Standard & Poor’s rates the creditworthiness of roughly 1,300 publicly traded, U.S.-domiciled companies. And only three of these companies are rated “AAA” – the highest tier.
The first two probably won’t come as a surprise.
Microsoft (NASDAQ:MSFT) and Johnson & Johnson (NYSE:JNJ) have enormous streams of stable cash flows. And both of these companies havenegative net debt (debt minus cash). In other words, they have more cash and cash equivalents than total debt. It’s virtually impossible to imagine a disaster scenario that would cause these companies to default on their bonds. Come hell or high water, they’re going to meet their obligations.
On the other hand, the third company that’s rated triple-A seems to be out of place. Unlike Microsoft and J&J, Exxon (NYSE:XOM) has far more debt than cash – and its debt levels are rising at a fast clip. Exxon’s net debt is $35 billion, up from just $2 billion in 2012. In fact, Exxon’s net debt-to-EBITDA, a measure of leverage, has never been higher.
Exxon, which has been triple-A rated by S&P since 1985, had its rating placed on negative credit watch on Feb. 2, 2016. I believe Exxon is about to lose its coveted AAA rating. Of course, a rating downgrade to AA+, or even AA, won’t be the end of the world for the company. Nonetheless, the marginal cost of debt capital does matter for a capital-intensive business.
Over the past five years, capital expenditures (capex) have totaled a whopping $158 billion for the oil giant. The price of crude oil and natural gas may have collapsed, but Exxon will need to continue to spend gargantuan sums to extract these commodities from the earth. Therefore, the debt issuance will continue unabated. Sometimes it’s easy to lose sight of how a business operates. A company raises capital, invests it, and then earns a return. When the return winds up being less than the cost of capital, there’s a problem.