Did you predict the Ahold scandal?

The danger of accounting irregularities creeping up on them is the one gripe that pretty well all credit analysts have about their jobs at the moment. Post Enron, the idea of unwittingly recommending a company that turns out to have cooked its books is enough to bring on a cold sweat. “How do you predict problems such as Ahold’s as an analyst? I think it’s a ferociously difficult job,” says Catherine Gronquist, director of international credit research at Morgan Stanley. “These demands on them have tested all credit analysts on the buy side and the sell side to practically their breaking point in some cases.” This nightmare came true once again when multinational retail group Ahold admitted accounting irregularities. Standard&Poor’s immediately downgraded Ahold’s bonds to junk  and they traded as low as 70 straight away. At press time, there was speculation that the bonds might fall even further to trade as distressed credits.

Something fishy
Euromoney challenged European credit analysts to send in published research on Ahold that could have saved bondholders from their losses. Dresdner Kleinwort Wasserstein sniffed out something fishy last November when Stephanie Foster, director of investment-grade research, said Ahold’s results were a paradox. “Although all indications from the other market participants, particularly in food retail, are negative, Ahold is still managing to pull out strong numbers in both food retail and foodservice,” she wrote. “We find this difficult to explain especially, for example, considering the 6.1% Q3 decline in foodservice sales.” The report concluded by urging investors to remain cautious and underweight on the credit.

JPMorgan’s high-grade consumer and retail analyst, Jonathan Todd, also went underweight on the credit on October 25 last year and on November 19 mentioned that further downgrades at the company and uncertainty resulting from poor communications could produce further spread widening before the company reported its results in March 2003. On January 10 he went further, citing “concerns over slower than expected debt reduction, a weakened US market, Ahold’s Latin American exposure and the group’s accountancy practices”. Congratulations to both firms.

When it comes to fraud, analysts can only go on information, or lack of it, from management in the same way as everyone else. However, analysts are trying to voice their concerns, even if they do not have concrete evidence of wrong-doing. JPMorgan has a list of European names it thinks have strange or cloudy accounting concerns or where bonds have widened recently based on fears of accounting irregularities. These include Bombardier, Olivetti, Suez, Rolls-Royce, Fiat, Volkswagen, Hanover Re and Zurich Financial Services.

Analysts predict that Europe will see still more accounting blow-ups. But investors should not be tempted to buy only highly rated credits in response. That could invite disaster. Matt King, head of European credit strategy at JPMorgan, says: “Owning low quality names isn’t risky per se. As Ahold demonstrates, what’s risky is having too much exposure to what you thought was a safe bet.”