Question

On August 20, 2018, S&P lowered its credit rating for Campbell Soup Company to BBB- from BBB after the company announced plans to sell its refrigerated foods and overseas businesses and use the proceeds to reduce its debt (Campbell Soup Company has a significant debt load). S&P believes these divestitures will make the company more reliant on its soup and beverage businesses that appear to be in decline. Discuss why credit ratings are important to a company like Campbell Soup Company. Do you agree with S&P's decision? Finally, Campbell Soup Company has some debt with covenants that are based on leverage ratios. What are the potential consequences if the company violates one of these ratios?

Answer 1

credit ratings are important to a company for following reasons: -

- Lower cost of borrowing:

A company with highly rated instrumet has the opportunity to reduce the cost of borrowing from the public by quoting lesser interest on fixed deposits or debentures or bonds as the investors with low risk preference would come forward to invest in safe securities though yielding marginally lower rate of return.

- Wider audience for borrowing:

A company with a highly rated instrument can approach the investors extensively for the resource mobilisation using the press media. Investors in different strata of the society could be attracted by higher rated instrument as the investors understands the degree of certainty about timely payment of interest and principal on a debt instrument with better rating.

- Rating as marketing tool:

Companies with rated instrument improve their own image and avail of the rating as a marketing tool to create better image in dealing with its customers feel confident in the utility products manufactured by the companies carrying higher rating for their credit instruments.

- Reduction of cost in public issues:

A company with higher rated instrument is able to attract the investors and with least efforts can raisefunds. Thus, the rated company can economise and minimise cost of public issues by controlling expenses on media coverage, conferences and other publicity stunts and gimmicks. Rating facilitates best pricing and timing of issues.

- Motivation for growth:

Rating provides motivation to the company for growth as the promotors feel confident in their own efforts and are encouraged to undertake expansion of their operations or new projects.

With better image created though higher credit rating the company can mobilise funds from public and instructions or banks from self assessment of its own status which is subject to self-discipline and self-improvement, it can perceive and avoid sickness.

- Unknown issuer

Credit rating provides recognition to a relatively unknown issuer while entering into the market through wider investor base who rely on rating grade rather than on ‘name recognition’.

-Benefits to brokers and financial intermediaries:

Highly rated instruments put the brokers at an advantage to make less efforts in studying the company’s credit position to convince their clients to select an investment proposal.

This enables brokers and other financial intermediaries to save time, energy, costs and manpower in convincing their clients about investment in any particular instrument.

S&P's decision: -

No, I don't agree with S&P decision as management focus is to reduce its high debt and focus on its main business which S&P thinks will decline in future. It appears to them it will decline in future. However, management opinion might be different, they are selling off the other businesses to pay off debt and has an chance to give full time to soup business. i personally don't think if soup business is in decline mode they would have taken this step. Therefore, management is focused on its soup business and it will rise in future.

Potential consequences if the company violates one of these ratios:-

Ratios are important and miantaining required ratios is a challenge. However, for investors and banks it is essential to have a required ratios to fetch funds and attact investors.