VideoRead the rankings of Europe’s 100 largest debt issuers by Moody’s KMV.
Wolfgang Reithofer was exasperated. When presenting a stellar set of 2007 results, the CEO of Wienerberger, a €2.5 billion Austrian building materials group, lamented how the firm's share price had "disconnected" from its financial performance.
Over the course of the year, Wienerberger's operating earnings grew by 17% but its share price fell almost as much. As shares continued to slide in the first half of this year, despite the company's guidance for market-beating 10% earnings growth, Reithofer and his colleagues took every opportunity to point out that share price performance "in no way reflected the strength of the company," as the chief executive put it in his annual letter to shareholders.
New research shows that many companies could make a similar case. Moody's KMV (MKMV), a credit research company owned by Moody's Analytics, crunched the numbers of Europe's largest 100 non-financial debt issuers for CFO Europe and found that the median company's probability of default is no higher than it was three years ago. Given the economic gloom, slumping stockmarkets and soaring cost of credit, the findings may seem counterintuitive.
Going for Broke
MKMV, which operates independently from the ratings agency, uses a proprietary methodology to derive its measure of credit quality, expressed as a company's Expected Default Frequency (EDF) score. These scores, which range from 0.01% to 35%, are calculated using market-based information such as share prices, balance sheets and the history of thousands of defaulting companies. (See "Explaining EDF" at the end of this article for the full methodology.)
"Believe it or not, business conditions relative to three years ago seem to be more stable," notes Brian Dvorak, managing director for credit strategies at MKMV in San Francisco. "At least, that is what the market is saying about asset volatilities."
Asset volatility, a key input to EDF scores, is nearly 10% less than three years ago for the median issuer in MKMV's sample. By itself, a decline in volatility reduces a company's EDF. But over the past three years, Dvorak notes, a rise in liabilities counterbalanced the fall in volatility. Compared with 2005, short- and long-term liabilities for the median issuer were, respectively, 45% and 22% greater. The net result is an EDF that's largely unchanged for a typical large, non-financial debt issuer in Europe.
Graham Secker, an analyst at Morgan Stanley, agrees balance sheets for most non-financial firms in Europe are in "reasonable shape," with aggregate gearing and leverage ratios in the region well below the heights reached going into the post dotcom downturn around 2000.
Nevertheless, few companies are finding it as easy to raise capital now as at any point in the recent past. MKMV tracks a measure it calls the "market Sharpe ratio," gauging the excess return debt investors require per unit of risk. The spread demanded for a broad basket of corporate bonds in relation to their credit risk — as measured by EDF scores — peaked in March at the widest it has been since the early 1990s.
When Telekom Austria looked into issuing a new bond late last year, it boasted an EDF of only 0.02%. Still, CFO Hans Tschuden found the interest rates on offer unacceptable. Despite the creditworthiness of the €5 billion company, it was "not the best time" to issue a traditional bond, Tschuden says.
His team went away to think of other ways to raise fresh funds. In August the company issued four-year promissory notes, instruments seldom used by Austrian companies but popular in neighbouring Germany. Provided that finance teams look around to find the markets that offer suitable spreads, "raising money is not a problem," notes Tschuden. He initially wanted to raise €100m, but demand from banks and insurance firms for the notes pushed the final issue to €300m — €200m in a floating-rate tranche that initially pays 6.2% and €100m in a fixed-rate tranche paying 6.08%.
Towards the end of the summer, despite reporting a lower than expected profit for the second quarter of this year, the telco's shares were buoyed after it confirmed previous guidance for profit and revenue growth, and a stable dividend, for the full year. Jittery markets appreciated the confidence in what Tschuden describes as "realistic and achievable" guidance.
Confidence Game
Logica, a UK-based IT services group, did even better, boosting its guidance for 2008 revenue growth, and reaffirming margin and leverage targets, as it unveiled half-year results last month. Notably, this happened even after the company took on much more debt after a string of acquisitions and devoted half the proceeds of the sale of its telecoms-products division last year to a share buyback, shortly before the credit crunch took hold.
"It's always easy to look back and say you should have done the share buyback at a different time," says Seamus Keating, Logica's CFO. "You do it when you do because you believe it's the right thing to do. We're confident in the cash flows of the business." So are the markets. Over the past three years, Logica's EDF has fallen by more than 60%.
Reader Comments» Post a comment