What are we looking for?
When interest rates are low, it is easy for many businesses to prosper. But when rates are rising, as we expect them to be later this year, many borrowers start to feel the pinch.
With that in mind, we thought we’d take a look at companies that would have the hardest time carrying and servicing their debt.
We ran a Capital IQ screen for Toronto Stock Exchange-listed companies that have earnings before interest and taxes that are less than 1.5 times their interest expense. The lower the ratio, the harder it is to make payments, and it provides a sense of how far earnings can fall before a company defaults on its debt payments. We set a total enterprise value limit of at least $500-million and excluded companies in the real estate and utilities sectors, since those tend to be heavily leveraged, on the whole.
What we found
The forestry and paper sectors feature prominently on our list. Lumber prices are close to where they were a year ago and the sluggish U.S. housing sector is still not out of the woods, though some analysts are upgrading their outlook on the long-troubled sector, anticipating a recovery south of the border and stronger demand from rapidly growing importing nations such as China. Pulp prices are also on the rise.
Ainsworth Lumber Co. Ltd. completed a restructuring process a couple of years ago. Its stock is now trading near $3.50.
Parkland Fuel Corp., Canada’s largest independent fuel distributor, delivered a return on equity of 17 per cent in its last financial year. The company, which was an income trust until recently, offers investors a dividend yield of 8.4 per cent. Its debt is more than four times earnings before interest, taxes, depreciation and amortization.
HomeQ Corp.’s debt is about 21 times that earnings measure. This company, which was also an income trust until recently, offers reverse mortgages to seniors secured by their homes. As a result, it is unusually sensitive to movements in interest rates, which have a powerful impact on the housing market.