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National Credit Ratings Ltd

Corporate Rating Methodology

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The corporate rating process of NCR starts with a review of the industry in which the company operates along with an assessment of the business risk, financial risk and the quality of the management of the company. Ratings are an assessment of an entity’s ability and willingness to meet financial obligations in a timely manner and are intended to be comparable across industry groups. NCR makes use of the analysis of both the qualitative and quantitative factors to assess the business and financial risks of the corporate entity. To achieve a clearer perspective on relative performance, a company’s historical financial performance is compared with that of others in its peer group. A key rating factor is financial flexibility, which depends, in large part, on the company’s ability to generate cash from operations.

 

1. Industry Risk Analysis:

NCR measures the industry risk by the strength of the industry within the economy. The analysis of industry risk focuses on the prospects of the industry and the competitive factors affecting the industry. The industry environment is assessed to determine the degree of operating risk faced by the company in a given business, investment plan of the major players in the industry, demand supply factors, price trends, changes in technology, international/domestic competitive factors in the industry, entry barriers, capital intensity, business cycles etc are key ingredients of industry risk. NCR also takes into account the strategic nature of the industry in the prevailing policy environment, role of regulation and legislation.

 

2. Business Risk Analysis:

Analysis of business risk involves evaluation of company’s historical performances with emphasis on assessment of adequacy of cash flow to meet its operating expenses. NCR measures the company’s competitive position within the industry by analyzing the historical performances. Some of the key parameters used for assessing business risk are:

 

2.1 Market share

The company’s current market share in its major activities and the historical protection of its position and projected ability for the future are important indicators of the competitive strengths of the company. It also cover the company’s past financial performances and its ability to maintain and improve them. Market leader generally has financial resources to meet the competitive pricing challenges.

 

2.2 Diversification

Companies operating in several industries are assessed by analyzing each major business segment separately. While diversification results in better sustainability in cash flows, NCR analyses the sustainability and adequacy of management structure in such scenario.

 

2.3 Size

Small size firms have limited access to funds leading to lack of financial flexibility resulting in lower protection of margins during economic downturn. Large firms, on the other hand, have ability to sustain, even during difficult times.

 

2.4 Seasonality and Cyclicality

Some industries are cyclical in nature with their performance varying through the economic cycle. Moreover, certain industries are seen to exhibit seasonality. NCR’s rating opinion aim to be stable across seasons and economic cycles and derived by analyzing the long term fundamentals.

 

2.5 Cost Structure

The cost factors and efficiency parameters of existing operations are assessed with respect to expenditure levels required to maintain its existing operating efficiencies as well as to improve its efficiency parameters in a competitive scenario. Nature of technology may also influence the cost structure.

 

2.6 Marketing and Distribution Arrangements

Depending on the nature of the product, NCR analyses the depth and importance of the marketing and distribution of the company.

 

3. Financial Risk Analysis:

Analysis of financial risk involves evaluation of past and expected future financial performance of the company with emphasis on assessment of adequacy of cash flow to meet financial obligations.

 

3.1 Cash Flow:

A thorough analysis of the cash flow statements reveals the ability of a company to pay its obligations. Cash flow analysis is an important tool for the assessment of financial risk.  The cash flow from operations provides a company with more secure credit protection than dependence on external sources. NCR analyses cash flow from core as well as non-core operations, the stability of cash flow and its adequacy to meet debt servicing requirements.

 

3.2 Capital Structure

NCR analyses capital structures to determine a company’s reliance on external financing. To assess the credit implications of a company’s leverage, several factors are considered, including nature of its business environment and the principal fund flows from operations.

 

3.3 Financial Flexibility:

Financial flexibility refers to alternative sources of liquidity available to the company as and when required. Company’s contingency plans under various stress scenarios are considered and examined. Access to alternate sources of funds whenever a company faces financial crunch is reviewed. Other factors that contribute to financial flexibility such as the ability to redeploy assets and revise plans for capital spending are also analyzed.

 

4. Management and Ownership:

 

Evaluation of the management quality is one of the most important factors supporting a company’s credit standing. An assessment of the managements plan in comparison to those of their industry peers can provide important insights into the company’s ability to sustain its business. Capability of the management to perform under stress provides an added level of comfort. Track record of the management team is a good indication for evaluating the performance of the management.

 

4.1 Corporate Governance:

The assessment of corporate governance involves analysis of the governance data and information and review of an entity’s governance practices. The independence and effectiveness of the board of directors are considered to be an essential element of a robust corporate governance framework. The board’s oversight of the audit function is assessed; being an important safeguard in protecting the integrity of an entity’s financial reporting. Special attention is given to the relative complexity of the shareholding/ownership structure, and/or ownership by private individuals and families, and the implications for the management behavior and financial stability of the entity are evaluated. The company’s business plan, mission, policies and future strategies in relation to the general industry scenario are assessed.

 

4.2 Systems & Control:

Adequacy of the internal control systems to the size of business is closely examined. Existence of proper accounting records and control systems adds credence to the accounting figures. Management information system commensurate with the size and nature of business enables the management to stay tuned to the current business environment. Personnel policies laid down by the company would critically determine its ability to attract and retain human resources.

 

4.3 Organizational structure:

An assessment of the organizational structure would indicate the adequacy of the same in relation to the size of the company and also given an insight on the levels of authority and relationship.

4.4 Performance of Group Companies:

Interests and capabilities of the group companies belonging to the same management give important insights into the management capabilities and performance in general.

 

5. Security Risk & Relationship Risk:

These risk factors are from the perspective of facility ratings or Bank Loan Ratings (BLR) and are more relevant to banks for sanctioning credit facility than assigning entity ratings. We have covered these risk factors in our Bank Loan Rating Methodology.

 

Key Ratios:

 

Financial ratios are used to make an assessment of the financial performance of the company and see its relative performance with respect to its peer group within the industry.

 

a. Growth ratio:

Trends in the growth rates of the company vis-à-vis the industry reflect the company’s ability to sustain its market share, profitability and operating efficiency. The focus is drawn on growth in total income, EBIT and NPAT.

 

b. Coverage and Leverage Ratios:

Coverage ratios show the relationship between debt servicing commitments and cash flow sources available for meeting those obligations. Leverage refers to the percentage of debt finance relative to an entity’s total capital. Leverage ratios help in assessing the risk arising from the use of debt finance.

 

Net debt to EBITDA provides perspective on an entity’s debt capacity and ability to meet debt obligations falling due. Debt to Equity ratio or Gearing shows total or net debt as percentage of shareholders equity. Gearing indicates the proportional share of the risk taken by owners and lenders and gives an indication of the flexibility to raise new debt.

 

c. Turnover Ratios:

Turnover ratios also referred to as activity ratios or asset management ratios, measure how efficiently the assets are employed by the company. These ratios are based on the relationship between the level of activity, represented by sales, CGS and the level of various assets including inventories and fixed assets. Inventory turnover ratio measures the number of times a company converts its stock into sales during the year. The asset turnover ratio indicates how effectively a company utilizes its investment in assets. Fixed Assets turnover ratio is a measure of how effectively Fixed Assets (e.g. Property, plant, equipment) are being used to generate sales.

 

d. Liquidity Ratios:

Liquidity ratios such as current ratio and quick ratio are broad indicators of the liquidity position of a company. Liquidity ratios are important parameters for rating short term instruments. Cash flow statements are also important indicators of liquidity.

 

e. Profitability Ratios:

Profitability reflects the final operational result of a company. The ability of a company to earn profit determines the protection available to the company. Gross Margin, Operating Margin and Net Profit Margin are important measures of profitability of a company and are quite helpful in assessing relative profitability of companies within the same industry. Return on Equity measures the annual return on equity. Since ROE is dependent on a company’s capital structure, the use of leverage can increase this ratio, assuming sufficient funds are available to service the debt. Comparing ROE across industries can be misleading, as riskier industries tend to have higher ROEs, which compensate shareholders for the inherent risk of the investment.

 

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For further details please contact:

National Credit Ratings Ltd

3 Bijoy Nagar (2nd & 3rd Floor)

Dhaka-1000

Tel: 0088-02-9359878, Fax: 0088-02-9332769
Website: www.ncrbd.com

 

 

 
NOVEMBER 2010 
DISCLAIMER
NCR has used due care in preparation of this document. Our information has been obtained from sources we consider to be reliable but its accuracy or completeness is not guaranteed. NCR shall owe no liability whatsoever to any loss or damage caused by or resulting error in such information. None of the information in this document may be copied or otherwise reproduced, stored or disseminated in whole or in part in any form or by any means whatsoever by any person without NCR’s written consent. Our reports and ratings constitute opinions, not recommended to buy or to sell.
Tel: 88 02 9359878, Fax: 008 02 9332769 



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