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A colleague has sent you this article from Fortune (http://www.fortune.com =
).
Reply to your colleague at vkaminski@aol.com=20
vkaminski@aol.com
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AGAINST THE GRAIN
Caught Off Balance
Bond sleuths were ahead on Enron. Now they have their sights  on three othe=
rs.
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 ho=
w 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 pictur=
e 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!=
=20
The best balance-sheet snoops are often way ahead of the pack in finding  s=
igns 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 li=
ke Egan-Jones of Wynnewood, Pa., or research  firms like New York-based Gim=
me 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 b=
eat 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 exist=
ing methods are adequate.)=20
Given the scope--and the surprise--of the Enron failure, it's worth  asking=
: Are there other companies out there that these aggressive  independent cr=
edit-rating agencies are flagging now? You can bet on it.  We're not necess=
arily talking future Enrons, but simply companies whose  financial situatio=
n 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 t=
his column a year ago) is Ford Motor. It's  no secret that Ford is having s=
erious problems, but you wouldn't know it  from its credit rating, which is=
 still investment grade. Egan-Jones,  however, labels it BBB-, a few notche=
s lower than the other rating  agencies do and just one step above junk. Th=
at's where Egan-Jones thinks  Ford will arrive within six months, as the sa=
les 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 parti=
cularly damaging  for Ford, whose ability to cover its debt has been deteri=
orating  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.=20
The ratio, which varies widely by industry, is key to credit analysis.  Ega=
n calculates that Ford's interest coverage has tumbled from 2.2 in  Septemb=
er 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 t=
hat it's "disappointed" by the Egan-Jones rating; both  S?and Moody's insis=
t they haven't been laggards and that their ratings  are appropriate.=20
Egan-Jones is even warier of computer maker Hewlett-Packard. Its credit  pi=
cture is as imperiled as its proposed Compaq merger, according to  Egan-Jon=
es--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 bus=
iness where it's the undisputed  leader--even its printer business is being=
 attacked." Making matters  worse: From October 2000, Hewlett-Packard's int=
erest 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.=20
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 a=
s 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 resul=
t, 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 offi=
cials say they have never "worked" with  Egan-Jones and point to the retail=
er's standing with the major rating  agencies instead. The problem is, as E=
nron proved, those agencies are  not always the first to sound the alarm.=
=20
 http://www.fortune.com/indexw.jhtml?channel=3Dartcol.jhtml&doc_id=3D205973=
=20
Colleague at Fortunehttp://www.fortune.com