Scope Ratings has today released its final rating methodology for European consumer and business services to complement its existing General Corporate Rating Methodology (last revised on 16 October 2023). This follows the call for comments period from 25 October 2023 to 24 November 2023.

The methodology provides a framework for analysing business risks specific to European business-to-business (B2B) and business-to-consumer (B2C) services companies. The methodology can also be applied to non-European issuers where appropriate. The financial risk profile assessment of services companies remains largely based on the metrics outlined in Scope’s General Corporate Rating Methodology.

The new methodology will improve credit differentiation through an industry-specific credit risk evaluation and a more comprehensive and nuanced assessment of credit factors. Scope’s approach further improves transparency and highlights the relative importance of key rating drivers when analysing services corporates.

Scope’s methodology defines B2B and B2C services corporates as those that generate most of their revenue and cash flow from services provided either to other businesses or directly to consumers. Scope classifies services companies as asset-light or asset-heavy. The methodology also differentiates between business models that i) require a specialised workforce; and ii) use a mainly unspecialised workforce, have services that are operated by the customer, or have digitalised services. IT services are not covered under this methodology.

Methodology highlights

Scope has refined the competitive position assessment for service companies, introducing service strength as a factor specific to the industry and fine-tuning the other three criteria:

1. Market shares: scalability of services introduced as a forward-looking indicator
    
2. Diversification: service offering and cross-selling potential identified as key factors
    
3. Operating profitability: Scope-adjusted return on capital employed and service quality used to assess actual and forward-looking operating profitability
    
4. Service strength: a new credit factor specific to the services industry consisting of i) brand strength and service quality to assess the ability to keep and attract business; ii) revenue stability and predictability as measured by the customer churn rate; and iii) service integration to assess the link to customers and a service’s ease of substitution.

Parameters that generally qualify a services company for an investment grade rating are: a strong brand with a high service strength, a scalable business, good cross-selling potential, a high market share (which translates into price-setting power that enables sufficient profitability) and cash flow with medium or low volatility. Investment grade companies should also be broadly diversified in terms of geographies, distribution channels, product portfolios and customer bases, and be able to sustain strong credit metrics. Companies with a non-investment grade rating will generally lack adequate financial depth and have more volatile revenues and profitability, with balance sheets more exposed to negative developments.

The methodology also covers environmental, social and governance considerations and how they are consistently incorporated into the credit analysis. In the services industry, social aspects are the most important and include labour treatment and working conditions. Environmental aspects also have some bearing on the credit assessment, such as the environmental impact of assets used to provide the services.

Rating impact and reviews

The methodology is expected to have no impact on existing credit ratings that will fall into the scope of the methodology.

The methodology is available for download on this link or on www.scoperatings.com.