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S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
Global Fixed Income Research: Diane Vazza, Managing Director, New York (1) 212-438-2760; diane.vazza@standardandpoors.com Evan M Gunter, Associate Director, New York (1) 212-438-6412; evan.gunter@standardandpoors.com
Table Of Contents
Debt, Earnings, And Cash Flow Have Grown Since 2011 The S&P MidCap 400 Has More Than Double The Number Of Speculative-Grade Companies Of The S&P 500 Outlooks Have Improved For Rated Companies In The S&P MidCap 400
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Credit Trends:
S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
During the first half of 2013, ratings improved for companies in the S&P MidCap 400, with more than three upgrades for each downgrade and a ratings bias that has grown more positive. While the ratings mix of index constituents has been improving, several credit measures, including debt relative to assets, earnings, and cash flow, appear to have weakened slightly for the index in aggregate. The ratings distribution for companies in the S&P MidCap 400 index is slightly stronger than that of rated U.S. companies as a whole (see chart 1). We can see this by comparing the ratings mix: 57% of the rated companies in the S&P 400 are investment grade (rated 'BBB-' and above), compared with only 46% of rated U.S. companies as a whole. In contrast, the S&P 500 has a much stronger credit mix because 88% of its rated companies are investment grade. The median rating for an S&P MidCap 400 company is 'BBB-', one notch higher than the median U.S. corporate rating of 'BB+', but two notches below the S&P 500 median rating of 'BBB+'. Total debt and EBITDA (earnings before interest, taxes, depreciation, and amortization) of the S&P MidCap 400 companies have each grown by 26% since 2010. Over this period, net debt (or total debt minus cash and short-term investments) to EBITDA has expanded to 2.2x, which is considerably higher for the S&P MidCap 400 than for the S&P 500, where it was 1.4x as of the end of the first quarter.
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
Chart 1
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
Chart 2
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
Chart 3
The median net debt to EBITDA climbed to 1.4x as of March 31, 2013, from 1.1x as of year-end 2011. The number of companies with net debt of less than zero fell to 89 as of first-quarter 2013 from 95 as of year-end 2011. Meanwhile, the number of companies that have net debt that is less than or equal to their EBITDA fell to 141 from 150. Nonfinancial constituents' debt relative to assets and equity has increased since 2011. Total debt relative to total assets increased to 28% as of first-quarter 2013 from 26% as of year-end 2011, while total debt to total debt plus equity rose to 43% from 42%. However, from 2011 to 2012, adjusted measures such as funds from operations (FFO) and free operating cash flows (FOCF) have been climbing. FFO has steadily increased since 2009, and FFO to debt has risen to 23% from 22% over the same period (see chart 4). FOCF has varied considerably since 2008--more than tripling from 2008 to 2009 then declining again in 2010 (see chart 5). The share of companies with negative FOCF declined to 19% in 2009 from 31% in 2008 despite falling revenues because companies maintained cash from operations and slashed capital expenditures, allowing for higher overall FOCF. As the recession ended in 2009, the economic outlook brightened and companies increased capital expenditures, leading to a slight dip in FOCF in 2010. Since 2010, aggregate FOCF to debt has hovered around 7%.
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
To compare these measures, we used credit-adjusted, financial data from CreditStats Direct for nonfinancial rated companies in the S&P MidCap 400 Index. FFO is defined as net income from continuing operations adjusted for depreciation and amortization and other noncash and nonrecurring items, while FOCF can be used as a proxy of a company's cash generated from core operations. Rated companies account for 85% of the nonfinancial constituents' total debt, 73% of total EBITDA, and 63% of total cash and short-term investments. Nonfinancial companies in the S&P MidCap 400 are split nearly equally between investment grade and speculative grade (rated 'BB+' or lower), with 104 companies and 103 companies, respectively. Investment-grade firms have a higher share of EBITDA ($51 billion) than speculative-grade ones ($42 billion). Meanwhile, speculative-grade companies have a higher share of total debt outstanding ($169 billion) than investment-grade ones ($157 billion) (see table 1).
Chart 4
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
Chart 5
Table 1
Total Debt, Cash, And EBITDA For S&P MidCap 400 Nonfinancial Companies By Rating Category
($ bil.) Number of companies 8 96 84 19 136 343 Cash and short-term investments 0.8 24.8 29.3 8.4 37.5 100.7
N.R.--Not rated. S&P MidCap 400 companies from the nonfinancial sectors (including REITs and excluding financial services companies). Data as of June 30, 2013. Source: Standard & Poor's Global Fixed Income Research and S&P Capital IQ.
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
The S&P MidCap 400 Has More Than Double The Number Of Speculative-Grade Companies Of The S&P 500
The S&P MidCap 400 includes 106 speculative-grade companies (including financial and nonfinancial), more than double the 51 in the S&P 500. Overall, 62% of the companies in the S&P MidCap 400 Index are rated, and 140 are investment grade (see chart 6). In comparison, a higher portion of the S&P 500 is rated (88%), and it has a much higher number of investment-grade companies (390). Of the $1.4 trillion total market capitalization of companies within the S&P MidCap 400, companies that Standard & Poor's Ratings Services rates contribute 64% of the total market capitalization. Of rated companies, the 'BBB' rating category is the largest by market capitalization, and the market capitalization of these companies has increased by 20% to $483.6 billion (through June 28) (see chart 7). Market capitalization rose among all rating categories and the unrated category.
Chart 6
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
Chart 7
Since the beginning of the year, upgrades outnumbered downgrades for the index constituents. Standard & Poor's upgraded 21 companies in the index and downgraded six (see tables 2 and 3). The financial sector had the most upgrades, with seven, as several REITs were upgraded. The industrials and utilities sectors followed, with four upgrades each. The consumer discretionary and health care sectors had the most downgrades, with two each. Five companies became rising stars when they were upgraded to investment grade from speculative grade. Standard & Poor's upgraded one rising star, Kansas City Southern, on March 8 while the company was still an index constituent, but it was subsequently moved to the S&P 500 in the second quarter. There are no fallen angels, or companies downgraded to speculative grade from investment grade, from the index so far this year.
Table 2
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
Table 2
Table 3
*Rising stars. Kansas City Southern subsequently removed from the S&P MidCap 400. Data and constituents as of June 30, 2013. Source: Standard & Poor's Global Fixed Income Research and S&P Capital IQ.
Outlooks Have Improved For Rated Companies In The S&P MidCap 400
The positive bias--the percentage of companies that have a positive rating outlook or are on CreditWatch with positive implications and therefore have the greatest upgrade potential--increased to 11.4% from 6.9%. Meanwhile, the negative bias--the percentage of companies with a negative outlook or on CreditWatch with negative implications--decreased to 9.8% as of June 30, 2013, from 10.6% as of Sept. 30, 2012. For the overall population of rated companies in the U.S., the negative bias is higher at 13.3% and the positive bias is lower at 7.4%, as of June 30.
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
Table 4
Sector Consumer discretionary Consumer staples Energy Financials Health care Industrials Information technology Materials Telecommunication services Utilities Total
As of June 30, 2013. Source: S&P Capital IQ and Standard & Poor's Global Fixed Income Research.
By sector, telecommunication services has both the highest negative bias and the highest positive bias of the sectors--with 50% each (see table 4). However, there are only two telecommunications companies in the index. Telephone & Data Systems Inc. has a negative outlook while TW Telecom Inc. has a positive outlook. Aside from telecommunications, the energy sector shows the highest negative bias with 26.7%, and the utility sector has the highest positive bias of 31.3%. Standard & Poor's assigns a positive or negative rating outlook when it believes that an event or trend has at least a one-in-three likelihood of resulting in a rating action over the intermediate term for investment-grade entities (generally up to two years) and over the shorter term for speculative-grade entities (generally up to one year). Standard & Poor's places a rating on CreditWatch if there is at least a one-in-two likelihood of a rating change within 90 days. Potential fallen angels are companies that Standard & Poor's rates 'BBB-' and have either a negative rating outlook or are on CreditWatch negative. A one-notch downgrade would move them to speculative grade and likely lead to higher credit costs. There are currently five potential fallen angels in the index (see table 5). These are First Horizon National Corp., Big Lots Inc., Harsco Corp., Janus Capital Group Inc., and Telephone & Data Systems Inc. Potential rising stars are companies that are rated 'BB+' and have either a positive rating outlook or are on CreditWatch positive. A one-notch upgrade would move them to investment grade and likely lead to lower credit costs. There are currently two potential rising stars in the index, Lender Processing Services Inc. and Steel Dynamics Inc. (see table 6). Corporate funding costs rise considerably when moving down the ratings scale to speculative grade from investment grade. Because a broader mix of investors and institutions can buy and hold investment-grade bonds, companies rated 'BBB-' and higher typically borrow at lower rates than those rated 'BB+' and lower. For example, on June 28, the yield
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
on 'BBB' rated U.S. corporate bonds was 1.5% lower than those on 'BB' rated bonds. We used financial measures from S&P Capital IQ in the charts and tables in this report. Standard & Poor's Ratings Services makes adjustments to company-reported financials according to its criteria, and the adjusted measures may diverge from those S&P Capital IQ reports. We've included these adjusted figures from CreditStats Direct in charts 4 and 5 of this report. The S&P MidCap 400 is an index that measures the performance of midsize companies and is distinct from the S&P 500 (see us.spindices.com for details regarding the S&P MidCap 400 Index's construction).
Table 5
Old Republic International Corp. NYSE:ORI StanCorp Financial Group Inc. Trustmark Corp. Raymond James Financial Inc. The Brink's Co. First Horizon National Corp.* Big Lots Inc.* Harsco Corp.* Janus Capital Group Inc.* Telephone & Data Systems Inc.* FTI Consulting Inc. Greif Inc. The Scotts Miracle-Gro Co. R.R. Donnelley & Sons Co. Bill Barrett Corp. Rovi Corp. Scientific Games Corp. Alpha Natural Resources Inc. Arch Coal Inc. Forest Oil Corp. SunEdison Inc. NYSE:SFG NasdaqGS:TRMK NYSE:RJF NYSE:BCO NYSE:FHN NYSE:BIG NYSE:HSC NYSE:JNS NYSE:TDS NYSE:FCN NYSE:GEF NYSE:SMG NasdaqGS:RRD NYSE:BBG NasdaqGS:ROVI NasdaqGS:SGMS NYSE:ANR NYSE:ACI NYSE:FST NYSE:SUNE
*Potential fallen angel. Data, index constituents, and ratings as of June 30, 2013. Source: Standard & Poor's Global Fixed Income Research and S&P Capital IQ.
Table 6
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Credit Trends: S&P MidCap 400 Credit Profile: Earnings Growth Tempers Rising Debt
Table 6
*Potential rising star. Data, index constituents, and ratings as of May 31, 2013. Source: Standard & Poor's Global Fixed Income Research and S&P Capital IQ.
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