Value Line assigns Financial Strength ratings across a spectrum from A++ (Highest) to C (Lowest). Generally speaking, the largest companies with the strongest balance sheets get the highest scores. Factors considered in making a rating determination include balance sheet strength, corporate performance, market capitalization, stability of returns, and business outlook, among others.
The covering analyst reviews a company’s Financial Strength rating quarterly. If he or she believes a change is needed, the recommended change is brought to the attention of a senior analyst. The covering analyst must then defend the decision based on his or her knowledge of the company and its industry. If the analysts are in agreement, then a change is made. If there is still a question, the analyst may be asked to monitor the company’s finances carefully over the next three to six months.
Market events may also affect Financial Strength ratings, so that the above process may take place at any time. A senior analyst who has noticed a particular trend in an industry or sector may also initiate a re-evaluation of a Financial Strength rating. In this case, the senior analyst may ask an individual analyst or a collection of analysts to review the financials and report back.
The Financial Strength rating and a stock’s Price Stability rank are the two main components used to determine Value Line’s proprietary Safety Rank, which measures the total risk of a stock relative to the approximately 1,700 other stocks under Value Line review.
Although a company’s Financial Strength rating is just one factor among many that investors should consider, it is an important one. Moreover, shareholders should take particular note of changes in this rating—both up and down. Value Line subscribers have access to our complete list of Financial Strength upgrades and downgrades each week in the Selection & Opinion section of the product. Noted here, however, is a recent upgrade awarded to Sigma-Aldrich (SIAL) and a downgrade given to Central European Distribution Corporation (CEDC).
Central European Distribution Corp.
CEDC, along with its subsidiaries, engages in the production, importing, and distribution of alcoholic beverages in Poland, Hungary, and Russia. Popular vodka brands that it distributes include Royal, Parliament, and Soplice. The company also imports various spirits, beer, and wine such as Jim Beam Bourbon, Remy Martin Cognac, and Budweiser (Budvar). Central European’s distribution channels include small and mid-size retail outlets, duty-free stores, and supermarkets. In 2011, the sales breakdown was as follows: Vodka, 80%, Beer, 5%, Wine, 10%, Spirits other than vodka, 3%, Other, 2%.
The alcohol company has faced its share of challenges lately. Last year’s performance was less than stellar, as CEDC recorded a full-year share loss. Factors such as higher input ingredients led to increased pricing and reduced demand. Tough market conditions in Russia and unfavorable exchange rates also contributed to the bottom line weakness. Furthermore, challenges in the distribution network are not helping to alleviate investor concerns.
We recently lowered the Financial Strength rating of CEDC, from a C+ to a C, after the company announced that it will not be able to pay its obligation of $310 million in convertible debt due in March 2013. This means that Central European will have to consider selling more of the company to Russian Standard (it already owns 9.9% of CEDC), which has expressed interest in upping its equity ownership. Another option is an outright sale of the company. Whatever the outcome, the near term outlook for Central European as it is currently constituted, is a bit gloomy.
Sigma-Aldrich Corporation is a life science and high-technology company. The organization develops, manufactures, purchases, and distributes a vast array of biochemicals, organic chemicals, chromatography products, and diagnostic reagents. Its products are used for research and development at universities, for the diagnosis of disease, and as specialty chemicals for manufacturing processes. SIAL markets over 176,000 products in 166 countries, and derives around 35% of its revenues outside of the United States.
The company possesses a stellar balance sheet, at this time. At the end of 2011, it had approximately $665 million in cash and roughly $220 million in near-term debt due. This scenario enables Sigma to strategically spend in order to expand the business. One growth avenue being explored is through acquisitions. It recently purchased BioReliance for $350 million in an all-cash transaction. BioReliance provides biological testing, specialized toxicology studies, and animal health services. This tuck-in acquisition is estimated to tack-on about $0.05 to SIAL’s share earnings this year. In addition, it is investing in foreign countries, most notably, through the establishments of new distribution and packaging centers in India and China. Furthermore, the bottom line should also benefit from new-product offerings in analytical biology and material science, as well as aggressive promotional activities at home.
All told, the rise in Financial Strength from A to A+ appears to be well deserved. The company has proven that it is a good warden of shareholder investments because of its effective utilization of capital. And SIAL rewards investors with annual dividend increases, and, on occasion, share buybacks.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.