What are we looking for?
TSX-listed companies at risk of having their credit rating downgraded to highly speculative. For investors, a credit downgrade could put further pressure on stock prices.
Between Feb. 23 and March 23, the total return of S&P/TSX Composite Index fell by more than 36 per cent, eliminating more than $1-trillion in value from Canadian equities, largely because of COVID-19 and the economic shutdown. Since hitting its lowest levels in nearly nine years, the S&P/TSX has rebounded by more than 30 per cent. Despite this, Canada faces tremendous uncertainty in the coming months as provinces look at how to safely reopen their economies.
Here’s how we searched for TSX-listed companies at risk of having their credit downgraded to highly speculative status.
- First, we screen for companies with a market capitalization greater than $1-billion.
- Next, we screen for companies with a forward net-debt-to-EBITDA ratio of greater than five, according to Refinitiv’s SmartEstimate (EBITDA stands for earnings before interest, taxes, depreciation and amortization). A ratio greater than five places companies in the top quartile of TSX-listed companies, signalling the company is highly leveraged relative to companies on the same exchange.
- Finally, we screen for companies with deteriorating credit. We use the Refinitiv StarMine Credit SmartRatio Implied Rating to screen for companies with an implied credit rating that is lower than their S&P long-term credit rating. The SmartRatio Implied Rating is based on the probability that a company will go bankrupt or default on its debt obligations. SmartRatio models incorporate information from both reported financials and forward-looking analyst estimates, use industry-specific metrics and give a higher weight for the most important ratios for a given sector. As a result, the SmartRatio model significantly outperforms traditional account-based credit models.
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What we found
The screen, ranked by net debt-to-EBITDA, produced six companies in the highly speculative camp, according to SmartRatio Implied Rating. Four are in the energy and utilities sector, one in the airline sector and one in the forestry-products sector. (S&P defines highly speculative as those lower than BB-minus.)
Note that all are now rated by S&P as investment-grade, except for Air Canada, which is non-investment grade (BB, one notch above highly speculative). Regardless, SmartRatio Implied Rating suggests all six companies should be rated as highly speculative.
Husky Energy Inc. has seen its stock price fall by more than 65 per cent year-to-date, and analysts are expecting the company to report a loss of $995-million this year. Husky’s dividend yield is the highest among the screened companies at 13.9 per cent, and if low oil prices persist, the company could look to cut or suspend its dividend. Standard & Poor’s revised its outlook on Husky to negative on March 26, and continued pressure on the energy industry could cause the company to lose its investment-grade status.
Air Canada has seen its equity value fall by more than 61 per cent year-to-date as demand for travel has come to a standstill, and the company is expected to post a loss of $855-million in the second quarter. The forward net-debt/EBITDA for Air Canada is more than 13 times larger than the second-ranked company (Inter Pipeline Ltd.), suggesting that analysts expect the airline to remain highly leveraged at the end of the fiscal year. The decrease in profitability, coupled with high leverage, could further erode its credit rating.
Investors are advised to do their own research before trading in any of the securities shown.
Stephen Donovan, MBA, is a customer success manager supporting Refinitiv’s trading, investment and advisory solutions.
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