The key principle to know here is “deleveraging,” or the process of a company reducing the debt on its balance sheet. Typically, companies would raise the money necessary to do so through secondary offerings. But once the credit crisis started in 2007, it became all but impossible. Their share prices were too low, so was demand, and they feared the market would further punish their already damaged stocks.
But since last year’s lows, in March, stocks have recovered enough that companies feel confident holding secondaries. And this has put many of them in what Cramer called a virtuous circle of debt. He means that as stocks go higher, companies are able to raise money through these offerings, which in turn improves their capital position. That removes a lot of investor and creditor concern and allows them to refinance their debt. This pushes the stock even higher, allowing for another secondary, if it’s necessary.
This is how capital markets are supposed to work, Cramer said, but the credit markets froze during the crisis and the markets tanked. This created a bottleneck of companies who needed to raise cash but couldn’t. But now that the overall environment has improved, that bottleneck is clearing, and it’s giving investors a chance to profit.
Some of the best secondary offerings we’ve seen since the crisis, Cramer said, have come from companies that were heavily in debt. They were able to put their new cash to work in a way that attracted investors, and that drove up the share price. That’s how US Steel’s offering priced at $25.50 but then jumped to nearly $37 for a 44% gain. And Vulcan Materials priced at $41 and then hit $47.25 soon after. Even Ford got in on the action, pricing its deal at $4.75 – about $1.50 below its trading price the week before – and then soared 30% to over $6 in just three weeks.
The bottom line is that companies with huge debt loads can offer a great opportunity to profit when they hold secondary offerings. You just need to know how to spot them and analyze them. Click here for Cramer’s how-to lesson on that.
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