are more flexible for opportunities such as extremely low interest rate environments or opportunistic acquisitions or large capital expenditures.
Full Disclosure: I am long MSFT, JNJ, and XOM at the time of this writing.
It’s not surprising that all of those financially secure companies are also companies that have had long consistent stretches of dividend growth, ranging from the better part of a decade to almost half a century.
They are not, however, the only four businesses that have great balance sheets. Several other businesses have extremely secure financial positions, and in this article, I’ll provide an overview of five excellent balance sheets. Some of them have balance sheets that rival or exceed their AAA counterparts.
Apple Inc. (AAPL, Financial)
Apple doesn’t have an AAA rating because it has no debt to rate. If it did, however, the Apple balance sheet would arguably be considered the strongest balance sheet of any business. It’s so strong actually, that one of the biggest financial complaints towards Apple was that it was hoarding too much cash instead of returning it to shareholders, and so CEO Tim Cook finally announced a dividend. The yield will be under 2%, but in terms of total payout, it’s one of the biggest quarterly dividend payments of any company in the world.
The company has approximately $100 billion in liquid money on its books. The company’s dividend may slow down cash accumulation, but shouldn’t draw into the cash reserves, because the current free cash flow covers the proposed dividend payout several times over. And because Apple sticks to only small, strategic acquisitions, the free cash isn’t reduced by any major acquisition expenditure.
The question for investment purposes is whether Apple can maintain their current innovation, or whether they’ll eventually fall behind. Unlike businesses that produce reliable cash flows with an economic moat, Apple is dependent on being able to release trendy market-beating products each year.
Chevron Corporation (CVX, Financial)
A few months ago, I posted an analysis of Chevron where I discussed how the company could absorb even a multi-billion-dollar litigation penalty if it had to, with regards to current media reports at the time.
Chevron’s total debt/equity ratio is around 8%, and their interest coverage ratio is very high. The company has approximately 10% worth of its market capitalization worth of cash equivalents on hand.
Due to heavy capital expenditure, free cash flow is fairly weak compared to net income ($14.5 billion in FCF vs. $27 billion in net income for 2011), but free cash flow still covers the dividend payout twice over in most years.
Intel Corporation (INTC, Financial)
Microsoft made it onto the AAA list, but Intel did not. Intel, however, has a current ratio of over 2, a total debt/equity ratio of around 16%, and an interest coverage ratio that is considerably above 100. The company has more cash on hand than their current liabilities are worth.
Intel, like Apple, is dependent on its ability to produce the best products every year. But unlike Apple, Intel gets design wins based almost strictly on performance rather than a combination of consumer preference and specs, and supports this performance with an R&D budget and a capital expenditure budget that vastly outmatches its rivals.
Here’s the recent analysis: Intel: Where are their Growth Opportunities?
Canadian National Railway (CNI, Financial)
Canadian National Railway may not have quite as low of a total debt/equity ratio as some of the others on this list, but what constitutes a good balance sheet varies by industry. When a company has a large base of assets and reliable cash flows, and still rather conservative balance sheet metrics, then it be considered as financially sturdy as a fast paced business with a leaner balance sheet.
This railroad system has tracks extending from the Atlantic Ocean to Pacific Ocean through Canada, and also has tracks extending down to the Gulf of Mexico. Railways, based on their position once developed, and based on their energy efficiency compared to other forms of transportation, have solid economic moats.
With a debt/equity ratio of around 60% and an interest coverage ratio of almost 10, CNI’s balance sheet is robust. Their dividend, which has increaed every year since the mid-1990”²s, is comfortably covered by free cash flows.
National Presto (NPK, Financial)
National Presto has some troubles with its cooking appliances segment, and while their defense segment is strong, there is uncertainty regarding how much of it can be maintained with a reduction in military activity. But one problem that National Presto doesn’t have, is a poor balance sheet.
This company, like Apple, has tons of cash and no debt. The company has $133 million in cash on their books, which is equal to approximately 25% of their total market capitalization. So, this small cap has a higher cash/market cap percentage than Apple or any other company on this list.
Their dividend policy differs from many others; rather than pay a set dividend that grows each year, they pay a large annual special dividend that is equal to approximately 90% of earnings. So their dividend scales with their performance, which has advantages and disadvantages.
The recent analysis: National Presto: Value Play or Value Trap?
Importance of Balance Sheet Strength
The importance of a strong balance sheet goes far beyond credit risk and liquidity risk. A company that has tons of cash and little debt is a company that’s flexible. Given the right opportunity, their balance sheet can absorb a big change by taking on debt, if need be.
If, for example, you have a company with $1 billion in assets, $500 million in debt, and $200 million in net income, then you have a fairly leveraged company. On the other hand, if a company with $1 billion in assets, no debt, and $200 million in net income existed at the same valuation, it would be a much better bargain, all else being equal. This second company could, for instance, make a targeted acquisition to come up to the same debt/assets ratio as the first company, but could then have tens of millions more in income. Emerson Electric, for instance, acquired companies to enhance its data center business during the recent recession. They had the balance strength to absorb a slightly higher degree of debt for a good opportunity.
Overall, it’s good to look for companies with above average balance sheets, as they can weather storms, and are more flexible for opportunities such as extremely low interest rate environments or opportunistic acquisitions or large capital expenditures.
Full Disclosure: I am long MSFT, JNJ, and XOM at the time of this writing.
