Downgrade Coming?

It’s revenues have been flat over the past several years, and some analysts are forecasting a decline in their top-line over time, due to the recession. At the same time, company expenses have been increasing—at a record pace. Earnings have declined the past eight years and retained earnings have been in a deficit, with no improvement in sight.

In addition, the company is bleeding cash, forcing it to increase recent borrowings by 7-fold from Q2 to Q3 last year! On top of that, the net increase in liabilities on it’s balance sheet have now increased almost 5-fold….in the Q3 fiscal quarter alone! That doesn’t even take into account Q4, which won’t be reported until March 12, nor the current quarter-to-date in which borrowings are looking like they are keeping pace with previous quarters.

To make things even more challenging, a vibrant, new (but inexperienced) CEO was put in place in January, along with a whole new management team, with a whole new philosophy on how to turn the business around. Namely, they plan to keep borrowing money and increase capital investments in core, as well as non-core businesses, with that borrowed money. They also plan to increase product prices to their best customers, and reduce prices for marginal customers and even give away free products to attract new customers. Their hope is that all this activity and investment will stimulate growth, improve the bottom line and eventually increase the stock price. However, even some of their own accountants and financial advisers, have cautioned them that this stategy is risky and there is a high probability of it failing because it is not focused on the real issue: growing top-line revenue and reducing it’s burgeoning debt.

Currently, this company (unbelievably) still has a AAA-rating. But if you own the bonds, I’d recommend you dump them, soon. If the rating agencies don’t downgrade the company, the market will. Eventually the credit rating on their bonds, will be downgraded, via the magic of the market’s price discounting mechanism. Once this happens, the company will have a very hard time raising capital, and it’s cost of capital will increase. To date, it’s creditors have been very patient and have been getting paid, but there is trouble brewing even with the creditors, as they are facing financial challenges of their own at this time, and their desire to keep lending money to this company is questionable. The wellspring of cash might be drying up for this company.

Should this company be downgraded, or not?