By Porter Stansberry in the S&A Digest:
The rally in stocks since early March included a bunch of garbage. I have a spreadsheet of about 400 companies with more than $100 million in market capitalization that are overleveraged, unable to refinance, and unable to meet their debt-service payments from earnings. They're like lit matches. It's only a matter of time until they burn out.
You've seen me write about many of these stocks over the past six months - General Growth, Macerich, MGM, etc. But since March, nearly all of these stocks have posted huge gains. Many subscribers, I'm sure, thought that meant my analysis was wrong. Nope. The stock market is a fickle beast... and it's never easy to make money on any trade - even when all of the facts and the circumstances are lined up in your favor.
What's happened with shorting these overleveraged companies is that too many people put too much money on the short side. When a position gets that unbalanced, it's sure to "snap back." In fact, over the last six weeks, companies with the most debt and the lowest returns on assets turned in their best six-week performances since 1938. Says Bloomberg: "The 130 companies in the S&P 500 and Europe's Dow Jones Stoxx 600 Index with debt-to-equity ratios above 50 percent and a return on assets of less than zero... rose an average of 82 percent from March 9 through April 17."
So the worst companies' stocks did about four times better than average during this rally. Meanwhile, nothing improved with the fundamentals of these businesses, most of which remain deeply troubled. How do you explain the worst stocks doing so much better than average? A short squeeze. The speculators holding these heavily shorted stocks were forced to cover. Reports coming from momentum hedge funds suggest their first-quarter losses were significant.
Let's look at one situation in particular - Macerich, the mall owner whose competitor, General Growth Properties, recently filed for bankruptcy. Macerich owes $6.7 billion in debt - mostly in the form of mortgages on its malls. It acquired most of its portfolio in 2002-2006, when real estate was extremely expensive relative to rents. (Macerich spent $2.3 billion for the mall owner Wilmorite Properties in late 2004; it bought another mall owner, Westcor, for $1.5 billion in 2002.)
But now mall vacancies are soaring. According to mall research firm Reis, retail tenants vacated 8.7 million square feet of space in the first quarter of this year, on top of the 8.6 million square feet vacated in all of 2008. Mall vacancy rates are now nearly 10% - a record increase from last year. Given the current market, Macerich won't be able to sell property for anything like the prices it paid. Assuming it could get 50 cents on the dollar, its asset base isn't worth the $6.3 billion it claims on its balance sheet. It's probably worth more like $3.1 billion. And that means it can't sell enough property to pay down its debts.
And that's not the worst part. The real problem is Macerich can't afford the interest on its debts. The analysis is simple: Macerich takes in rents. It pays for its overhead, its interest, and the upkeep in its buildings. It brought in $537 million in rent during 2008. It spent $16.6 million on overhead and $277 million on upkeep. That left $243 million for interest. But interest expense was $281 million.
My bet is the great garbage rally of 2009 is finished. While I expect high-quality companies with good businesses to continue to do well, I don't expect companies like Macerich or any of the other overleveraged companies to make it out of this recession. They're going bankrupt. It's only a matter of time.
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Topics: Porter Stansberry, Bear Case, Stocks
