Morningstar has started publishing credit ratings for about 100 of the largest U.S. companies. Over the next year, it plans to produce credit ratings for up to 1,000 companies currently covered by its equity analyst team. The ratings are available for free for institutional equity research clients at its website.
Morningstar is drawing on its equity research, which is has been producing since 1998, to bring a distinct perspective to debt ratings. Its equity analysts produce detailed five-year forecasts of cash flows for stock evaluation. The company then compares these forecasts with liabilities coming due to offer insight into companies' creditworthiness.
An added distinction of Morningstar's credit rating methodology is its reliance on an Economic Moat calculation of competitive advantage in looking at both a firm's financial prospects as well as its business risk.
Morningstar's credit rating is based on four key quantitative and qualitative factors. The first is business risk, which is an evaluation of industry and company risk factors such as Morningstar's proprietary Economic Moat and Uncertainty Rating. Economic Moat is a measurement of a firm's competitive advantage, and the Uncertainty Rating measures the predictability of future cash flows.
The next is the Cash-Flow Cushion, which forecasts future cash flows against firms' financial obligations. There is also the Solvency Score, which is a proprietary scoring system that measures a company's financial leverage, liquidity, interest coverage, and profitability.
The last one is the Distance to Default, which is a quantitative model that projects the probability of a company falling into financial distress.
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