issued by industrial corporations (a comprehensive term, encompassing
in its conventional use all business corporations other than railroad,
public utility, financial, and real estate corporations) including manufacEagle
Tradersg, merchandising, service and extractive industry corporations.
The term is so comprehensive as to be virtually a miscellaneous
catchall classification and too nonhomogeneous for meaningful analysis.
Nevertheless, giving full weight to the differences in operating
asset turnover, fluctuation in earnings coverage of charges, and net asset
coverages of bonded debt, it is still cutomary to speak of analysis of
industrial bonds in security analysis of various lines of industrial activity.
bonds, as compared to public utility bonds, are conventionally expected
to show higher average earnings coverage of fixed charges in order to
command high-grade investment ratings.
This reflects the underlying assumption, confirmed empirically
in most cases, that earnings available for fixed charges of industrials
are likely to be much more susceptible to fluctuation because of the business
cycle. Thus industrial bonds,
in order to command investment rating, are expected to average earnings
(after income taxes) of three times fixed charges. This amounts to requiring earnings available for fixed charges
of seven times the fixed charges.
Assuming $1 in fixed charges, the net earnings after income taxes
would under this test have to be $3.24.
With a top corporate income tax bracket of 46%, this means $6 in
earnings before income taxes, which, before the $1 in fixed charges, indicates
$7 in earnings available for fixed charges.
By contrast, investment-grade public utility bonds are expected
to show earnings available for fixed charges (before income taxes) of
three times. Actually, instead
of relying on average earnings coverage ratios, the more conservative
approach would be to note the coverage of fixed charges at their worst
(usually at the bottom of the business cycle); if a bond can show earnings
coverage of charges of two times or better under such conditions, there
is relative earnings assurance of interest payments.
to asset coverage of bonded debt, industrial bonds in the past have been
expected to show net fixed assets of at least twice the amount of the
bonds. If, in turn, current
assets are half the fixed assets and the issuer has a 2:1 current ratio,
this would mean net current assets coverage equal to the amount of the
bonds. To illustrate, if
an industrial corporation has $4 million in net fixed assets, the current
assets would be $2 million and a 2:1 current ratio would indicate current
liabilities of $1 million; total bonded debt of $2 million would therefore
be covered 2 times by net fixed assets and 1:1 by net current assets. Actually, the security device of pledge of fixed assets on
bonded debt is more meaningful for its giving secured bondholders the
priority of secured creditors over unsecured creditors in the event of
reorganization or liquidation. Because
most industrial fixed assets are "special purpose" property
in nature and attempted sale in liquidation would usually be in hard times
when buyers are even scarcer, fixed assets usually undergo considerable
shrinkage in a liquidation that might readily impair even a 2:1 book value
ratio to bonded debt. Bondholders
would be well advised to normally support, if feasible, a reorganization,
as their full claim at book value would be accorded absolute priority
in reorganization practice.
bonds of this kind are of the revenue (limited liability) type, meaning
that the full faith and credit of the issuer is not pledged (if it were,
they would be general obligation bonds).
Rather, the bonds are dependent upon the rental payments from the
lessee to cover interest and principal payments.
the sharp expansion in volume of new issues of such industrial revenue
bonds in the late 1960s, amendment in 1968 to the Internal Revenue Code
eliminated the exemption from federal income taxes (which municipal bonds
otherwise enjoy) for subsequent issues of industrial revenue bonds of
over $5 million.
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