Corporate Entity Credit Rating Introduction Corporate credit rating is an assessment of relative credit quality of an entity’s ability to meet contractual, financial debt obligations as a going concern, on time and in full. The core issue in corporate debt rating is the entity’s
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Beacon Ratings Corporate Sector
Corporate Entity Credit Rating Introduction Corporate credit rating is an assessment of relative credit quality of an entity’s ability to meet contractual, financial debt obligations as a going concern, on time and in full. The core issue in corporate debt rating is the entity’s capability to generate cash from core business operations, predictability of such cash flows and assessing adequacy of the cash flows to meet debt servicing obligations over the tenure of a rated instrument; and other su
Corporate Entity Credit Rating
Introduction
Corporate credit rating is an assessment of relative credit quality of an entity’s ability to meet contractual, financial debt obligations as a going concern, on time and in full.The core issue in corporate debt rating is the entity’s capability to generate cash from core business operations, predictability of such cash flows and assessing adequacy of the cash flows to meet debt servicing obligations over the tenure of a rated instrument; and other supplementary sources of cash flow including cash balances, liquid marketable securities, external sources of financing, or some manner of third-party support.
Corporate credit rating criteria
Beacon Ratings’ corporate rating criteria includesindustry growth prospects, operating performance, financial performance, liquidity position, financial flexibility and funding profile, corporate governance, management quality, parent entity support and debt servicing history.
Industry growth prospects
The industry growth prospect is assessed to determine the performance and associated risks of the industry. Industry parameters are:
Growth prospects:Growth prospects of an industry affect the earnings and returns of entities operating within it.
Cyclicality:Cyclical industries are categorized into two: those that are influenced by the performance of the economy - real estate, and those influenced by the level and volatility in commodity prices - agriculture.
Competitive intensity: High-level competition in an industry reduces entities’ capability to grow revenues and increase profits.
Regulatory risk:Regulatory intervention in multiple forms, including taxation, duties and levis, import/export restrictions, and outright bans.
Competitive position and diversification
Corporate entity’s performance is a function of scale and scope of operations, competitive position, diversification for customer diversity, products, geography and supplier:
Relative scale -Large scale is a sign of strong market position, operating and financial flexibility, and operational efficiency.
Competitive position:Competitive position determines sustainability or fragility of its business model. Source of competitiveness - strong brand, wide distribution network, deep customer relationships, etc.
Customer diversification:An adequate degree of customer diversification reduces an entity’s vulnerability to (i) variability in demand associated with a select few customers, and (ii) disruption in the business of a single customer.
Geographic diversification:Degree of geographical diversification reduces vulnerability to (i) variability in demand (ii) demand disruptions caused by force majeure events or adverse regulatory actions in a geographical area.
Product diversification:Diversification aimed at selling variety of products to same set of customers or expanding breadth of products to new customers.
Supplier concentration: Dependence on a single supplier for raw material or other production factors are risky in case of disruption at the supplier’s end.
Operating performance
Corporate entities have relatively strong positioning and high market share in their business segment and competitive advantage. The following are assessed:
Products and services profile
Timely availability of raw materials, manpower and utilities
Bargaining power with key customers and suppliers
Value addition in the product and services
Product and service distribution networks and channels
Business contracts with customers and order quantities
Relative scale:large scale is associated with operational efficiency
Operating efficiency
Operating activity and efficiency are assessed using financial ratios such as:
Cost of production per unit compared to competitors
Stock turnover
Debtors’ collection period
Creditors’ payment period
Turnover to total assets
Current capacity utilisation
Operating expense to income
Sensitivity of key drivers, selling prices and input costs
Infrastructure and technology
Corporate entities use of modern technology infrastructure to achieve efficient production cycle, reduce wastes, sustain quality products and demonstrates willingness of management to grow the business within changing times.
Project risks management
Corporate entities undertaking a large-sized capital expenditure project is exposed to risks, including:
Track record of entity in project implementation
Experience and track record of suppliers
Competitive capital cost
Financing arrangements
Raw material linkages
Costs and time over-runs
Financial performance
Past financial performance trends and forecasts are used to assess future financial performance and risk exposures.
Profitability:Profitability is a measure of earnings generated by an entity in relation to resources deployed. Entities with higher profitability have better resilience to economic downturns and are more likely to generate adequate internal resources to re-invest and service debt. Profitability indicators assessed include:
Gross profit margin
Operating profit margin
Net profit margin
Return on assets
Return on equity
Solvency and leverage:Financial leverage is a measure of an entity’s dependence on borrowed funds. The lower the dependence on borrowings, the better the leverage. Borrowed funds have obligations in the form of interest and principal repayments, irrespective of the cash flow generation. Gearing and debt coverage indicators such as:
Debt to total assets
Debt service coverage
Interest coverage
Liquidity:Liquidity is the measure of an entity’s capability to meet its short-term cash obligations from various internal or external resources. Liquidity indicators include:
Current ratio
Quick ratio
Cash ratio
Cash flows: Cash flow analysis is critical in assessing creditworthiness as it provides an indication of whether operations are capable of funding itself or relying on external sources.
Cash flow from operating activities
Cash flow from investing activities
Cash flow from financing activities
Free cash flows
Financial flexibility:An entity’s financial flexibility as reflected by its unutilized bank credit limits, liquid investments, and the nature of its relationship with financial institutions and other intermediaries are assessed.
Capacity to raise funds at short notice from banks
Bank lines for working capital, revolving credit facilities
Investments in liquid mutual funds
Treasury bills and other short-term notes
Cash or encumbrance-free fixed deposits in banks
Supply chain partners
Supply chain partners need to be operationally effective and efficient as they play key role. Business partners’ operating, investing and financial activities are assessed.
Suppliers
Vendors
Bankers
Customers
Other associated partners
Management quality
Management quality is measured by the extent of management's past experience, strategy, and future plans. Factors assessed include:
Related track record experience
Succession planning
Employee relations
Management risk mitigation plans
Management’s past success in new projects
Management stability and pro-activeness
Capability of the second layer of management
Corporate governance
Board’s commitment to transparency and credible practices through financial reporting, level of disclosures, consistency in communication and openness with regard to sharing information are assessed.
Board composition
Board independence
Board committees
Strategy execution track records
Board oversight responsibilities
Board practices and support for management
Strategy execution track records
Other factors relevant factors
Foreign currency risks:Foreign currency risks arise when an entity’s primary costs and revenues are denominated in different currencies. An assessment of hedging policy, tenure, structure contracts with suppliers/customers – short-term/ long term, fixed price/ variable price.
Contingent liabilities: The existence and likelihood of contingent liabilities and off-balance sheet exposures crystalizing are evaluated.
Other factors relevant factors
Imported table
Rating scale
Interpretation of rating scale
Investment grade
AAA
Highest credit quality, risk factors are negligible, being only slightly more than for risk-free Government of Ghana’s treasury bill
AA
High credit quality, protection factors are strong. Risk is modest but may vary slightly from time to time because of economic conditions
A
Good credit quality, protection factors are adequate. Risk factors may vary with possible changes in the economy
BBB
Adequate credit quality, protection factors are reasonable and sufficient. Risk factors are considered variable if changes occur in the economy
Speculative grade
BB
Obligations deemed likely to be met, protection factors are capable of weakening if changes occur in economy. Overall credit quality may move up or down on the scale
B
Capable of fluctuating widely if changes occur in the economy. Overall quality may move up or down on the scale
CCC
Considerable uncertainty exists towards meeting the obligations, protection factors are scarce and risk may be substantial
CC
A high default risk
C
A very high default risk
D
Default obligations
Rating outlook
Imported table
Positive
Indicates a rating may be raised
Negative
Indicates a rating may be lowered
Stable
Indicates a rating is likely to remain unchanged
Developing
Indicates a rating may be raised, lowered or remain unchanged
Rating outlook assesses the potential direction of the entity’s rating over the intermediate term - typically over one to two-year period. Ratings from AA to B may be modified by a positive (+) or negative (-) suffix to show its relative standing within the major rating categories.