Where Credit Is Due

A new study of the largest issuers of corporate debt shows that recent gains in creditworthiness are more fragile than you think.

Survivors

For some companies, overhauling the balance sheet has been a matter of survival. Look, for instance, at The Williams Cos., whose 68 percent reduction in EDF last year also landed it in the top 10 among those showing the biggest one-year gains. The Tulsa gas-pipeline and-production company faced a severe liquidity crunch following the loss of its energy-trading business some two years ago, and that, coupled with a credit-rating downgrade from BBB- to B-, required a $900 million “rescue loan” last year from Berkshire Hathaway and Lehman Brothers. No wonder Williams’s EDF reached 20 percent in August 2002, placing it among the 12 companies most likely to default, according to MKMV.

But thanks to $3 billion in sales of noncore assets this year, Williams increased its cash position to $3.2 billion at the end of the second quarter of 2003 from $1.7 billion at the end of 2002, and reduced its debt by almost $1 billion. Its default point, to be sure, rose 5 percent during the past 12 months, but the increase was much smaller than during the two previous years (the rise in its default point for the entire period was 61 percent).

Meanwhile, Williams’s market leverage and asset volatility have decreased in the past year. As a result, notes company spokesperson Kelly Swan, “the capital markets reopened to us this spring,” allowing Williams to redeem enough preferred stock to save $17 million a year in aftertax financing costs and help move the company toward its goal of investment-grade credit ratios by the end of 2005.

Other companies have seen their EDFs remain stubbornly high despite dramatic efforts at capital restructuring. Take Sears, Roebuck & Co. Although it decided earlier this year to sell off its credit-card portfolio and return to its roots as a retailer, Sears’s EDF rose some 65 percent during the 12 months that ended last August 31, from 0.51 percent to 0.84 percent. That put the company in the same league in terms of percentage change (but not basis-points change) as troubled energy concerns like Duke Energy, El Paso Corp., and FirstEnergy. On the other hand, Sears’s three-year numbers look better. And, of course, its EDF remains much lower than that of many struggling energy companies or, for that matter, Delta Air Lines, which saw its EDF soar more than 220 percent in the past year, to about 7 percent.

Tarred and Tethered

Delta is mired in an industry deeply out of investors’ favor, and indeed, all four airlines among the top debt issuers fall in the bottom 20 of MKMV’s EDF ranking. Telecom and energy are also overrepresented at the bottom; the latter industry includes Duke Energy Canada, which had the highest percentage increase in EDF during the past year, and El Paso, which had the highest basis-point increase (see “The Best and the Worst,” at the end of this article).

A company inside a poor-performing industry may find itself trapped, even if it shows an improvement in creditworthiness. One such company is TXU Energy, which saw its EDF more than double during the past three years, while its asset value declined 21 percent. While TXU has reversed that trend in the past six months, its overall EDF remains much higher than it was three years ago. TXU was in large part a victim of the terrible environment for energy companies, with its asset volatility rising some 31 percent during the period.

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