Woolworths’ credit rating cut

Standard & Poor’s slapped Woolworths with a rating downgrade today. It’s less worrying than the share price reaction suggests.

Yesterday, Woolworths’ share price was saved by the Reserve Bank’s interest rate cut. By contrast, today’s decision by Standard & Poor’s to downgrade Woolworths credit rating has caused it to fall 7%. Some of this decline is probably a delayed reaction to yesterday’s sales announcement.

Credit rating downgrades do have a real impact because they generally mean a company will pay a higher interest rate on its debt. But they’re rarely worth worrying about unduly.

For one thing, they’re backward-looking. They tend to arrive when companies are obviously under pressure. For example, Santos’s credit rating downgrade took place in January 2016 after the stock had already fallen 80% (incidentally marking the recent low point for the stock).

Woolworths’ credit rating has been downgraded to BBB, which is still ‘investment grade’ (although two more downgrades would take it below ‘investment grade’). However, it’s surprising that BBB was also Santos’s rating prior to January. How a ratings agency could consider Woolworths and Santos to be almost equivalent credit risks defies logic.

Woolworths has $3.5bn of net debt on the balance sheet. It’s not particularly stretched but nor is it super-conservative. As we indicated in Woolworths takes tough decisions, cash flows are likely to weaken in the short term so a capital raising is possible if conditions deteriorate.

This is another issue we’ll explore in a full review next week. With the stock closing in on the $20 level a more emphatic positive view looms. BUY.

Note: The Intelligent Investor Equity Income Portfolio owns shares in Woolworths. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

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