Question

In the coronavirus pandemic, stock analysts have a new job: credit analysis.

As the global economy grinds to a standstill amid mandatory shutdowns, the survival of many businesses is suddenly in doubt, especially those in vulnerable sectors such as airlines, hotels and restaurants. Instead of asking how fast a company can grow, ever-optimistic equity analysts now have to answer a grimmer question: how long can it last if its revenue vanishes? This focus on cold, hard cash means they have to do work that is more familiar to credit analysts: analyzing available liquidity, looking at debt covenants and repayment schedules and checking the extent to which assets are unencumbered.

While the current economic freeze is unprecedented, making it hard to prepare for, investors overlooked credit health in the bull market. They were focused on growth -- never mind whether companies were able to make money -- and often pie-in-the-sky projections of potential market size. Now that balance sheets have taken center stage, traditional metrics like net debt to earnings before interest, taxes, depreciation and amortization or even tangible book value are back in vogue.

Even for companies whose businesses aren't immediately at risk, refinancing existing debts could pose big problems. The junk-bond market has stalled in recent weeks, so investors need to understand what alternative financing channels are available to companies: credit lines from banks or assets that could be used to secure loans. Even for those that can still borrow, the surging costs will hurt their profits down the road. Average yield on dollar-denominated, junk-rated corporate bonds stands at 12%, up from below 6% just a month ago, according to data from S&P Dow Jones Indices.

With everyone in cash-preservation mode, companies that used to pay generous dividends are starting to cut back. Delta Air Lines, Marriott International, Macy's and Ford Motor have all suspended their payouts in recent days, and more will likely follow.

Analysts better acquainted with income statements need to pay closer attention to companies' balance sheets right now.

===========================================================

Required:

i) What information will you collect for credit analysis and briefly introduce your analysis process. [hint: use the knowledge learned in this course to answer the question]

ii) Compare stock analysis and credit analysis in the context of this article.

Answer 1

(i): The information that I will collect for credit analysis will pertain to the aspects of the company’s characteristics like character (reputation) of the borrower, capital (leverage) of the borrower, capacity to pay (volatility of earnings), and conditions of the borrower’s business. The objective here is to determine the ability of the company to meet its credit obligations and so as a credit analyst the focus will be on finding credit risk and default risk of companies. Here the ratios that will be looked into are gross profit margin ratio, EBITDA margin, operating profit margin, ROA, ROE, debt to asset ratio, asset to equity ratio, debt to equity ratio, debt to capital ratio, interest coverage ratio, debt service coverage ratio, cash coverage ratio and asset coverage ratio.

(ii): In the context of this article stock analysis focuses on growth aspect of a company and mainly looks at growth of free cash flows of the company. Using this intrinsic value of the company is determined. On the other hand credit analysis looks into the current leverage situation of a company and then determines that company’s credit risk and its ability to pay back its debt obligations and remain liquid in future. Thus stock analysis is more concerned with the income statement and cash flow statement while credit analysis is more concerned with the balance sheet of a company.