DOW THEORY

FORECASTS
®

Vol. 65, No. 3, January 19, 2009 Sto c k Mar k et Tr end s & Se c uri tie s Re p or t s Sin c e 19 4 6

www.DowTheory.com
Debt woes not as bad as they look
Don’t give up With the economy shrinking and
credit markets in disrepair, many in-
total capital, and seven saw a decline
in cash as a percentage of total debt.
on stock funds vestors see debt as an unqualified evil.
But businesses still see debt as a tool
However, many sectors look fairly
healthy relative to historical norms.
With the exception of U.S. Treasury for everything from funding expan- Outside of the financial sector, long-
securities, just about all mutual- sion to leveraging profit growth. term debt as a percentage of total
fund categories lost money in 2008. Issuing debt is cheaper and (until capital has fallen over the last year.
U.S. stock funds were among the recently) easier than issuing stock. Unfortunately, balance sheets can
hardest hit, with the average large- Used wisely, debt can boost returns erode rapidly, and a prolonged eco-
cap blend fund down 38%. and allow companies to make acquisi- nomic downturn would make it more
While many investors feel snake- tions or invest in growth initiatives. difficult for companies to cover debt
bitten, now is not the time to give There is some justification for in- payments out of operating profits.
up on stock funds. In fact, given vestors’ worries, though the problems The credit crunch has also made it
the stock market’s swoon, many are not as bad as many think. more difficult for companies to bor-
investors’ portfolios have become All nine of the nonfinancial sectors row — a fact that can cause trouble
underweighted in stocks and over- in the S&P 500 Index saw total debt even for companies not adding ad-
weighted in bonds. rise in the 12 months ended Septem- ditional long-term debt. Nonfinancial
To be sure, a defensive posture ber. Eight of the nine saw an increase
seems prudent, at least in the in long-term debt as a percentage of Continued on page 4
near term. But investors with the
discipline to maintain exposure
to stocks should eventually be re-
OUTSIDE FINANCIAL SECTOR, DEBT LEVELS APPEAR REASONABLE
warded when the economy — and
$6.0 32%
stock market — rebound. Total capital (trillions, left scale)
Traditionally, growth-and-in-
4.5 30
come funds have offered a smooth- Long-term debt as % of
er ride than typical stock funds total capital (right scale)
3.0 28
because of an emphasis on high-
quality, dividend-paying stocks.
On the whole, these funds invest 1.5 26
Long-term debt (trillions, left scale)
mostly in large, well-known com-
panies and have sizable exposure to 0.0 24
–————————— previous 19 quarters –————————— last
the financial, industrial, and health- qtr.
care sectors. Balanced funds limit While the balance-sheet woes of financial companies have made front-page
risk by holding both stocks and news, debt levels outside the financial sector are not high relative to total
fixed-income securities, typically capital. The ratio of long-term debt to capital has declined slightly over the
investment-grade bonds. last five years. Data above reflect debt and capital levels for 390 of the 416
nonfinancial companies in the S&P 500. The remaining 26 companies did
Continued on page 2 not have five years of history.

Dow Theory Forecasts is an independent investment adviser and makes no commissions on the stock transactions of its subscribers.
Debt woes not as bad as they look Continued from page 1
companies in the S&P 500 Index com- many borrowers may have trouble ed by total debt. Especially recently,
bined to carry $2.72 trillion in debt in refinancing that debt. Fortunately, a shares of companies weak in these
the September quarter, of which $578 government push to loosen the lend- areas have trended to underperform
million — or 21% — is classified as ing market for consumers offers some the average stock in many sectors.
short-term, meaning that it is probably hope that business lending will also ◆ Cash position. Most companies
due within 12 months. All of that debt pick up in the year ahead. have more debt than cash. But a
must be either paid off or refinanced The amount of difficulty companies large cash balance can change the
in an unfriendly market. face in refinancing their debt depends picture. If a company has enough
Most short-term debt falls in two on several factors, most of which are cash to pay off long-term debt, it does
categories: short-term notes payable reflected in a table on page 5: not matter if the debt-to-capital ratio
to banks and other creditors, and the ◆ Debt level. Lenders may view is high.
portion of long-term debt due over the companies that carry heavy debt as ◆ Existing credit lines. Do compa-
next year. Both of those types of debt poor risks. High credit ratings have nies have sufficient credit to cover
come with their own problems: historically been a license to borrow. their needs without arranging new
➤ Short-term notes. Many compa- But, after meltdowns in the balance financing? This can be difficult to
nies rely on banks or other creditors sheets of highly rated companies last determine, as disclosure requirements
to obtain working capital. Such loans year, skepticism abounds. In gen- are limited. Even if a company tells
must be refinanced frequently, and in eral, the Forecasts doesn’t like to see you it has a large credit line, it may not
the current environment, new money long-term debt represent much more tell you how fast it is likely to draw
may prove hard to obtain. A loss of than 50% of total capital. Capital is down that credit. You don’t have to
short-term liquidity can be devastat- the combined book value of equity, look far back (think Bear Stearns and
ing. Short-term notes account for long-term debt, preferred stock, and Lehman Brothers) to find companies
about 60% of all short-term debt. minority equity interests. that claimed to be well-capitalized
➤ Long-term debt. While most ◆ Interest coverage. Our Quadrix® right before the bottom fell out.
companies are covering their debt Financial Strength score considers The table on page 5 lists Forecasts
payments well enough, the trouble three measurements of how easily recommendations with solid balance
comes when long-term loans mature. a company can meet its debt pay- sheets, along with large-cap market
In 2008, about 10% of S&P 500 com- ments — interest coverage (income leaders that look too risky for our
panies’ long-term debt came due, and excluding interest expense divided by taste. In the following paragraphs, we
even more is slated to mature this interest expense), cash flow divided by discuss three attractive options.
year. In the current environment, interest expense, and cash flow divid- Microsoft ($20; MSFT) broke
from tradition twice in 2008. In Janu-
SECTOR ANALYSIS ary, it announced a willingness to take
on significant long-term debt to help
In the 12 months ended September, most of the sectors in the S&P 500 Index finance a $45 billion offer to buy Ya-
saw an increase in long-term debt as a percentage of total capital and a decline hoo. This from a company that’s never
in cash as a percentage of total debt, suggesting higher leverage and more risk of had more than $1 million of long-term
default. However, the picture doesn’t look as bleak relative to five-year averages. debt since 1989.
Data reflect statistics for the capitalization-weighted sectors in their entirety. In September, Microsoft authorized
up to $6 billion in debt financing and
Long-Term Debt As Cash As
—— % Of Total Capital —— —— % Of Total Debt ——
promptly issued $2 billion in short-
S&P 500 Sector Now 1 Yr. Ago 5-Yr. Avg. Now 1 Yr. Ago 5-Yr. Avg. term commercial paper. In support of
Consumer Discretionary 53.4% 48.9% 51.9% 25.7% 27.0% 23.0% the new program, Microsoft arranged
Consumer Staples 35.2 32.4 36.8 16.3 19.2 20.5 for a $2 billion unsecured credit line,
Energy 22.9 22.1 24.2 40.1 43.0 44.2
Financials 75.4 67.0 70.0 NM NM NM which was untapped at the end of
Materials 32.1 33.6 37.8 20.1 19.9 21.8 September. Not that Microsoft needs
Health Care 26.4 23.8 22.6 71.0 97.1 102.0 the liquidity.
Industrials 52.8 50.6 49.8 15.8 10.5 11.5
Technology 19.1 16.5 15.7 165.0 182.9 224.6
Cash exceeds $20 billion, comfort-
Utilities 53.4 53.0 56.5 7.1 8.1 7.4 ably covering current debt and the
Telecom Services 40.5 34.8 39.2 4.6 6.4 12.6 amount spent on dividend payments
NM Not meaningful. and stock repurchases in fiscal 2008

4 Dow Theory Forecasts, January 19, 2009

ended June. Microsoft, slated to release at an annualized rate of more than 2% Operating cash flow has risen in 11
December-quarter earnings Jan. 22, is a over the last three years. Moreover, straight quarters, helping Western
Buy and a Long-Term Buy. Chevron has a $5 billion credit back- build up cash holdings to $1.22 bil-
It has been a rough stretch stop available if needed. lion, or $5.38 per share. Aggressive
for energy companies, but Chevron’s In January, Chevron cited lower en- moves to cut costs during the down-
($72; CVX) robust balance sheet ergy prices in warning that December- turn should help keep the balance
should keep the company upright quarter earnings would be “signifi- sheet strong, though Western has
until it reaches calmer waters. The cantly lower” than year-earlier results. enough cash to support research and
oil-price boom helped boost Chevron’s However, the consensus already pro- other operating expenses for nearly
operating cash flow and cash hold- jected an 18% decline. Chevron also two years.
ings 36% in the nine months ended reported production slightly below For added protection, Western
September. Chevron has enough cash guidance for the first two months of Digital obtained a $250 million credit
to retire all its debt — with $4 billion the quarter. Chevron is a Buy and a line in February. Western Digital earns
to spare. The cash surplus could also Long-Term Buy. Quadrix Overall, Quality, and Value
fund continued stock repurchases. Western Digital ($13; WDC) scores in the upper 90s. Western Digi-
Chevron has lowered its share count is highly liquid and carries little debt. tal is a Buy.

THE STRONG . . .
Debt in and of itself is not a bad thing. But in a climate scores. The Financial Strength score considers debt levels,
of tight credit, weak profits, and ongoing doubts about interest coverage, and profit margins. The 11 stocks listed
the accuracy of credit ratings, stocks with low debt, solid in the bottom table, all components of the S&P 500 Index,
growth, and high credit ratings have an edge. All nine of have problems with debt. The Forecasts does not recom-
the recommended stocks in the top table have solid balance mend any of these stocks, and subscribers holding them
sheets and high Quadrix Financial Strength and Overall should be wary of deterioration in the balance sheet.
Debt % Of Cash Plus Long- LT Debt Cash Cash Flow Quadrix
— (Millions) — Total Available Term As % Of As % As % –— Scores * –— Interest
Long Short Debt Due Credit Debt Total Of Total Of Total Financial Coverage
Term Term Next Yr. (Mil.) ** Rating Capital Debt Debt Strength Overall Ratio Advice
Accenture ($34; ACN) $1 $1 51% $4,484 A+ 0% NM NM 94 90 142.1 Focus Buy †
Biogen Idec ($50; BIIB) 1,042 10 1 1,925 BBB+ 15 149% 143% 87 93 26.8 Focus Buy †
Chevron ($72; CVX) 6,129 832 12 15,983 AA 7 158 453 89 96 134.8 Buy †
Exxon Mobil ($78; XOM) 7,383 2,881 28 38,434 AAA 6 374 590 84 90 47.6 LT Buy
Microsoft ($20; MSFT) 0 1,975 100 22,722 AAA 0 1049 967 95 85 NM Buy †
National Oilwell ($26; NOV) 1,493 19 1 6,206 A- 11 117 143 88 97 30.4 Buy †
Schlumberger ($43; SLB) 3,528 2,211 39 5,593 A+ 16 61 124 91 83 26.0 LT Buy
St. Jude Medical ($31; STJ) 197 1,205 86 1,079 A- 5 41 73 89 77 38.7 Focus Buy †
Western Digital ($13; WDC) 462 45 9 1,465 NA 14 240 292 84 96 30.7 Buy

. . . AND THE WEAK

Debt % Of Cash Plus Long- LT Debt Cash Cash Flow Quadrix
— (Millions) — Total Available Term As % Of As % As % –— Scores * —– Interest
Long Short Debt Due Credit Debt Total Of Total Of Total Financial Coverage
Term Term Next Yr. (Mil.) ** Rating Capital Debt Debt Strength Overall Ratio Sector
AES ($8; AES) $17,690 $954 5% $4,402 BB- 69% 20% 11% 14 81 1.3 Utilities
Caterpillar ($41; CAT) 19,794 14,370 42 5,911 A 66 6 17 39 81 3.5 Industrials
CMS Energy ($11; CMS) 6,108 649 10 1,152 BBB- 69 3 NA 18 60 1.8 Utilities
Deere ($41; DE) 13,899 8,521 38 4,254 A 68 12 9 46 74 2.2 Industrials
Embarq ($36; EQ) 5,838 2 0 1,083 BBB- 99 1 30 66 84 2.6 Telecom Services
Ford Motor ($2; F) 156,793 0 0 46,766 CCC+ 100 23 5 8 6 0.9 Cons. Discretionary
General Electric ($15; GE) 329,915 218,748 40 78,677 AAA 73 3 8 21 43 1.6 Industrials
General Motors ($4; GM) 37,947 7,208 16 20,574 CC NM 36 NM 1 0 NM Cons. Discretionary
Qwest Commun. ($4; Q) 12,815 1,240 9 1,436 BB 97 4 21 36 64 1.6 Telecom Services
Textron ($14; TXT) 9,384 550 6 1,654 BBB+ 73 4 11 28 62 3.1 Industrials
Windstream ($9; WIN) 5,371 24 0 455 BB+ 91 2 20 58 83 2.0 Telecom Services
S&P 500 Nonfinancials ‡ 2,095 198 9 NA NA 32 25 45 62 69 5.8
NA Not available. NM Not meaningful because Microsoft has no long-term debt, Accenture has just $2 million in total debt, and General Motors has
negative values for total capital, income before interest, and operating cash flow. † Also qualifies as a Long-Term Buy. ‡ Median stock.
* Quadrix scores are percentile ranks, with 100 the best. ** Available credit data taken from company filings in most recent quarter (usually September
quarter). Data will not reflect borrowings since quarter end and may not reflect all credit available to a company.

Dow Theory Forecasts, January 19, 2009 5