McGraw-Hill, Moody’s Risks Rise After S&P Cut

Standard & Poor’s increased the risk of investing in the bond-rating service’s owner and its biggest
competitor by taking away the U.S.’s AAA designation, according to Peter Appert, a Piper Jaffray & Co. analyst.

The chart above compares this year’s performance of McGraw-Hill Cos., S&P’s parent company, and Moody’s Corp. with the S&P 500 Index. Both are higher for the year even after they sustained bigger losses yesterday than the index, which tumbled 6.7 percent in its sharpest drop since December 2008.

McGraw-Hill and Moody’s face two threats because S&P cut the U.S. government to AA+, Appert wrote yesterday in a report.

The first is greater regulatory scrutiny of the rating industry, which has been criticized for flawed assessments of mortgage- backed securities during the past decade’s housing bubble.
“The perception in Washington that the rating agencies have too much power and must be ‘reined in’ will undoubtedly by reinforced by S&P’s decision,” he wrote.

The second risk is that bond sales may become more volatile as the lower rating helps slow economic growth, the report said. Assuming that occurs, revenue and earnings at McGraw-Hill and Moody’s would become less predictable as well.

These issues weren’t big enough to prompt Appert to reduce his ratings on McGraw-Hill and Moody’s. He has the equivalent of a “buy” recommendation on both stocks, which he sees as cheap by comparison with projected earnings. Yesterday’s closing prices were about 11.5 times his profit estimates for next year.