Cash is the lifeblood of any business. No matter how much paper "profit" a company might report, it is cash flow that's truly vital to a company's survival.
Companies that continually burn through cash generally must rely on external financing to keep the party going. Or as Kathryn Staley writes in The Art of Short Selling, "banks and other short-term lenders control the destiny of a company that has negative cash flow."
And if a cash-strapped company already has large amounts of debt, further financing to keep it afloat is likely going to be very costly - assuming it is even able to obtain that financing. That is a dangerous place for any company to be.
Liquidity vs. Solvency
When talking about a company's financial health, it is important to distinguish between its liquidity and its solvency.
Liquidity is a measure of the firm's ability to meet its short-term obligations. Solvency is a measure of the firm's ability to meet its long-term obligations. It's more of a measure of a firm's long-term survival.
It is possible for a company to have poor liquidity but still remain solvent, especially if it doesn't carry much debt. This is often the case with small, rapidly growing firms.
But for a business that's already strapped for cash and highly leveraged, look out. A relatively minor downturn in business could spell disaster.
Important Ratios
So what are some ways to measure a company's financial health?
One of the most common liquidity ratios is the Current Ratio. This compares a company's short-term assets to its short-term liabilities: Current Assets / Current Liabilities. The higher the current ratio, the greater a firm's ability to pay its bills as they come due.
But not all current assets can be converted to cash quickly. For instance, a company may have trouble selling obsolete inventory in a short amount of time to meet current obligations. That's why many analysts will strip out inventory when looking at a company's liquidity. That calculation is known as the Quick Ratio: (Current Assets - Inventories) / Current Liabilities.
An even more conservative ratio is the Cash Ratio, which measures only a company's cash (including cash equivalents and short-term securities) against its current liabilities: (Cash + Cash Equivalents + Short-term Securities) / Current Liabilities. This ignores both inventory and receivables and is the strictest of all liquidity ratios.
These ratios will vary across industries, so it's important to compare them to their peers. But in general, the higher the ratios the better.
One of the most common solvency ratios is the Debt/Equity ratio: Total Liabilities / Shareholder Equity. The higher this ratio, the more leveraged a company is. This is important for stockholders to consider, since debtholders have first claim on a company's assets. If a company becomes distressed, you can bet that those interest payments will get sent out before any dividend checks.
One important ratio to measure a company's ability to meet its long-term debt obligations is the Interest Coverage Ratio. This takes a company's earnings before interest and taxes over a given period and compares it to its interest expense: Operating Income / Interest Expense.
The higher the debt burden a company has, the lower its Interest Coverage Ratio will be and the higher its D/E ratio will be. Again, these will depend on what industry a company operates in. Capital-intensive businesses will typically carry larger amounts of debt on its balance sheet. So it's important to consider industry averages.
Highly Leveraged Companies Burning Through Cash
So what are some highly leveraged companies currently burning through cash?
I ran a screen using Research Wizard to look for companies with high debt burdens, poor liquidity ratios and negative operating cash flow. Here were the criteria:
- Quick Ratio less than 0.8
- Cash Ratio less than 0.5
- Operating Cash Flow less than 0
- Debt / Equity greater than 1.0
- Interest Coverage Ratio less than 1.5
Here are 4 names from the list:
Verso Paper Corp. (NYSE:VRS)
Quick Ratio: 0.6
Cash Ratio: 0.02
Trailing Twelve Month (ttm) Operating Cash Flow: -$41 million
Debt / Equity Ratio: -3.2 (total stockholders' deficit of -$501.0 million)
Trailing Twelve Month (ttm) Interest Coverage Ratio: -0.1 (operating income was negative)
Verso Paper primarily supplies coated papers to catalog and magazine publishers.
Maui Land & Pineapple Company Inc. (NYSE:MLP)
Quick Ratio: 0.5
Cash Ratio: 0.1
Operating Cash Flow (ttm): -$3 million
Debt / Equity Ratio: -2.7 (total stockholders' deficit of -$27.8 million)
Interest Coverage Ratio (ttm): 0.0
Maui Land & Pineapple Company owns more than 23,000 acres of land on Maui and develops, sells, and manages residential, resort, commercial, and industrial real estate.
Amyris Inc. (NASDAQ:AMRS)
Quick Ratio: 1.6*
Cash Ratio: 1.2*
Operating Cash Flow (ttm): -$92 million
Debt / Equity Ratio: -3.1 (total stockholders' deficit is -$112.5 million)
Interest Coverage Ratio (ttm): -9.6 (operating income was negative)
* Includes the temporary liquidity benefit from the issuance of significant debt in Q1. Quick and cash ratios were 0.7 and 0.2 before the debt issuance, respectively.
Amyris applies its industrial synthetic biology platform to provide sustainable alternatives to a broad range of petroleum-sourced products.
Navistar International Corporation (NYSE:NAV)
Quick Ratio: 0.9
Cash Ratio: 0.3
Operating Cash Flow (ttm): -$183 million
Debt / Equity Ratio: -2.9 (total stockholders' deficit of -$4.1 billion)
Interest Coverage Ratio (ttm): -4.1 (operating income was negative)
Navistar is a holding company whose subsidiaries and affiliates produce commercial and military trucks, diesel engines, and school and commercial buses under the International, MaxxForce and IC Bus brands.
The Bottom Line
If cash is the lifeblood of any business, then these 4 companies are on life support. Each have high debt levels, poor liquidity and negative cash flow.
Todd Bunton, CFA is a Stock Strategist for Zacks Investment Research and Editor of the Income Plus Investor and Surprise Trader services.