AAA Is for Apple

Phil Kernen

TO BE AWARDED a triple-A credit rating was once a priority for some of the biggest and best-known U.S. companies. Only the financially strongest companies, organizations and governments can earn a triple-A rating.

The triple-A rating typically bestows the lowest borrowing rates and suggests the highest ability to repay bondholders. But the triple-A club has been shrinking over the past four decades. Apple recently became only the third current corporate member of this exclusive club.

The list of companies holding triple-A credit ratings was once much longer. In 1980, nearly 60 companies carried a triple-A rating. These companies prioritized solid balance sheets and enjoyed the lower borrowing costs that flowed to financially robust borrowers.

But starting in the 1980s, the U.S. business landscape began to change. Intense business competition, the buyout and acquisition binge, and evolving corporate financial policies conspired to create a willingness to take on more debt.

Business struggles forced Ford and General Motors from the triple-A club in 1980 and 1981, respectively. Growing competition from Japanese automakers, higher fuel prices and rising interest rates damaged the two automakers’ finances so much that they couldn’t maintain their financial strength while also competing effectively.

In 1986, Coke lost its triple-A rating when it took on debt to create a new bottling network. Competitive issues led to Sears being downgraded in 1980, followed by AT&T in 1984, drug-maker Schering-Plough in 1985, Eastman Kodak in 1986 and IBM in 1993.

Buyouts and acquisitions also took their toll. They ushered in a dramatic rise in the use of debt to increase shareholder returns and fund takeovers. Companies with large cash balances became attractive targets for corporate raiders. After being acquired, many targets lost their triple-A rating, as the new owners used the acquired company’s cash plus more debt to pay for the deals. Getty Oil and Gulf Oil both experienced this in 1984, Sterling Drug in 1988 and Amoco in 1999.

Changes in financial policy were the final nail in the coffin for many triple-A-rated firms. Some companies decided to deemphasize building up large cash balances in favor of more debt, hoping that would lead to higher profits. DuPont lost its triple-A rating in 1981 following a change in financial policy. Macy’s, Kraft Foods and General Foods also all lost theirs in 1981, Kellogg’s and Chevron in 1984, and Procter & Gamble in 1987.

By 2011, the list of triple-A-rated companies had narrowed to just four companies after General Electric, Berkshire Hathaway and Pfizer lost their triple-A ratings following 2008’s Great Financial Crisis. But because monetary policy was so easy, interest rates so low and bond demand so great, interest costs for a triple-A-rated credit were hardly different from those for lower-rated companies.

Suddenly, the cost savings derived from a higher credit rating mattered less than ever. After taking on more debt, payroll processor ADP was downgraded in 2015, followed by Exxon in 2016. That left only Microsoft and Johnson & Johnson with AAA ratings, until Apple’s elevation last month.

Apple didn’t sacrifice other business initiatives to prioritize credit strength, and it didn’t achieve a triple-A credit rating because that was its goal. Rather, Apple’s triple-A credit rating is the culmination of the company’s programming, design, production and marketing decisions that lead to billions in excess cash and a solid balance sheet.

Apple made loads of money by competing, executing and winning. Credit rating agencies are routinely late in realizing what markets have already seen. Eventually, Apple’s business success made it impossible not to give it the top AAA rating.

Phil Kernen, CFA, is a portfolio manager and partner with Mitchell Capital, a financial planning and investment management firm in Leawood, Kansas. When he’s not working, Phil enjoys spending time with his family and friends, reading, hiking and riding his bike. You can connect with Phil via LinkedIn. Check out his earlier articles.

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