What are we looking for?
The Federal Reserve’s “higher-for-longer” monetary policy is bringing the era of cheap debt to an end and may reshape corporate debt structures. As interest rates remain elevated, higher borrowing costs place sustained pressure on corporate earnings. Companies carrying heavy debt burdens are particularly exposed, as maturing debt must be refinanced at significantly higher yields, increasing interest expenses and compressing margins.
To identify resilient businesses, investors can look across the mid- and large-cap universe for companies with conservative leverage and strong cash flow generation. Businesses operating with low debt levels, high returns on invested capital and robust interest coverage are well-positioned to service debt effortlessly, fund internal growth without relying on expensive credit markets and outperform peers during restrictive monetary policy regimes.
The screen
We screened the U.S. equity universe for mid- and large-cap companies with market capitalizations greater than US$5-billion, applying the following criteria:
- debt-to-EBITDA (earnings before interest taxes, depreciation and amortization) below 1.0 times – identifying companies with low debt levels;
- free cash flow yield greater than 5 per cent – requiring the business has stronger and healthy cash flow relative to valuation;
- three-year average return on invested capital (ROIC) greater than 10 per cent – identifying companies that use their capital efficiently;
- interest coverage ratio (EBIT to interest expense) greater than 10 times – requiring a strong ability to cover interest payments;
- dividend yield greater than 2.5 per cent – screening companies offering steady income returns.
For informational purposes, we have included one-year price return and trailing price-to-earnings ratio.
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What we found
Accenture PLC ACN-N, an information technology and consulting company, is the second-largest company in our screen and posted the highest three-year average return on invested capital of 31 per cent. That combination suggests a large, established business that continues to use its capital efficiently. With debt-to-EBITDA of 0.6 times, it shows low debt and strong ability to cover interest costs also reducing the pressure created by higher borrowing rates. Accenture may therefore appeal to growth-oriented investors who are looking for a financially resilient company in the technology sector.
EOG Resources Inc. EOG-N, a major U.S. oil and natural gas producer, is the fourth-largest company in our screen. The company has an impressive interest coverage ratio of 34.2 times, indicating a limited financing pressure. EOG also generates a 16.2-per-cent free cash flow yield, the third highest in our screen, providing substantial flexibility to fund operations and shareholder returns. The stock may appeal to investors who are seeking energy exposure backed by strong cash generation and conservative leverage. However, investors should note that earnings remain sensitive to changes in commodity prices.
Watsco Inc. WSO, a distributor of heating, ventilation, air-conditioning and refrigeration equipment. The company has generated a three-year average return on invested capital of 23.4 per cent, carries debt-to-EBITDA of just 0.5 times and offers a 4.2-per-cent dividend yield. These characteristics reflect a financially disciplined business with strong capital efficiency. In a higher-rate environment, Watsco may appeal to investors seeking industrials exposure, steady income and a company with the financial flexibility to support operations and shareholder returns through changing conditions.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
Anuj Anand, MBA, LLM is an Investment Analyst at Inovestor