Corporate Entity Credit Rating

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.

Beacon Ratings’ corporate rating criteria includes industry growth prospects, operating performance, financial performance, liquidity position, financial flexibility and funding profile, corporate governance, management quality, parent entity support and debt servicing history.

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.

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.

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 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

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.

Corporate entities undertaking a large-sized capital expenditure project is exposed to risks, including:

1. Track record of entity in project implementation
2. Experience and track record of suppliers
3. Competitive capital cost
4. Financing arrangements
5. Raw material linkages
6. Costs and time over-runs

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 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 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

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

• 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.

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.