Investment research provider Morningstar started publishing credit ratings for about 100 of the largest U.S. companies.
Over the next year, it plans to produce credit ratings for up to 1,000 companies currently covered by its equity analyst team. In a release this morning, the research firm said that the ratings are available for free at Morningstar.com, its investment Web site. The forecasts and scores underlying the ratings can be accessed by institutional equity research clients.
According to the company's release, it has been producing equity research since 1998 and draws on this experience to bring a distinct perspective to debt ratings. Its equity analysts produce detailed five-year forecasts of cash flows for stock evaluation. The company then compares these forecasts with liabilities coming due to offer insight into companies’ creditworthiness.
An added distinction of Morningstar’s credit rating methodology is its reliance on an Economic MoatTM calculation of competitive advantage in looking at both a firm’s financial prospects as well as its business risk.
Morningstar’s credit rating is based on four key quantitative and qualitative factors. The first is business risk, which is an evaluation of industry and company risk factors such as Morningstar`s proprietary Economic Moat and Uncertainty Rating. Economic Moat is a measurement of a firm's competitive advantage and the Uncertainty Rating measures the predictability of future cash flows.
The next is the Cash-Flow CushionTM, which is a proprietary, forward-looking ratio that measures Morningstar analysts` forecasts of future cash flows against firms’ financial obligations.
There is also the Solvency ScoreTM, which is a proprietary scoring system that measures a company`s financial leverage, liquidity, interest coverage, and profitability to determine its financial health relative to other firms.
The last one is the Distance to Default, which is a quantitative model that projects the probability of a company falling into financial distress. This is based on the market value as well as volatility of its assets.
Morningstar’s credit committee reviews all ratings initiations and proposed changes. The committee, which includes Morningstar’s director of stock research, sector specialists, as well as senior members of its research team, evaluates each rating factor with an emphasis on cash-flow, financing, and business-risk assumptions.
Morningstar assigns scores for each key factor and issues one of the following overall ratings to each company:
AAA (extremely low default risk)
AA (very low default risk)
A (low default risk)
BBB (moderate default risk)
BB (above average default risk)
B (high default risk)
CCC (currently very high default risk)
CC (currently extreme default risk)
C (imminent payment default)
D (payment default)
“Investors benefit when they have access to multiple perspectives on an investment,” said Catherine Odelbo, president of equity research for Morningstar. “Credit ratings are a natural extension of the equity research we’ve been producing for the past decade. We believe we have a unique viewpoint to offer on company default risk that leverages our cash-flow modeling expertise, proprietary measures like Economic Moat, and in-depth knowledge of the companies and industries we cover.”
As of Sept. 30, Morningstar had over 100 equity analysts around the globe with around 2,000 firms under coverage.