Question

** When analyzing the collateral and analyzing the business risk and ability to pay for corporate bonds, market participants often separate issuers into these four sectors:

(1) Utilities, (2) Transportation, (3) Industrials and (4) Banks/Financial Institutions.

1. Why are transportation companies considered separately from industrial companies? In other words, what is different about these types of companies?
2. Why are utilities considered separately from industrials? In other words, what is different about these types of companies?

Answer 1

a]

Transportation companies are those engaged in transportation services such as airlines, railroads, roadways, shipping etc. whereas the industrial sector comprises companies manufacturing goods. Companies engaged in the transportation sector have risks and financial metrics different from those in the industrial sector. Transportation companies typically have higher payback periods, higher cost of capital, and lower ROE compared to industrials. This is because of their higher initial investment, higher risk (required rate of return), and longer periods required to turn profitable.

b]

Utilities are companies involved in providing basic services such as electricity, water, natural gas etc. They are usually more regulated than industrials, since they provide basic public services. Utility companies typically require large investments in infrastructure, and therefore usually have significant amounts of debt. ROE is limited due to heavier regulation. They have a stream of regular cash flows which do not have the potential for sharp growth (as they are regulated), but are usually stable over long periods. However these cash flows are required to upgrade and maintain infrastructure, and to service debt.