Alstom on the cusp

French engineering group Alstom was the worst performing European credit for the second consecutive day after it issued a profit warning yesterday.

The company said that orders for the first nine months of the year (its fiscal year-end is March 31) fell 12% and that it would fail to meet its target of positive free cash flow. Alstom's operating margin will also drop to 7% from 7.2% - its aim was for a stable margin.

A profit warning is never good news but is particularly concerning for Alstom as its investment grade rating appears increasingly vulnerable. It only graduated from high-yield fairly recently, so the management's commitment to maintaining its investment grade rating is the main focus of credit investors.

Alstom's cash burn rate is clearly a problem, as is the outlook for orders. The company has stated that it intends to sell some €2bn in assets to reduce leverage but this may not be sufficient. Alstom has the options of cutting its dividend or raising cash through a rights issue, but the latter was ruled out by management in November. The negative reaction in the stock market, however, suggests that shareholders fear the worse.

S&P rates Alstom 'BBB' on negative outlook, while Moody's rates it 'Baa3' with a stable outlook. If the latter agency changes its outlook in a negative direction, then we could see further volatility in Alstom's CDS. Its spreads widened 17bps to 175bps, and has given up 28bps in the last two days. A profit warning from rival ABB didn't help matters.

Elsewhere, there was a moderately negative tone to the market. The Markit iTraxx Europe was 1bp wider at 72.5bps, while the Markit CDX.NA.IG widened by 0.5bp to 66bp. A bumper Spanish government bond auction had little impact on sentiment, with investors now seemingly accustomed to high demand for peripheral debt.

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