Moody's is materially understating the credit risk of Ryder System, Inc. (NYSE:R) with its Baa1 rating. Our fundamental analysis highlights a much riskier credit profile for R. While their cash flows would cover all obligations going forward, the combination of their cash flows and cash on hand would fall short of all obligations beginning in 2017 as debt maturities would exhaust their remaining cash reserves. We therefore rate R six notches lower at an HY2+ credit rating, or a B1 equivalent using Moody's ratings scale.
Moreover, CDS markets are materially understating R's credit risk with a CDS of 76bps relative to an intrinsic CDS of 231bps, while cash bond markets are understating credit risk with a cash bond YTW of 2.686% relative to an intrinsic YTW of 3.506%.
Cash Flow Profile
We produced a Credit Cash Flow Prime chart for Ryder System, Inc., as we do for every company we evaluate. The chart provides a far more comprehensive view of credit fundamentals than traditional ratio-based analyses. It shows the cash flow generation and cash obligations related to the credit of the firm, adjusted for non-cash financial statement reporting distortions from GAAP. The blue line indicates the gross cash earnings (Valens' scrubbed cash flow number) expected to be generated based on consensus analyst estimates and our in-house research team. The blue dots above that line include the cash available at that time while the blue triangles indicate that same amount plus any existing, available lines of credit.
The colored, stacked bars show the cash obligations of the firm in each year forecast. The most difficult obligations to avoid are at the bottom of each stack, such as interest expense. The obligations with more flexibility to defer year to year, such as pension contributions and maintenance capital expenditures, are at the top of the stacked bars. All of the calculations are adjusted for non-cash distortions that are inherent in GAAP accounting, including the highly problematic and often misused statement of cash flows.
If the company generates and has cash levels that are above their obligations, the risk of default is extremely low. Even if the cash generated yearly is close to the levels of the stacked bars, a company generally has the flexibility to defer payments of various kinds. For example, they can allow assets to age a little longer, or they can cut certain maintenance costs such as maintenance capex. While decisions such as those can create other business concerns, the issue in credit risk is simply this: Does the company have enough cash to service their credit obligations?
R's cash flows would exceed all operating obligations going forward, but would be insufficient to handle all obligations including debt maturities beginning in 2016. Moreover, they may experience a liquidity crunch in 2017, even with the help of their cash on hand. That said, the firm could alleviate liquidity pressures by reducing annual capex outlays. Moreover, their robust recovery rate indicates that they should have access to credit markets to refinance.
Like most people, senior executives and board members do what they are paid to do. This is why R's Form DEF 14A is key to understanding this company's fundamentals, something that credit agencies seem to be missing. Our Incentives Dictate Behavior analysis focuses on R's senior executive compensation and governance. This analysis is meant to help investors understand corporate governance, how aligned a management team may be with shareholder interests, and the potential consequences of a management compensation framework to the business.
R management's short-term incentive compensation payout is based on comparable earnings per share and operating revenue. Meanwhile, their long-term compensation incentives are paid through stock options, performance-based restricted stock rights, and performance-based cash awards.
Both short- and long-term compensation incentives are favorable for an ROA expansion as they may drive management to focus on improving growth and profitability due to the operating revenue and comparable EPS metric. Meanwhile, the ROC metric should keep management mindful about the company's growth and how its assets are utilized. Thus, management appears incentivized to drive sustainable ROA expansion and growth over the long run.
We provide analyses of companies' statements on earnings calls, termed Earnings Call Forensics. This analysis is meant to help assess a management team's confidence in their conference calls when discussing certain areas of the business such as operations, stability, strategies, their ability to manage business risks, and especially their liquidity and solvency.
In the case of R, the analysis of their Q1 2016 earnings call highlights mixed markers from management. Management generated excitement markers when saying that Q1 2016 is in line with their plan and that more tractors are being offshored than vehicles. They are confident that they will have lower capex on new vehicles in 2016. On the other hand, they appear concerned about the sustainability of revenue growth and the sustainability of growth in new customers who are outsourcing for the first time.
Ultimately, a company's credit risk (or lack thereof) is driven by cash available against cash obligations. R's credit risk is being materially understated by Moody's and CDS markets, and understated by cash bond markets given their weak cash flows relative to operating obligations, recurring debt maturities, and sub-cost-of-capital ROA' profile. As a result, ratings are expected to be downgraded and credit market spreads are expected to widen going forward.
Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article along with the lead analyst, Rafael Formoso. Professor Litman is regarded around the world for his expertise in forensic accounting and "forensic fundamental" analysis, particularly in corporate performance and valuation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.