Just four months after it downgraded Forward Air’s debt rating, S&P Global Ratings has done it again.
Two downgrades in four months is viewed as unusually rapid and reflects not only the weak freight market but burdens unique to the less-than-truckload carrier.
Forward was cut to B+ by S&P Global in February. The latest move takes it down an additional notch to a B, which is five steps into non-investment-grade territory. There are 12 non-investment-grade ratings, with D for default at the bottom of the pile.
The move by S&P actually lags the latest downward trend for the rating on Forward Air’s debt. Recent moves by Moody’s and Fitch Ratings to a rating of B2 and B, respectively, put those two agencies below where S&P Global (NYSE: SPGI) was after its move in February to B+. With S&P Global now at B, all three key ratings agencies are at levels considered equivalent.
When Forward Air had its debt rating taken down from BB- to B+ in February, the outlook on the company was listed as “stable.” That generally means conditions are not in place for either an upgrade or a downgrade anytime in the near future.
Outlook is “negative”
But in this latest move, in addition to taking Forward Air down to B, S&P Global changed the company’s outlook to “negative.” A downgrade often comes with a stable outlook as the ratings agency has done its work and has a time frame that does not foresee a significant change in the short or medium term. A negative outlook is often a precursor to a debt downgrade, whereas a positive outlook is often a precursor to a ratings improvement.
Such a quick downward move without an interim move to a negative outlook before the downgrade, followed by being immediately slapped with a negative outlook even after the downgrade, was described by one corporate debt analyst as “not good.”
The report by S&P Global sums up the two-pronged issues at Forward in the opening two sentences. “Ongoing weakness in the freight industry is contributing to weaker-than-expected performance across all of Forward Air Corp.’s operating segments,” the report said. “In addition, we believe the company faces execution challenges associated with cost-savings initiatives and its Omni integration, which pose further downside risk to credit measures and liquidity.”
But S&P then goes on to note that Forward Air also is trying to work through the issues involved in its acquisition of Omni Logistics. That deal, announced last July, has sent the company’s stock crashing and led to financial upheaval in the company that is creating much of the basis for the debt ratings.
“We believe the company faces execution challenges associated with cost-savings initiatives and its Omni integration, which pose further downside risk to credit measures and liquidity,” the S&P report said.
The immediate reason for the move is S&P Global’s new estimate on Forward Air’s (NASDAQ: FWRD) ratio of funds from operations (FFO) to debt. The ratings agency said it now expects that ratio to slide to about 8%.
Falling below 8% does not take that metric at Forward significantly below where it was projected to be in February when S&P Global cut the rating to B+. In that report, S&P said it expected an FFO ratio of 8.2% this year. But the new estimate helped trigger the downgrade.
Weak earnings a possible factor
Forward Air’ first-quarter earnings were considered disastrous. They appeared to be on the minds of the S&P Global analysts.
“The company’s cost profile had trended higher than we had envisioned,” the analysts wrote. “We now estimate weaker operating margins inclusive of the Omni acquisition (and its Final Mile sale), with Omni contributing earnings and cash flow below our previous estimates. The impact highlights a significant decline in our estimates for earnings and FFO this year, and corresponding pressure on FFO to debt.”
Forward defends its outlook
Forward Air provided FreightWaves with a comment on the ratings downgrade. “We ended the first quarter of 2024 in compliance with our covenants and over half a billion dollars in liquidity,” the spokesman stated. “We see tremendous opportunity for Forward to maximize value for customers, employees and shareholders going forward. Our team is focused on execution and we are aggressively taking action to improve profitability, maximize synergy capture and drive our leadership in global supply chain and domestic transportation services.”
Conditions can improve at Forward Air in the next 18 to 24 months, S&P said, “but several risks remain.” There is ongoing cost cutting at Omni, the agency said, and most corporate-wide savings will come from there “as duplicative costs are removed and synergies realized. This primarily includes the consolidation of linehaul routes, facilities, and selling, general, and administrative (SG&A) savings.”
But the changes in the executive suite at Forward Air including new CEO Shawn Stewart and new interim CFO Jamie Pierson “contribute a degree of uncertainty regarding the company’s strategy, particularly with respect to its integration with Omni and cost initiatives,” S&P Global said.
The assumptions S&P is making are that revenue will decline 3% this year after having assumed an increase of 3.5%. Its expedited segments will be down 3%, according to the S&P Global forecast, but its intermodal segment will be down 16% in revenue this year. Revenue from the acquired Omni operations will be down about 1% in 2024.
Free operating cash flow (FOCF), an important metric for the ratings agencies, will be negative $50 million this year. But S&P Global said that includes about $60 million in integration costs. Any improvement in earnings before interest, taxes, depreciation and amortization and in cash flow will need to come from cost savings, which have been announced at $75 million by the company.
The silver lining noted by S&P is that with the integration costs mostly running their course this year, and the cost cuts in place, FOCF at Forward can reverse itself in 2025 to a positive $95 million.
Two indicators suggest improvement
The irony in the downward move is that market indications suggest that on two metrics at least, a bottom in those markers may have been reached, at least for now.
The yield on Forward Air’s 9.5% debt series maturing in 2031 has fallen in recent weeks, suggesting that even as the rating has moved down, investor confidence has increased. A few weeks ago, the yield on the 9.5% debt issue was close to 12% but is now closer to 10.7%.
And the company’s stock price has rebounded recently. It hit a low of $11.21 on May 21. But it reached a one-month high Monday of $22.53 before closing at $20.97, though it remains down almost 83% from the $121.38 where it stood on July 27, just before it announced the Omni deal.
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