U.S. Markets close in 3 hrs 27 mins

Zacks Investment Ideas feature highlights: Noranda Aluminum, PetroQuest Energy, Rentech and ClubCorp - Press Releases

Zacks Equity Research

For Immediate Release

Chicago, IL- May 19, 2015 – Today, Zacks Investment Ideas feature highlights Features: Noranda Aluminum (NOR), PetroQuest Energy (PQ), Rentech (RTK) and ClubCorp ( MYCC ).

4 Companies Drowning in Debt

Following the bursting of the housing bubble and subsequent financial crisis, debt has become somewhat of a 4-letter word to many Americans. And while there are many benefits to debt-free living for households, in the corporate world, debt is often desirable.

The Benefits of Debt

In order for a company to grow, it must finance that growth. This can come from retained earnings, issuing debt, or by selling new shares of stock. While many investors seem to prefer debt-free balance sheets, there are actually quite a few benefits for a company to have some debt:

It's cheaper than equity financing. Interest payments are tax deductible, while dividends paid to shareholders are not. Issuing debt does not dilute shareholder value, unlike issuing new equity.

Too Much of a Good Thing...

Of course too much debt can be crippling for a company if business turns south. The more debt financing a company uses, the greater its risk of bankruptcy.

If a company is distressed, you can bet that those interest payments will get sent out before any dividend checks. And in the event of a bankruptcy, debt holders have first claim on company assets over stockholders.

So what's the right balance of debt and equity for a company? Ideally, a company should operate around its optimal capital structure - where its weighted average cost of capital (WACC) is minimized. But finding the right amount of debt-to-equity may be more art than science.

There are ways, however, for investors to tell if a company is carrying too much debt. And that involves looking at various financial ratios.

Liquidity vs. Solvency

Two of the best types of ratios to consider are liquidity and solvency ratios.

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 the firm's long-term survival.

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.

Another 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.

4 Companies Drowning in Debt

I ran a screen for companies with poor liquidity and solvency ratios. While this doesn't necessarily signal imminent bankruptcy, these companies all appear to be cash-strapped and overleveraged at the moment. And that's a dangerous place to be, especially if business doesn't improve.

Here are four names from the list:

Noranda Aluminum (NOR)

Quick Ratio: 0.8
Cash Ratio: 0.1
Interest Coverage Ratio (TTM): 0.8
Debt/Equity: 17.6

Noranda Aluminum Holding Corporation produces Primary Aluminum Products, as well as rolled aluminum coils.

PetroQuest Energy (PQ)

Quick Ratio: 0.5
Cash Ratio: 0.1
Interest Coverage Ratio (TTM): (negative)
Debt/Equity: 36.8

PetroQuest Energy is an oil and gas exploration and production company.

Rentech (RTK)

Quick Ratio: 0.7
Cash Ratio: 0.4
Interest Coverage Ratio (TTM): (negative)
Debt/Equity: 6.0

Rentech owns and operates wood fiber and nitrogen fertilizer businesses.

ClubCorp (MYCC )

Quick Ratio: 0.6
Cash Ratio: 0.2
Interest Coverage Ratio (TTM): 0.9
Debt/Equity: 9.0

ClubCorp owns and operates private golf and country clubs and private business clubs in North America.

The Bottom Line

For corporations, a prudent amount of debt can be beneficial. But too much debt will increase the risks of bankruptcy and put shareholders at risk. These four companies appear to be in over their heads at the moment.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
NORANDA ALUMINM (NOR): Free Stock Analysis Report
PETROQUEST ENGY (PQ): Free Stock Analysis Report
RENTECH INC (RTK): Free Stock Analysis Report
CLUBCORP HLDGS (MYCC): Free Stock Analysis Report
To read this article on Zacks.com click here.