Posted on 01/13/2002 10:15:39 AM PST by MeneMeneTekelUpharsin
If you learn nothing else from the Enron mess, take this lesson to heart: A company's inability to handle its debt can be its downfall--no matter how much Wall Street likes its stock. Indeed, while earnings may be a window to a company's psyche, the balance sheet is what gives you a truer picture of its well-being. Bond analysts make a beeline to this crucial piece of financial disclosure, paying special attention to a company's ability to service its debt. And when the ratio of cash to debt plunges--watch out!
The best balance-sheet snoops are often way ahead of the pack in finding signs of trouble. Sometimes, however, the big credit-rating firms, Standard & Poor's and Moody's, which get paid by the companies they rate, are slow off the mark--slower, as a rule, than independent bond-rating services like Egan-Jones of Wynnewood, Pa., or research firms like New York-based Gimme Credit. "We don't have the constraint of trying to keep a company happy," says Egan-Jones President Sean Egan, whose downgrade of Enron to junk beat the big guys by about a month. (To be fair, Moody's is revising how it assesses companies, taking into account additional information that could lead to a default. Standard & Poor's, for its part, argues that its existing methods are adequate.)
Given the scope--and the surprise--of the Enron failure, it's worth asking: Are there other companies out there that these aggressive independent credit-rating agencies are flagging now? You can bet on it. We're not necessarily talking future Enrons, but simply companies whose financial situation is more dire than the market thinks. Certainly one where the alarm bells are ringing loudly (and which--don't remind me--got a positive nod from this column a year ago) is Ford Motor. It's no secret that Ford is having serious problems, but you wouldn't know it from its credit rating, which is still investment grade. Egan-Jones, however, labels it BBB-, a few notches lower than the other rating agencies do and just one step above junk. That's where Egan-Jones thinks Ford will arrive within six months, as the sales boost from the much heralded 0% financing starts to wane and bad auto loans pile up. Junk status raises the cost of borrowing and would be particularly damaging for Ford, whose ability to cover its debt has been deteriorating rapidly. Egan and other bond analysts measure this by calculating a company's interest coverage ratio--pretax income plus interest expense divided by interest expense.
The ratio, which varies widely by industry, is key to credit analysis. Egan calculates that Ford's interest coverage has tumbled from 2.2 in September 2000 to just above 1 now. "That's akin to saying that nearly everything you earn will have to be used to pay your interest expense, which doesn't leave a lot of money to invest in the business," he says. Ford responds that it's "disappointed" by the Egan-Jones rating; both S&P and Moody's insist they haven't been laggards and that their ratings are appropriate. Egan-Jones is even warier of computer maker Hewlett-Packard. Its credit picture is as imperiled as its proposed Compaq merger, according to Egan-Jones--which has already tossed the tech giant's debt on the junk heap with a rating of BB+, several notches below that of the major rating agencies. "It's appropriate to view Hewlett-Packard on a stand-alone basis, which is not particularly attractive," Egan says. "Today it is hard to name any business where it's the undisputed leader--even its printer business is being attacked." Making matters worse: From October 2000, Hewlett-Packard's interest coverage has sunk steadily from 19 to just 6.6. (By contrast, IBM's ratio, according to Egan-Jones, is 11.7.) Hewlett-Packard officials couldn't be reached for comment.
Finally, there's retailer Gap (another company this column once argued you should never bet against, because of its miracle-working marketing genius of a CEO, Mickey Drexler). While Gimme Credit's Carol Levenson says Gap's balance-sheet condition is not yet critical, it's "not nearly as strong as it used to be." Egan-Jones points out that Gap's interest coverage ratio has plunged from 27.3 down to 8.8 over the past four quarters. As a result, the firm rates the retailer's debt one step above junk and a couple of notches below that of both Standard & Poor's and Moody's ratings. Gap officials say they have never "worked" with Egan-Jones and point to the retailer's standing with the major rating agencies instead. The problem is, as Enron proved, those agencies are not always the first to sound the alarm.
The point of interest about this story from Fortune is that Calpine (CPN) is not mentioned. CPN is a major independent power producer whose stock has tanked recently. Also, Mirant is not mentioned and its stock has dropped precipitously like many other independent power producers who did/don't do business like Enron.
If Calpine were like Enron, most assuredly this article would have mentioned such. The Street.com articles disparaging Calpine leaves room for the opinion of possible coordination with short-sellers and the Feds ought to check into that.
Any thoughts from the financial gurus on Calpine and its prospects? Also, regarding dividends, does anyone know about the company Ekchor Motorcycles (EKC)? It is based in Hong Kong...any FR members in Asia could tell me about this firm?
Because Ford also has access to the technology developed by Mazda in Japan, it means Ford does have considerable expertise in building small vehicles. Also, Ford's excellent F-Series of pickup trucks are still very popular.
They will NEVER pay a dividend, and there is no safer place to put your money, regardless of the Feds.
Lindows is coming out soon despite Microcraps best efforts to stop it.
One rule of investing is to find out who runs the company. If it's a utopian, run. They don't have a clue.
It looks like we have accounting and auditing firms misleading the public. The tip of the iceberg is all we see at the present time. I served as a broker for a time and got out of the business when the various scams became apparent to me.
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