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Date: Sat, 12 Jan 2002 01:40:34 -0500 (EST)
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Subject: Caught Off Balance
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A colleague has sent you this article from Fortune (http://www.fortune.com ).
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AGAINST THE GRAIN
Caught Off Balance
Bond sleuths were ahead on Enron. Now they have their sights  on three others.
Herb Greenberg
Mon Jan 21 00:00:00 EST 2002
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?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. 
 http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=205973 
Colleague at Fortunehttp://www.fortune.com