Credit markets fell into a trap with this conglomerate
Conglomerates might be difficult to evaluate as they operate multiple businesses under the same umbrella.
While some of the businesses may perform well and have high growth opportunities, the other businesses may drag the conglomerate down.
That is why equity markets usually apply an economic concept to these types of companies called the “conglomerate discount”.
One great example is Griffon Corporation (GFF). But in this case, the conglomerate discount is playing double duty for the company as credit markets are applying a discount for its credit ratings too.
Let’s have a look at the company through the Uniform Accounting lens and see how the conglomerate discount has been dragging down the company’s actual credit risk assessment.
We can use Uniform Accounting to put the company’s real profitability up against its obligations and decide for ourselves the true risk of this business.
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Conglomerates are large corporations that own and control diverse businesses across different industries.
These companies are more complex and potentially subject to inefficient management across a set of various industries and businesses.
Even if that’s not the case, some businesses in the portfolio of companies may perform well and others may not, depending on economic cycles.
This situation usually leads to lower investor confidence and valuation in the stock market, resulting in an economic concept called the “conglomerate discount”.
One of the victims of the conglomerate discount has been Griffon Corporation (GFF).
The company makes home and building products including fans and storage and organization products for residential, industrial, and commercial use.
Also, it is the largest manufacturer and marketer of garage doors and rolling steel doors in North America.
Additionally, it has made things like microphones and radars for the Navy for 90 years but divested that business last year.
The conglomerate is also seeking strategic initiatives to spinoff or divest from some of its businesses in order to focus more on home improvement space.
So, it’s a conglomerate… but it’s a sleepy one at that.
Its primary business, home and building products, is not in an exciting or high growth industry as well, but it’s not a dying business.
This means the company doesn’t typically have amazing returns, but it is doing well enough to finance its operations pretty easily.
However, rating agencies seem to miss that fact.
S&P, for instance, thinks that it’s just a conglomerate, has dying businesses in its portfolio, and will have difficulty with meeting its obligations in the next few years.
Due to these factors, S&P gave a B+ rating to the company, implying a chance of default of around 25% and placing it among the lowest tranches of the high-yield basket.
We think that Griffon doesn’t deserve this double down conglomerate discount, at least not on the credit side. The company only has one debt maturity in the next five years, and it should have plenty of cash flow to cover that.
This rating is unreasonably low, let’s take a look…
We can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (“CCFP”) to understand how the company’s obligations match against its cash and cash flows.
Griffon only has about $1 billion in debt coming due in 2028. Despite being a sleepy business, it’s one that should keep having the cash flows necessary to keep the lights on in the coming years, and it should be able to service all its debt down the road, or refinance, as necessary.
It also has lots of cash flows to service all obligations going forward, including a debt maturity in 2028.
In addition, unlike typical conglomerates, Griffon is taking steps to focus its efforts into a specific industry.
Because of these reasons, at Valens, we think that Griffon does not deserve to be among the lowest of high-yields and should have a much safer credit rating.
That’s why we are giving an IG3+ rating to this company. This rating only implies a probability of default of around 1% and places the company in the investment-grade basket.
It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.
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Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research