You can still find a triple-A credit rating in the United States. You just have to look past the obligations of the U.S. government to four blue-chip companies that remain proud owners of the rating.
Yes, it's possible for a corporation to have a higher credit rating than the country where it's based. And, with Friday night's downgrade of the United States by Standard & Poor's, a handful of companies – Exxon Mobil, Microsoft, Johnson & Johnson and Automatic Data Processing – all sport higher-quality debt than the U.S. government.
There's no reason for that to change, S&P noted this summer when it put the U.S. on warning that a ratings action could be coming. "A change in the credit rating or outlook on a sovereign issuer does not necessarily lead to a change in the rating or outlook on other similarly rated non-financial corporate issuers located in that country."
There are solid reasons why each of the four companies has won S&P's top rating.
Automatic Data Processing, perhaps the least familiar of the four, is best known as a payroll company. But it also provides a wide range of outsourcing services to business, with an entire division devoted to servicing automobile dealers.
ADP has essentially no long-term debt and strong, consistent cash flow. In the last three full fiscal years, ADP has produced free cash flow – which we'll define as operating cash minus capital expenditures – of between $1.4-billion (U.S.) and $1.6-billion, on more than $8-billion of revenue each year. Free cash flow topped $1.1-billion in just the first three quarters of the fiscal year that ended June 30.
Credit analyst Jacob Schlanger says the rating reflects "its very strong cash flows and balance sheet, consistent revenue and earnings growth, strong market position, and low technology and economic cycle risks."
Exxon Mobil, with sales approaching $400-billion, produces more free cash flow – $25-billion in the last twelve months – than many companies' annual revenue. The company could pay off its long-term debt and short-term borrowings of $16.5-billion in just over six months. (S&P considers Exxon Mobil's nearly $35-billion in retirement obligations as debt, too.) The company's shareholders' equity tops $155-billion.
"Exxon's capital structure is extremely strong," said analyst Patrick Jeffrey, who says the rating "reflects the company's excellent business risk profile because of an outstanding competitive position in all facets of the oil and gas industry and its minimal financial risk."
Johnson & Johnson, the maker of health-care products and devices, has produced about $14-billion in free cash flow in each of the last two years on just over $60-billion in revenue. It has $18-billion in long-term debt and short-term borrowings.
S&P says Johnson & Johnson, like Microsoft and Exxon Mobil, has a "significant global profile" that helps insulate it from problems in the U.S. economy. (Less than half its revenue is from the U.S., with about a quarter coming from Europe and around 15 per cent from the Asia-Pacific region and Africa.) Microsoft's position on the list may surprise investors who have come to see the stock as a long-term dog (it trades today below November, 1998, levels). The company's lacklustre stock performance, however, comes because it's a cash machine in a technology sector where growth is still an obsession.
Cash and marketable securities totalled more than $51-billion at June 30; S&P analyst Philip Schrank says the company's annual discretionary cash flow (after dividends) has averaged more than $14-billion over the past three years, more than the firm's $13-billion in debt and short-term borrowings. (And, by the way, revenue grew nearly 12 per cent and profit by 33 per cent in the most recent fiscal year.)
While S&P "views the high-tech industry as having higher-than-average business risk," Mr. Schrank said in a recent note, the agency regards software companies more favourably because of the recurring nature of the business, significant barriers to entry, and strong cash flow generation. "We believe Microsoft will maintain the technical, managerial, and financial wherewithal to adapt to industry transitions as successfully as it has in the past."
Now, a caveat: triple-A-rated companies are not triple-A-rated stocks. A rating agency's measure of creditworthiness is designed to evaluate how well a company will pay its obligations to its creditors, who are an entirely different bunch than the shareholders.
There is reason for investors to take note, however. Nearly without exception, it is the best-managed companies that attain the best credit ratings. These firms are unlikely to go away soon. In an environment where a significant amount of your portfolio can vaporize in days, staying power is worth something.
Yields of dreams
The four remaining triple-A-rated U.S. companies are both higher rated and also higher yielding than 10-year U.S. Treasury bonds.
Automatic Data Processing
Its $1.44 (U.S.) annual dividend represents about a 3.15-per-cent yield.
Its $1.88 dividend equals a yield of 2.7 per cent.
Johnson & Johnson
Its $2.28 annual dividend works out to a 3.7-per-cent annual yield.
Its 64-cent dividend is equivalent to a yield of about 2.6 per cent.
Based on stock prices as of Aug. 8.