BNP Paribas predicts the U.S. might witness a shallow recession between January and July 2024.
The global growth outlook isn’t any better. Real global GDP is expected at 2.9% for the year and is likely to decelerate to 2.5% in 2024. Given the economic uncertainties, it’s important to remain cautious and avoid taking excessive risk within equities. One strategy to use is avoiding high-debt stocks.
Historical evidence demonstrates that leverage can kill in times of economic uncertainty. It’s best practice to avoid overleveraged companies. Even if these companies survive the downturn, weak credit metrics will translate into stock price correction.
Let’s focus on three high-debt stocks that can potentially trend lower in the coming quarters. It’s probably wise to steer clear of these stocks until the economy recuperates.
Carnival Corporation (CCL)
During times of slowdown or recession, luxury spending takes a hit. Therefore, investors are urged to remain cautious on exposure to leveraged travel and tourism stocks.
Notably, Carnival Corporation (NYSE:CCL) stock touched highs of $19.6 in July. However, the stock has corrected by 35% and is clearly discounting the slowdown concerns.
According to the company’s balance sheet, total debt as of Q3 2023 was $31.3 billion. For the first nine months of the financial year, Carnival reported an interest cost (net of capitalized interest) of $1.6 billion. Assuming a scenario where revenue and EBITDA are impacted, CCL’s leverage and coverage ratios will worsen significantly.
And yet, the Q3 2023 results have been encouraging. Total customer bookings are robust, and the outlook for the coming year seems stable. Yet, CCL stock is telling a different story. And the reason is leverage coupled with fears of renewed economic downturn.
American Airlines (AAL)
American Airlines (NYSE:AAL) is another stock that has corrected sharply in the last few months.
First, with American Airlines’ significant debt, an economic slowdown is likely to impact the company’s cash flows. Next, even with decelerating GDP growth, oil prices have remained firm on production cuts and geopolitical tensions. Therefore, fuel cost is likely to remain high and will impact key margins.
This past June, American Airlines reported total debt of $34.7 billion. Including operating lease liabilities, total debt would swell to nearly $43 billion. Heavy with high debt, the airline reported interest expense of $1.1 billion for the first half of the year. Obviously, debt and debt servicing are concerns, and a potential recession would imply that AAL stock remains in a downtrend.
Verizon Communications (VZ)
Verizon Communications (NYSE:VZ) is among the high-debt stocks to avoid even after a correction of 21% for year to date (YTD). Although the stock trades at an attractive forward price-earnings ratio of 6.7, if economic conditions are sluggish, the stock is likely to remain undervalued on the back of high credit stress.
As of Q2 2023, Verizon reported total debt of $152.6 billion. Of course, with a robust EBITDA, debt servicing is unlikely to be a concern. For the first half of 2023, Verizon reported total interest expense of $2.5 billion. However, investors should remain cautious since the company’s revenue declined by 2.7% for the first half of 2023. Further decline in revenue or EBITDA margin compression can translate into VZ stock trending lower.
Among the positives, VZ stock offers a dividend yield of 8.46%. Another 10% to 15% correction from current levels would be an attractive entry point.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
