3 Companies Boosting Earnings With Debt
It would appear that for the next few years, the low interest rate environment currently prevailing around the world will continue. While this isn't good for savers, it is good for companies with lots of debt, and it's even better for their shareholders, as lower interest costs mean higher profits.
As I hold shares in Altria , I like to keep tabs on what the company is up to. I was delighted when I read that the company was planning to refinance a portion of its debt at half the rate of interest the company was originally paying.
Altria refinanced its debt through a tender offer to repurchase $2.1 billion of debt, which paid out a fixed rate of interest of between 9.25% and 10.2%. Obviously, paying a rate of interest that high in this low interest rate environment would be madness. To fund this tender offer, Altria issued $1.4 billion of 10-year notes with a 4% coupon and $1.8 billion of 30-year notes with a 5.375% coupon. 10% interest on $2 billion is around $200 million in annual interest payments. Altria's replacement debt issue of $3.2 billion, which offers an average interest rate of 5% should only cost the company $160 million in interest per year. Based this back-of-the-envelope and 2012 numbers, this move would add 1% to Altria's annual net income.
Because Altria is buying back this debt early, it is having to pay a slight premium for the debt. As a result, the company is expecting to take a one-off charge of $1.1 billion, or $0.34 per share. Unfortunately, because of this charge, Altria's full-year earnings per share will come in at $2.23 to $2.28. Excluding this special item and others, on an adjusted basis, EPS is expected to come in at $2.36 to $2.41. Based on the fact that Altria is locking in these low rates of interest for up to 30 years, it would appear that this small charge is worth taking.
Rising from the ashes
Meanwhile, Lee Enterprises is facing pressure from shareholders to refinance its debt at a lower rate. Currently, Lee is paying 9.2% to borrow after the company filed for a Chapter 11 bankruptcy during 2012 and reorganized its $935 million debt pile.
Lee has been working to reduce debt during the past year, and at the end of the company's most recent fiscal quarter, its total debt had fallen to only $847.5 million. Reducing debt from $935 million to just under $850 million, or just under 10%, in the space of a year is extremely impressive.
Before its Chapter 11, Lee was able to borrow at 5.2%. If, in the best-case scenario Lee refinances at this rate, interest costs will half from $22 million per quarter to $11 million. Ultimately, this will triple pre-tax income and allow the company to reduce its debt even faster. Still, this is the best-case scenario, but even a 1% reduction in interest costs will give Lee an extra $2.2 million a quarter, doubling second-quarter income.
The longer interest rates remain at rock-bottom levels, the faster Lee will be able to stage a recovery.
Private equity assistance
Private equity firms like KKR & Co. L.P. and Carlyle are also refinancing. While this should benefit investors, it appears that low rates are not filtering through to their investments.
In the first nine months of 2013, KKR and Carlyle renegotiated more than $110 billion in existing debt to lock in low interest rates for themselves. Over the same period, these two companies received $40 billion in dividends from their investee companies in the process.
Unfortunately so, for it would appear these low rates are not being passed on. For example, KKR and its co-investors recently announced they were making a $300 million investment in investee First Data to help the company refinance some of its debt. According to Reuters, First Data is refinancing $2 billion of 11.5% senior notes that are due in 2016 with the cash, and $1.4 billion in new senior notes with a 14.5% coupon. For its cash, KKR will receive convertible preferred stock in First Data.
Still, First Data is a risky investment, and KKR reckons that its stake in the company was only worth $0.70 on the dollar as of June. It seems that the rate of interest is indicative of the risk in place here.
Having said all of that
Although low interest rates are beneficial for big companies looking to refinance, savers are suffering. However, dividend stocks are a great alternative and many companies currently offer a yield greater than that offered by many savings accounts right now.
While dividend stocks don't garner the notoriety of high-flying growth stocks, they're also less likely to crash and burn. And over the long term, the compounding effect of the quarterly payouts, as well as their growth, adds up faster than most investors imagine. With this in mind, our analysts sat down to identify the absolute best of the best when it comes to rock-solid dividend stocks, drawing up a list in this free report of nine that fit the bill. To discover the identities of these companies before the rest of the market catches on, you can download this valuable free report by simply clicking here now.
The article 3 Companies Boosting Earnings With Debt originally appeared on Fool.com.
Fool contributor Rupert Hargreaves owns shares of Altria Group. 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.
Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.