Stocks: 11 Leveraged Laggards

S&P latest's screen turns up names with high debt levels, low margins, and poor quality scores

by Michael Kaye From Standard & Poor's Equity Research

Leery about leverage? You're not alone. Rising interest rates have put a chill on debt markets in recent weeks, and have caused investors in high-yield bonds to think twice about taking on riskier plays. Offerings for many new high-yield bonds have either been reduced or delayed after the volatility in the markets the last couple of weeks, notes Action Economics. Among the deals affected have been debt offerings that were supposed to finance private equity buyouts of ServiceMaster (SVM) and the U.S. Foodservice unit of Ahold (AHO).

Whether it's a buyout shop looking to finance a deal or an existing company already encumbered with lots of debt, high leverage in a time of rising interest rates is not usually a good thing. In this suddenly more cautious environment, we thought it might be a good idea to identify companies where the rise in bond yields may spell additional risk for investors. Basically, we wanted to find highly leveraged companies faring poorly on an operational basis.

For starters, we looked for those companies that were lagging far behind the overall market in terms of a key operating measure. We compiled a list of companies in our equity universe that had a gross profit margin in the lowest 20% of the U.S. equity universe. Gross margin is a good indication of how profitable a company is at the most fundamental level. Companies lagging in this category may find it harder to generate the cash needed to finance their indebtedness.

Step Further

Then we looked for a second warning signal. We searched for those companies with a debt-to-capital ratio in the highest 20% of the U.S. equity universe. That means these companies carry a far greater degree of leverage than the broader market.

And if the combo of lagging profitability and high leverage wasn't enough, we wanted to take things a step further. For our next filter, we looked for those stocks carrying an S&P Quality Ranking—which measures growth and stability of earnings and dividends over a 10-year period—of C or worse.

To avoid speculative issues, we only included those names with a stock price above $5 per share and a market capitalization above $1 billion.

Many "Junk" Credit Scores

Our screen uncovered 11 names. We checked on the S&P credit ratings of the companies that popped up and, unsurprisingly, the majority of the companies carried below-investment-grade ("junk") credit scores from Standard & Poor's Ratings Services. (Credit ratings are not a measure of a company's worthiness as an investment, but are often viewed as a good indicator of its financial strength.)

NR—Not rated

Kaye, a chartered financial analyst, is an analyst for Standard & Poor's Portfolio Services.