In todays article, we shall discuss the rating methodology
adopted by Caricris in assigning ratings for manufacturing
and services companies. Publication of these methodologies
is an important part of Caricris effort to be transparent
and to bring about investor confidence in the analytical robustness
and the objectivity of its credit ratings.
Caricris framework for assessing credit quality of manufacturing/service
companies covers three broad sources of risk that these companies
face viz business risk, financial risk and management risk.
In addition to these three, if the company is in the process
of implementing any large project, project risk is assessed
as a separate risk category.
1. Business risk analysis covers the business fundamentals
of the rated company, the characteristics of the industry
in which it operates, its competitive market position in the
industry, its operational efficiencies as well as the state
of the economy in which the company operates.
2. Management risk analysis includes an evaluation of the
companys management in terms of its competence in running
its chosen lines of businesses, its risk appetite as well
as managements integrity in its dealings with all its
3. Financial risk analysis includes an assessment of the companys
accounting quality, its past financial performance, Caricris
assessment of its future performance and its financial flexibility,
with particular emphasis on its cash flows.
4. Project risk analysis includes an assessment of the nature
of the project, funding pattern for the project and any funding
risks, technology/implementation risks in the project, any
cost/time over-runs and managements experience in this
line of business.
It must be emphasised here that the above framework is the
generalised version of the methodology that Caricris will
use to analyse manufacturing and service companies. The analysis
of entities in specific industries will be based on customised
versions of this general methodology.
Let us now take a closer look at each of the key risk elements.
For the Caribbean region in particular, risks must be assessed
in the context of small, open economies. Factors such as economic
stability, how open the economy is to trade in respect of
a particular industry, the performance and potential threat
of imports, the extent to which the industry players export
their goods, the industrys dependence on government
trade support policies and conversely the ability of industry
players to overcome trade barriers, the governments
tendency to intervene and the overall performance and structure
of the economy are important inputs to the evaluation of business
The relative vulnerability of each Caribbean economy to natural
disasters, such as hurricanes, must also be taken into consideration.
The assessment of the risk posed by the industry in which
a company operates includes an examination of market attractiveness,
extent of competition, bargaining power with customers/suppliers
and government policy.
A market is more attractive if it is bigger, more diversified
and less cyclical with respect to revenues and/or costs. Questions
such as how important the market is to the overall economy,
in what stage of its life cycle is the product and is there
imminent risk of product obsolescence must also be answered.
When high barriers to entry and low threats from substitutes
characterise an industry, either domestic or imported, then
the revenues of entities operating within such an industry
are relatively protected. The extent of bargaining power enjoyed
by a company with its customers and suppliers also indicates
the relative ability to protect margins.
Apart from the foregoing, Caricris takes into consideration
a governments stated or implied position towards an
industry as well as any tendency to intervene/support.
Market position can be broken down into issues that affect
a companys pricing power such as market dominance, brand
equity and price elasticity of demand and an examination of
issues affecting revenue stability such as diversity across
markets, customers and products. Prospects for growth and
sources of competitive advantage are also assessed.
Operating efficiency identifies the factors that impact costs
such as the cost structure, efficiency of production and cost
efficiencies arising from sourcing, distribution and effective
use of technology. Operating efficiency also examines factors
that threaten or ensure the continuity of a companys
operations such as labour relations, product development skills
and research and development.
A companys market position and operating efficiency
must be examined in the context of the industry in which it
operates. Therefore, competitive dynamics such as number of
players, market fragmentation, expansion capacity of key players
and indicative operational efficiency measures across the
industry are key inputs to the assessment of the rated companys
The risk arising from management and its actions has the potential
to override for better or for worse every other source of
risk. Caricris assesses a companys management across
three areas: competence, risk appetite and integrity.
1. Competence examines experience and qualifications, ability
to cope with crisis and external factors, skills in human
resource management, past track record of performance of the
management, stability in the senior management team, adequacy
of planning and succession, etc.
2. Risk appetite looks at managements propensity to
borrow and undertake large projects, its tendency to enter
new markets and products, and its ability to manage the risks
arising from such actions.
When assessing risk appetite Caricris also studies the rated
companys investment and financing policies.
3. Integrity includes aspects such as transparency in group
company transactions, transfer pricing, business ethics and
the overall corporate governance systems and structures to
ensure checks and balances and quality of disclosure.
Caricris begins its financial risk assessment with an evaluation
of a companys accounting policies with a view to determining
the degree of transparency and disclosure exercised by management.
Some of the factors examined are the companys policies
on income recognition, depreciation, inventory valuation and
off-balance sheet items and contingent liabilities and the
consistent application of the chosen policies.
Wherever required, a companys financial statements are
recast to accurately reflect its performance in a format that
is comparable over time and across companies.
Caricris constructs financial projections incorporating its
expectations on economy, industry and business variables as
well as managements strategic plans. Caricris then uses
a variety of financial ratios to analyse a companys
financial strengths, current and future. In addition to earnings,
cash flow is closely examined to determine levels and stability
over time and projected into the future.
Moreover, Caricris examines a companys ability to raise
funds from a variety of sources in times of stress or crisis.
This would include a companys reserves, relationship
with bankers, ability to raise capital from the market, marketable
securities/investments and its overall liquidity position.
The key ratio categories analysed by Caricris are profitability,
capitalisation, debt coverage, cash flow and liquidity.
If a company is executing or intending to execute a major
project, Caricris evaluates the risks associated with that
project as an input into the companys overall credit
rating. Risks affecting the implementation and viability of
the project such as the likelihood of time and/or cost overruns
and risks arising from the funding structure of the project
Caricris will also take into account the companys track
record in implementing projects of similar magnitude.
The size of the project relative to existing operations as
well as its potential impact on existing business indicate
to what extent the project risk assessment will impinge on
the overall credit rating.
Based on the above, Caricris arrives at the stand-alone creditworthiness
of the entity being rated. In addition, Caricris assesses
any external support that the entity/rated debt can derive,
such as support from a stronger parent or group or other forms
of credit enhancement such as a guarantee, if applicable.
Caricris is the Caribbeans Regional Credit Rating Agency.
This article forms part of a series on issues surrounding
capital markets and credit ratings.
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or call 868-627-8879.