Microsoft Corporation (MSFT) and Johnson & Johnson (JNJ): The Last AAA Survivors

One of these stocks has a greater chance of staying on the AAA list

Microsoft Corporation (MSFT) and Johnson & Johnson (JNJ) are now officially the last men standing after the ranks of American AAA-rated companies just got thinned by one. The S&P lowered Exxon Mobil Corporation (XOM) credit rating two notches from its impeccable AAA to AA+.

Microsoft Corporation (MSFT) and Johnson & Johnson (JNJ): The Last AAA SuvivorsFor Exxon, the move will have very little real impact on the company’s finances. In today’s credit environment, borrowing for any investment-grade-rated company is so cheap that it’s virtually free.

So XOM doesn’t need to worry about the interest rate it pays on its debt suddenly going through the roof. And credit ratings are often taken with a grain of salt.

Remember, the U.S. government itself had its credit rating downgraded by S&P in 2011, and its yields immediately fell rather than spiked.

The bigger story here is that, eight years after the 2008 financial crisis, the list of AAA-rated companies keeps getting shorter. As recently as 2008, there were six AAA-rated companies. But now four have been dropped, and no new ones have been added.

So will these last two dominoes fall? Is the AAA corporate rating about to go the way of the dodo bird? Let’s take a look.

MSFT’s Outlook

Microsoft is one of my favorite stocks and perhaps the best tech turnaround story since Apple Inc. (AAPL) reinvented itself with the iPod and later the iPhone. Under CEO Satya Nadella’s leadership, Microsoft is successfully untethering itself from the stagnant PC ecosystem and becoming the premier cloud services company.

Or at least that is the narrative. The reality has been a little harsher. As I wrote recently, the strength in MSFT’s emerging cloud businesses are not quite strong enough to compensate for weakness in its PC-centric businesses. And revenues were actually down last quarter.

Microsoft maintains a pristine balance sheet with over $105 billion in cash and marketable securities. But long-term debt has been creeping up as well, and it now amounts to over $40 billion.

MSFT’s debt-to-equity ratio is still modest at 0.62. But it’s creeping higher for several years running, as has its dividend payout ratio. As things stand today, Microsoft actually pays out more in dividends than it earns in profit. Most of this is due to one-time charges that won’t be repeated.

But you still have to ask: Is this a characteristic of a AAA-rated company?

I’m not expecting a downgrade any time soon. But if MSFT’s turnaround doesn’t pick up speed soon, it can’t be ruled out.

Why JNJ Still Stands Strong

Moving on to Johnson & Johnson, we have one of the most stable icons of American capitalism. While no company can ever be considered truly “future proof,” JNJ comes close. Until Dr. McCoy’s medical tricorder from Star Trek becomes a reality, we’re going to need the bandages and other medical products JNJ is known for.

Johnson & Johnson has also managed its balance sheet pretty conservatively since the crisis. Its debt-to-equity ratio is essentially unchanged since 2008. And the dividend payout ratio, at 54%, is well within reasonable levels.

That said, JNJ has had a hard time growing its revenues in recent years. Sales today are only marginally higher than in 2012. Part of this is due to the strong dollar, of course. And notably, JNJ has managed to keep its margins intact. So, while revenue growth has been in short supply, the company is anything if not a pillar of stability.

I suppose anything could happen. In the 1980s, Johnson & Johnson had to recall virtually every Tylenol capsule on every shelf in America due to a cyanide poisoning crisis. If something like that were to happen again, then JNJ’s financial position could be compromised, at least for a while.

I suppose an event like that could lead to Johnson & Johnson’s AAA credit rating being called into question. But otherwise, I’d say JNJ’s rating is about as safe as a credit rating can be.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he was long MSFT and JNJ.

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