Read 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.