Understanding Corporate Group Rating
When we do the analysis of the group (here), the questions we ask are different, for example: is the group profitable ? Is it risky? What kind of risk? Will the companies involved continue to operate ?
It is not always easy to answer these questions, each group has its own peculiarities, but I try to give you my own ideas.
The Group (for the definition http://en.wikipedia.org/wiki/Corporate_group) is a single entity, but at the same time is composed of different realities inside. So, when we talk about a group’s analysis, we must never forget that in order to determine the economic and financial stability, we must think on two different levels, one leading to another.
The first focuses on checking and determining the structure and composition of the group: we should investigate which companies belong to the group and therefore the relationship of associated and controlled company. This is done for two different reasons: the first is to understand who is the last entity (a physical person or a company) controlling the whole system and, secondly, to determine what companies are belonging to the group. Needless to say, the more players involved, the more intricate it becomes.
The second level on which the study is conducted is to analyze one by one, the companies that make up the group. In case where the size of the subject is significant (numerous companies involved), then we will focus on those companies that are deemed strategic and / or operational, then those that actually contribute to the determination of the soundness of the entire complex.
After conducting the first part of the analysis, we focus on the definition of soundness and solvency. As for this type of analysis, we can envisage various scenarios.
The reality is very complex and there are many different possibilities, but in our case, through simplifying, we can imagine three possibilities as follows:
a. The Group is solid, all the companies that belong to the group to have a good economic and financial situation.
b. The Group has a diverse situation, the holding company and some companies have a sufficient profitability and solvency while others are in crisis (the most common situation).
c. The Group has significant economic and financial problems, many companies belonging to the group are failing.
As for the scenarios A and C paradoxically, in ways diametrically opposed to the outcome of the analysis is relatively simple: in case of A there is nothing to worry about, since the group and the companies that belong to the group have a solid position. In case of C, the questions to be answered can be something like these: is the management taking adequate measures to rehabilitate the group? What are the chances of success in practice? How likely is that the group will continue its operations in the short / medium term, i.e. how much this is likely to fail ?
But in the case of B the likely outcomes are different, below we have the most common case: First, the situation of the parent company is analyzed in depth (or the company that ultimately provides the financial resources). In most cases this is the only holder of all shares and acts as a ” bank ” of the entire group (holding). Precisely for this reason, the following question arises: is it able to meet the financial needs of the subsidiaries ? The indicator that is more useful in this case is just the leverage (definition), which represents the relationship between the third party resources and the resources of their own. If this indicator has low values, there will be no major concerns, in the opposite case however, it could be that the company is already widely leveraged (high value of debt to equity) to meet the demands of its subsidiaries, and this could represent a source of weakness in the whole group.
However, the sensitivity of this topic requires further study: an analysis very helpful is to reclassify the debt maturity profile and make a projection precautionary cash flow of the company, so as to try to capture whether the firm will be able to pay back its debts in the medium and long term.
Also, do not forget that the first objective of a company is to generate wealth, then, secondly, it will be necessary to study the level of profitability of the parties involved and investigate the goodness of the various indices used to describe it (ROE, ROI, …, but not only for a wider choice: link).
The group study is complex because you have to consider different realities and sometimes investigate the robustness which is not always so straightforward. For this reason, we must be able to obtain much information as possible that are not only financial but also qualitative, among them : an analysis of the notes (for more details on the content: link) or report on Operations (link and in particular the outlook) or any other document capable of expressing what could be not only the current situation but also a possible trend future.
Always remaining in the size of the qualitative information, there is also a need to consider some events that may affect the soundness of the entire system, e.g. restructuring plans, layoffs or quality of the leadership, all of the information that help us have an overview as complete as possible.
As we have seen, there are numerous aspects to be considered in the Corporate Group Rating and indeed the types of analysis to be carried out concerning both the quantitative (solvency, profitability, schedule of debts, cash flow, etc.) and the qualitative sphere (restructuring plans, quality of management, etc.). The thing that you have to keep in mind is that every piece of information is important and the more information is gathered, the more you can create a picture of the reality that is complete and comprehensive.