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HD Supply Soars but It Has Too Much Debt

Stocks in this article: HDS HD

NEW YORK (TheStreet) -- Do you remember HD Supply  (HDS)?

Its shares are trading near all-time highs despite results earlier in the week that the company posted another loss. As it struggles to be profitable, the burden of a high debt level and an overhang from private equity shareholders should worry investors. These risks are not factored into the current share price.

This construction-sector distributor offers more than a million products, had a difficult IPO last summer, and is still 65%-owned by three private equity companies plus Home Depot (HD) -- who sold most of the company to those firms at the height of the buyout boom in 2007. Despite posting losses in each quarter since floating, the shares hit an all-time high above $26.50 earlier in the week. That's a good gain from the $18 IPO price.

The bad news is, it has more than $5 billion in debt on its balance sheet. The amount is approximately the same as the company's market value. In short, debt is a big burden.

HD Supply has been successful, in these times of low-interest rates, at re-pricing some loans and extending the maturities of others. Here's the bottom line, though: The interest cost payable during 2013 was still higher than HD Supply's profit before interest and tax. This is why the company is a loss-maker. The debt burden is still a big problem. 

Optimists will point to 9% sales growth in 2013 and the company's hope that both residential and non-residential construction momentum will  build through 2014. This may continue and, finally, HD Supply may post a net profit during 2014.

I am reminded, though, of the old stock-market saying, that "it is better to travel than arrive."

If HD Supply makes a profit in 2014 and it becomes possible to calculate valuation measures like a price-earnings ratio, investors may suddenly discover that the shares are good value, especially with that big debt burden that is only being reduced slowly.

There is another negative angle, too. The lock-ups on further sales by the private equity companies have now expired. Having a share price near an all-time high and a company close to breaking even again could push the private equity names to look to exit at least part of their stakes and move onto something else.

Putting the big debt burden, a high valuation (even if the company makes a profit) and the potential for big shareholder stake sales all together means investors have a lot to worry about. The share near an all-time high, in my opinion, does not reflect this.

At the time of publication, the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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