Stocks attract all the glamour from investors, but bonds are where the real money is. More than twice as many dollars are invested in U.S. debt instruments today than in stocks -- and the differential is accelerating. In 1999 alone, $10.9
in new debt was issued in the United States vs. about $100 billion in initial public offerings of stock.
With so much money at stake, institutional investors seem to demand more intellectual rigor and honesty from debt analysts than from stock analysts. Researchers at independent debt-rating agencies are much quicker to erect a big, red, flashing "avoid" sign over a faltering company than their equity cousins, whose worst rating on a stock is typically a mealy-mouthed hold. At key inflection points in 2000, for instance, skeptical bond analysts were far more
pessimistic on the prospects for overleveraged stink bombs
than their equity counterparts.
The good news for private investors is that the Internet has provided a channel for bond research at no cost. And both of the big debt-rating agencies --
-- recently upgraded their Web sites to allow anyone who's handy with a screening engine to find and act upon timely reports. You might find their no-nonsense candor on underperforming firms helpful in uncovering good candidates to sell short, or bet against, in the equity markets. When a bond-rating agency announces in a press release that it either has placed a public company's debt on a watch list for possible downgrade or has actually changed its ratings to negative, it is usually a leading -- not a trailing -- indicator of poor times ahead for the stock.
Let's look closely first at the past year's reports on Xerox. To their credit, the equity analysts did their part to warn investors of impending trouble at the copier giant. The trouble is, they did it too modestly. On June 16,
Salomon Smith Barney
both downgraded the company's stock from buy and attractive, respectively, to outperform and neutral. On July 25,
Credit Suisse First Boston
downgraded the stock from buy to hold. And on July 26,
downgraded the stock again, from outperform to neutral.
Yet none of those ratings -- whether hold or neutral -- had the plain-spoken impact or the immediacy of the reports from IBCA Fitch, a global rating agency formed by the merger of Fitch Investor Services and IBCA Group in 1997.
On Dec. 13, 1999, Fitch put Xerox's senior unsecured debt and commercial paper on rating alert -- negative, citing the company's own warnings of slower sales growth and reduced earnings expectations.
On Aug. 31, 2000, Fitch definitively downgraded Xerox's debt and commercial paper ratings to outlook negative, citing that its credit statistics for the first half of the year showed that the firm's debt-to-earnings ratio had jumped by almost 50% in the past six months. Basically, this meant the company would have an increasingly hard time paying its debt holders from its income stream. Bondholders hate that.
Both ratings were prescient. Xerox stock fell 60% from the date of the December alert through Oct. 20 and fell 48% from the date of the August downgrade. In both cases, the stock didn't react much, if at all, to the downgrade until several days or weeks later.
Now look at the case of another
blowup well outside the realm of the dot-com bubble. Stock analysts meekly raised red flags about the threats posed to building-materials maker Owens Corning by asbestos lawsuits. But only Fitch made the problem brutally clear.
On April 12,
downgraded the stock from recommended to market perform. On June 27,
First Union Securities
downgraded it from buy to hold. On June 29,
initiated it at neutral.
Fitch didn't pull any punches. It put Owens Corning on ratings watch negative on June 27, citing the high fixed-cost obligations represented by asbestos-suit settlements. On Aug. 7, Fitch made the rating official, downgrading Owens' debt to junk status and stating the outlook remained negative.
The stock fell about 12% in the week after Fitch's first warning, but it was just getting started. Owens sought protection from its creditors in early October and is now down 89% from the date of the June 27 report and 79% even from the Aug. 7 report.
It's easy to track Fitch and Moody's analysts. To see that the Fitch folks are up to, visit its
Web site and click the "Open Search" link in the upper right section of the home page. When the cool little search engine tab slides open, click on the drop-down box that initially says "All Sectors" and choose "Corporate Finance" from the list. This prevents you from having to look at Fitch's ratings on government bonds. Next, check the "Press Releases" box, type "negative" in the search box, then click "Go." On the subsequent page, click a headline to read the report.
You'll see Fitch's warnings and downgrades on corporate debt issuers going back for the past two years; it seems there are about seven to 10 per month. Once you read through a few and check stock prices against the negative-alert dates, you'll get a feel for the agency's remarkable capacity for predicting nightfall about an hour before dusk. Here are two recent warnings:
is a Delaware manufacturer of chemicals and fibers. On Oct. 17, the company warned that it's third-quarter profits would come in below estimates, and its chief executive resigned. On Oct. 19, Fitch placed its senior unsecured debt on ratings watch negative, citing worse-than-expected credit-protection measures, changes in management and delayed sales of noncore businesses. That sounds a lot like its warning on Xerox back in August.
is a Wisconsin-based discount retailer. On Oct. 5, the company warned of an earnings shortfall and saw its stock fall from $10 to $8. On Oct. 12, Fitch changed its ratings on the firm's senior notes and credit line from stable to negative. Shares have since slipped to $6.13 but bad news often seems to get worse for highly leveraged companies under stress. Fitch warned that its change in outlook reflected Shopko's "competitive environment, deteriorating credit fundamentals and higher debt balances."
Moody's search engine is harder to use but still well worth a try. Visit its
home page and click the "Advanced Search" link. On the right side of the search engine, labeled "Search Research Reports," change the search date range to a recent period -- for instance, "Published After Oct. 1, 2000" and "Published Before Oct. 25, 2000" -- and choose the document type "Rating Action"; then click the "Search Link" located directly beneath the drop-down menus. On the subsequent page, look for headlines with phrases in their titles like "Outlook Changed to Negative" or "Review for Possible Downgrade," and click to read the full report.
Two recent downgrades follow the pattern of suggesting that sick companies often get much weaker before they convalesce and strengthen:
is the country's leading manufacturer of recreational vehicles and the No. 2 maker of manufactured housing. On Oct. 20, Moody's cut its rating on Fleetwood's long-term debt and declared its outlook negative. The report cited a "significant deterioration in the operating environment of Fleetwood's manufactured housing and RV businesses" and said it was entering challenging times "without adequate committed borrowing facilities." Contributing to the gloom were factors including a "significant contraction in the availability of retail financing, high inventory levels, excess manufacturing capacity and competition from the growing supply of used foreclosed units."
is the voice and data-networking equipment giant. On Oct. 22, Moody's placed its senior unsecured debt on review for possible downgrade following an announcement by the firm that estimates for the current quarter (ending Dec. 31) would reflect a 7% decline in revenue and break-even earnings. The report cited a "greater degree of financial deterioration than was implicit" in the firm's previous comments and increased concerns that "the recovery may be more protracted. More ominously, Moody's expressed skepticism over Lucent's current restructuring plans -- pointing out that efforts "which fail to adequately address earnings weakness or include a material restructuring of its balance sheet" would have "incremental negative rating implications."
A good set of short sales on weakened stocks can smooth out the volatility of a growth-oriented SuperModels portfolio. But even if you never plan to short, visit the debt researchers' ratings from time to time in case they've turned their attention to one of your holdings.
Moody's also publishes a uniquely intelligent, acerbic daily market analysis under the title "Rating Action: Moody's Market Wrap-Up." Find it using the Quick Search at the top of its home page by seeking documents with "Wrap-Up" in the title.
In its report on Oct. 19, Moody's warned that the U.S. companies' record sales-growth rates will inevitably lead to overinvestment in manufacturing capacity and unsold inventories -- events that lead to widespread earnings shortfalls and stock price declines. Its conclusion: "Too many investors may have grossly overestimated what is sustainable for the U.S. economy in terms of growth rates for both household expenditures and business investment. When growth rates blast above trend, slowdowns are inevitable."
At the time of publication, Jon Markman owned or controlled shares in the following equities named in this column or listed in the SuperModels portfolios: AES, Check Point Software Technologies, Cisco Systems, EMC, Fifth Third Bancorp, JDS Uniphase, Kopin, Maxygen, Microsoft, Nokia, Nortel Networks, Oracle, Qualcomm, Siebel Systems, Superconductor Technologies, VERITAS Software and Xcelera.com. He welcomes your feedback at
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