You might’ve heard about Credit Suisse (CS) in the news recently…
Earlier this month, reports surfaced that the Swiss investment bank could face serious financial risks going forward. Some folks are warning about a “Lehman-like collapse.”
You see, a lot of bad news has rocked the company over the past 18 months or so…
The trouble started in the first quarter of 2021. Back then, Credit Suisse reported $4.8 billion in losses after it invested in a hedge fund that went belly up (Archegos Capital Management).
Then, this past June, Swiss courts fined Credit Suisse roughly $22 million for “lax controls” related to a long-running Bulgarian drug ring. The court found that a Credit Suisse employee had helped the drug ring launder money between 2004 and 2008.
And to make matters worse, Credit Suisse’s investments are suffering along with the broad market. In July, the company reported a roughly $1.6 billion loss in the second quarter.
But the thing is… the recent warning about Credit Suisse shouldn’t be surprising.
After all, the company has displayed classic “zombie” symptoms since at least early May. And based on what we talked about in February, it’s no surprise that it just stumbled…
To summarize for those of you who missed my two-part series in February…
“Zombie companies” have simply taken on too much debt. And based on how their business is going, it’s unclear if they’ll be able to pay off that debt as required in the future.
Importantly, a couple of Power Gauge factors help us know which stocks to avoid. Let’s look at what these factors said about Credit Suisse back in early May…
First, we’ll cover the company’s long-term debt-to-equity (D/E) ratio. This Power Gauge factor weighs a company’s debt against the value of its shares. And then, the company is rated accordingly – from “very bearish” to “very bullish.”
In May, the Power Gauge rated Credit Suisse as “very bearish” in this factor. That means the company’s use of debt relative to the value provided to shareholders was very poor.
As I’ve said before, it’s best to avoid companies with D/E ratios greater than 2. And at the time, Credit Suisse’s D/E ratio was around 3.2.
Credit Suisse’s grade for the earnings growth factor was also “very bearish” in May. That paints a bad picture of its ability to generate enough money to pay down its future debt.
Lastly, the company’s interest-coverage ratio was in dangerous territory. While this factor isn’t covered directly in the Power Gauge, it’s critical…
You see, this factor tells you how many times a company’s earnings will cover its debt payments (interest). A ratio below 1 means the company doesn’t make enough money to pay its interest obligations. That’s a very risky position.
And in February, I recommended avoiding any stocks with interest-coverage ratios below 2. That’s because the Fed planned to hike interest rates (which it has done since March).
In May, Credit Suisse’s interest-coverage ratio was below 2. And today, it’s well below that threshold. That means Credit Suisse doesn’t generate nearly enough money to cover its debt expenses.
That’s dire. And Wall Street thinks so, too. That’s what I was talking about earlier…
In early October, the prices of Credit Suisse’s credit-default swaps (“CDS”) spiked.
A CDS is an investment tool that allows folks to buy “insurance” in case a company defaults on its payments. And if the price of insurance surges, it means something is likely wrong.
Specifically, in this case, the price of Credit Suisse’s five-year CDS soared. That means investors believe the chances are pretty high that the company will default on a bond payment within five years.
Given Credit Suisse’s fall into zombie status, it’s no wonder that the price of its five-year CDS spiked. Frankly, I’m just surprised it didn’t happen sooner…
The Power Gauge was “bearish” on Credit Suisse as far back as April. And it maintains that dismal rating today. Stay far away from this stock.
And for investors like us, a broader takeaway is clear…
Avoid stocks with “neutral-” or worse ratings in the Power Gauge. Be especially cautious of companies with “bearish” or worse grades in the D/E ratio and earnings-growth factors, as well as interest-coverage ratios below 2.
As I said back in February, with rising interest rates, companies will run into trouble rolling over their debt.
The Fed is hunting zombies. And it will be a bumpy ride for many of them.
Good investing,
Karina Kovalcik
