"Four months and seven weeks ago (more or less) Moody's brought forth upon the debt markets a new survey, conceived in logic, and dedicated to the proposition that a whole lot of companies are about to go bankrupt."
-- Me (with apologies to Abraham Lincoln)
The title of the survey: "Bottom Rung." And its bottom line reads like this: Nearly 300 of the nation's best-known corporate titans are in peril.
Burdened by debt and strangled by a consumer-driven recession, 283 companies populated Moody's inaugural edition of the report back in March. And since its publication Moody's says "the list has been an accurate indicator of defaults, capturing all but two of the 50-plus defaults of rated non-financial corporate defaults this year."
- Chrysler's bankruptcy? Moody's called it.
- Charter Communications? Moody's got that one, too.
- It also accurately nailed companies that went through "limited defaults" (essentially, distressed debt restructurings), like Ford (NYSE:F) and Hawker Beechcraft (a company part-owned by Goldman Sachs (NYSE:GS)).
Now here's the really scary part. The inaugural edition of "Bottom Rung" contained 283 companies that were rated "B3 Negative or Lower" and at risk of further downgrade. The ensuing months have seen four dozen of these companies default, removing them from the list. Want to guess how many companies remain in peril today?
Let's see now ... so 283 minus 48 equals ... not 235. To the contrary, as the global economy has continued to founder, the population on Moody's report has swelled ever higher. As of June, 288 companies now crowd the "Bottom Rung."
Round up the usual suspects
As published on June 1, the list now includes all the names you'd expect to find:
- We've got airlines -- US Airways (NYSE:LCC) and UAL (NASDAQ:UAUA).
- We've got homebuilders -- M/I Homes and Beazer.
But we've also got more than a few names from industries you'd expect to have a better grip on their finances. Low-fixed-cost, high-margin tech shops such as Advanced Micro Devices (NYSE:AMD), Level 3 Communications (NASDAQ:LVLT), and Palm (NASDAQ:PALM) can all be found standing on the Bottom Rung.
What's it mean to you?
It depends. Moody's estimates that about 45% of the Bottom Rung companies will "default" within 12 months. However, whether that hurts you, the individual investor, depends to a large extent on what particular flavor of "default" occurs. We could be talking about a mere "limited" default -- the sort that Ford incurred when it offered creditors the chance to trade it their risky loans for Ford common stock back in March.. In which case, something short of tragedy could ensue. (Since Ford made its exchange offer, the stock has gained about 300%.)
But what if we get the other kind of default? You know, the sort of massive corporate failure that struck Chrysler or GM? Restructuring debts at these two companies has left common stockholders like you and me with nothing. In which case, "default" can wipe you out entirely.
Um, I'll take the first kind, please
Yeah, me too. But we can't always have our druthers. And to my mind, the combination of:
- a 45% probability that something bad will happen to any given company on the list; plus
- any percentage chance, no matter how small, that such "something bad" could take the form of the company going kaput, and wiping out your investment entirely,
- equals the following conclusion: Keep a close eye on the Bottom Rung list.
After all, Moody's makes the list freely available to the public four times a year. While only paying customers get to see updates as they issue each month, the quarterly reports can be viewed on moodys.com without charge. (Although you do need to register.)
There be dragons
One final word of warning: Disasters come in all sizes, but small companies with weak balance sheets can succumb to economic downturns even faster than big firms with worse balance sheets. Small shops just don't have as many options available to "keep the game running" -- but this fear can also depress their stock prices inordinately, creating even greater upside potential.
That's one reason why we love investing in small caps here at Motley Fool Hidden Gems. But you should also know that we're hip to the risk of debt disasters here at the Fool. As the scale of the current crisis became apparent last year, the Gems team undertook a full-scale review of every stock we recommend, aiming to measure their ability to withstand a prolonged economic downturn. (Recent reports of economic green shoots notwithstanding, we think the rising tide of bankruptcies justifies an extra dose of caution.)
Oh, and just like Moody's, you can see our Defense Ratings free of charge, just by signing up for a free 30-day trial to the service. Start here.
Fool contributor Rich Smith does not owns shares of any company named above. The Motley Fool has a disclosure policy.
