A debt free balance sheet is an impressive statement of financial strength. Although leverage has certain benefits and is, in fact, advisable and appropriate for some industries, operating without debt materially increases a company’s financial flexibility. For example, in lean times, such as a recession, a debt free balance sheet can allow a company to continue operations without interruption. This is a margin of safety that a highly leveraged company may not have.
Investors using dividend income to pay living expenses should find such stocks of particular interest. Indeed, if a company, industry, or the entire economy should fall on hard times, a debt-free balance sheet increases the chances that a company will maintain its dividend payments unaltered. Thus, an investor’s “paycheck” won’t take a hit at the same time that the value of his or her portfolio is declining.
Indeed, such dividend payments can allow the investor to ride out the bad times and the likely corresponding share price decline. Although capital preservation is clearly important, sometimes the best way to preserve capital is to sit tight with a good company regardless of what the emotionally driven stock market is doing. Dividend distributions supported by a strong financial structure should make that easier to do.
To find such companies, we used the online screening tools of The Value Line Investment Survey to cull out companies, such as Cypress Semiconductor Corp. (CY), Activision Blizzard, Inc. (ATVI), and Quality Systems, Inc. (QSII), that have no long-term debt, pay dividends, and have good investment merit. Clearly, the screen could be altered to meet the needs of investors looking for a particular level of dividend payments or made more lenient for those who believe a little bit of debt is a good thing.
Cypress Semiconductor Corp.
Cypress Semiconductor designs, manufactures, and markets a broad line of high performance digital integrated circuits used in smartphones, GPS systems, PCs and PC peripherals, audio and gaming devices, washing machines, and communications devices. Major products include its Programmable System-on-Chip platform (includes touchscreen controllers), high speed Static Random Access Memories (SRAMs), Programmable Logic Devices (PLDs), Programmable Read-Only Memories (PROMs), specialty memory, and timing devices.
Cypress enjoyed positive year-over-year earnings comparisons during the latter half of 2011. Revenues were fueled by healthy results from the Consumer and Computation division, which benefited from higher sales of its touchscreen solutions. Increased factory utilization helped profits, though margins generally narrowed, reflecting an unfavorable product mix.
However, we have pared our 2012 sales and earnings estimates. Although the Consumer and Computation segment should continue to post good gains during the year, Hewlett-Packard’s (HPQ - Free Hewlett Packard Stock Report) plans to shut down its tablet computer operation, will likely constrain results for Cypress, which was the primary supplier of touch controllers for the HP TouchPad. Despite the reduced view, we still anticipate respectable growth in the current year as new design wins at HTC and Nokia (NOK) help the company regain lost ground. Also, Cypress has a strong balance sheet with no debt and an ample amount of cash. We expect increases to the dividend payout down the road (current yield is 2%).
Activision Blizzard, Inc.
Activision Blizzard is one of the largest and most profitable developers, publishers, and distributers of interactive entertainment software for the home video game market. The company publishes online games, as well as titles for personal computers, consoles, and hand-held systems. It is organized into three business segments: Activision Publishing, Blizzard Entertainment, and Distribution.
Activision has benefited from the release of two important titles. Call of Duty: Modern Warfare 3 was released on November 9, 2011, and within 24 hours of going on sale, the game sold 6.5 million copies in the U.S. and U.K., grossing $400 million, making it the biggest entertainment launch in history. In the first 16 days of availability, it generated over $1 billion in revenues, a feat that was accomplished faster than the highest-grossing major motion picture of all time, Avatar. Management revealed that the game’s premium online service, Call of Duty Elite ($49.99 for a one year subscription) has been doing well and already has over one million users. We look for continued healthy sales from the service moving forward. Additionally, Skylanders Spyro’s Adventure has also been well received by both critics and consumers and we expect a solid showing for the fourth quarter.
Guidance calls for a moderate fourth quarter revenue contraction due to strong sales of last year’s World of Warcraft expansion pack causing a difficult comparison. Still, margins should continue to expand due to a mix shift toward the more profitable subscription based model. What’s more, the company has a strong pipeline of products for the current year, including Diablo III which is expected to be released in the first quarter and has been experiencing strong pre orders, as well as extension packs for Starcraft II and World of Warcraft which are set for release sometime in 2012. All of these franchises have proven to have extremely loyal fan bases and are among the highest grossing video and PC game series to date.
Given its debt-free balance sheet and strong cash flow from operations, we look for continued increases in the annual dividend, which was recently raised 10%, and now yields 1.4%.
We note that the success of the overall video game industry is highly dependent on discretionary consumer spending patterns, a trait that may dissuade more conservative investors, considering recent weakness in that area. Activision Blizzard is set to release December-quarter earnings on February 9th, after market close.
Quality Systems, Inc.
Quality Systems develops and markets healthcare information systems that automate certain aspects of physician, inpatient and dental practices, ambulatory care centers, community health centers, and medical and dental schools. Products include scheduling and billing software and programs that automate patient records. The former market is mature and QSII generally competes for replacement business, whereas the latter replaces paper-based patient records and still has a vast opportunity for growth. 2010 revenue breakdown was as follows: NextGen (75%), Practice Solutions (14%), QSI Dental (6%), and Inpatient Solutions (5%).
We look for Quality Systems to remain in growth mode in the near term. The company displays a solid history, with persistent revenue growth, year over year. The trend continued in the first three reporting periods of fiscal 2011 (ends March 31, 2012). Expansion should continue, as management has stated that market potential is wide, especially in small rural hospitals and ambulatory care clinics. Indeed, it revealed that contracts rose 36% year over year, in the most recent quarter and that the current revenue pipeline is well ahead of last year’s level (although growth did slow somewhat sequentially). Considering less than a quarter of hospitals have electronic medical records that are fully functional, this leaves a lot of room for add-on, trade-in, and replacement opportunities.
The future looks bright, as well. As Quality’s customers grow, business coming from them should also climb. Furthermore, the company is exploring international opportunities. The firm’s balance sheet remains healthy with no debt and ample cash on hand. We look for a solid increase in the dividend by 2014-2016 (current dividend yield 1.7%). Additional acquisitions may be in the cards, as well.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.