Category Archives for "High Yield Strategy"
We are into the home straight for 2020, but one can be forgiven for thinking that the roller-coaster ride might still have a few twists and turns to come yet. As it stands, markets have staged the most incredible of recoveries. There has been much hope littered with periods of fear. Everything has been smoothed over by lashings of central bank liquidity and more recently, the coronavirus vaccine news.
Risk market prices had hit rock bottom back in that early March/April period, but without quite falling out of bed. But we go into the final weeks of the year with the US markets at or around record highs. European markets are at or around being in the black for the year.
Rates have remained better bid throughout. Credit spreads in IG are remarkably flat year to date and we are in positive territory in total return terms in IG and HY (iBoxx index).
The stand-out market though is a non-standard market. It’s the crypto sphere – and Bitcoin in particular. Given huge credibility afforded by Paypal’s most recent participation in the crypto currency, we have seen a remarkable – almost exponential, rise in Bitcoin’s price. It’s not for the faint-hearted, though.
Its price has taken a hammering in Thursday’s session, losing 10% (or $2k per coin) in what is probably a correction, but is still higher by 300% since March, generating option-like returns for investors. Now it’s at around $17,000 USD a coin and some forecasts have it pitched up at more than $100,000 a coin by the end of 2021.
While the equity markets rediscover themselves following that tech-led September sell-off, the credit market hasn’t quite been affected in the same way, or in a way we might have anticipated. That is, higher volatility and a sharp drop in equities usually means wider spreads, especially in higher beta markets. We haven’t seen that.
Instead, spread markets almost across the board have been firm, resolute in the face of the pressure elsewhere (equity market valuations, corporate profitability, a constant feed of geopolitical rumblings, macro uncertainty and so on).
Flow, volumes and investor interest to transact in the secondary market is, well, secondary to the need to get some more risk on board – but through the primary market. IG has a habit of receiving all of the attention and gets all the headlines. But the HY pipeline is building and we are on course for this to be – quite amazingly – a record year for issuance in the euro denominated HY corporate bond market. Another €18bn between now and year-end will do it.
Mid-August greetings – and what a surprise. The US equity markets are toying with a record high in the case of the S&P index. Other markets are feeding off it, rising tides and all that. Should it be so? We’re still gripped by the coronavirus pandemic, as well as the timing of potential for the development of an effective vaccine (facing continual lockdowns, and closing air bridges etc).
There’s also plenty of uncertainty in the West (and others) versus China on a whole host of issues. The US election is also now firmly in view and market volatility in the weeks around it could be something else.
That aside, easier liquidity conditions are here – forever, it seems; In fact, we’re going to see said conditions ease more. That is, there’s more stimulus coming. That money will need a home, so look for ‘the bubble’ to inflate some more and valuations to continue to not fit with any historical models. The message is clear – don’t fight it, chase it. Look for a good run into year-end.
It’s very early days with a mixed start to the second half, but the key takeaway is that markets can continue to move higher. Economies are generally back in business. In some cases, further policy stimulus is coming, consumer confidence and industrial sentiment are recovering, while manufacturing and service sector activity hauls itself off the floor. It’s been a deep recession but also a ‘V’ recovery to start with.
The risks are clear, though. We have an earnings season coming up which isn’t going to be a good one, virus second waves are in evidence across several jurisdictions, and the US promises a more disjointed recovery as a result. China is being a nuisance in several key areas although it has pulled back (for now) in its confrontation on the disputed border with India.
In credit specifically, however, we are in the midst of a record run-rate in IG issuance, where Q2 saw €50bn or more issued in each of the months – the first time in Eurobond history. Few treasury desks are taking chances of something more sinister later in the year.
At €268bn of IG non-financial issuance year to date, we should be past the record €318bn from last year by the end of September – en route, quite possibly, to €400bn for the full-year.
The high yield market has finally plugged into the narrative. In a 6-week period from late February and taking in the whole of March, we didn’t get a single deal. But the primary machinery has started to churn them out now, with €13bn issued in June and July off to a decent start (€3.4bn).
And the pipeline builds. Last year’s full-year record total of €76.4bn looks like being surpassed IF risk markets don’t fall out of bed between now and year-end.
So the appetite for HY paper is recovering as the overall news flow improves. Low rates ‘forever’ and the ECB’s recent increased QE-related purchases have turned the screw. There’s a subliminal message in there somewhere. The crowding-out effect (in IG) will reinvigorate that bid for higher-yielding corporate debt.
Global risk markets have been ripping higher. The huge liquidity injected into the financial system to help ease the pain of the economic downturn is looking for a home anticipating business as normal through H2. That’s before annual GDP growth shoots higher through the second leg of a V-shaped recovery in 2021.
The drivers are clear. All the data post-April is showing us that we are beginning to claw back lost growth, it’s going to be a long journey. Covid-19 transmission rates and associated deaths are declining. Lockdowns are easing. Economic recovery is picking-up albeit not quite bursting out of the starting blocks. That’s understandable.
Rates are lower for longer. The ECB/EU are adding more firepower to make sure there is no relapse and no deflation.
US equities (S&P) are now flat for the year to date and several good sessions away from their record level. European equities of late have joined the party, commodities haven’t done too badly and credit’s lure is undimmed.
We have a record run-rate in IG non-financial primary issuance, the bank AT1 market has re-opened with some massive investor interest and we can see the first signs of light emerging in high yield primary. S&P’s latest default comment has seen the agency give itself a wide berth as to what the default rate in Europe might peak at – a low of 3.5% and a high of 11.3%, but likely around the 8.5% mark.
After an early to mid-May hitting of the proverbial brick wall, credit spreads have resumed their tightening trend. In the high yield market, the Markit iBoxx index has tightened by 14bp in the month to B+641bp – or by 35bp against the mid-May wide. There will be no miracle ratchet tighter because a lot of bad news is still to come, but we are unlikely going to witness a massive blowout in spreads either. We anticipate a steady tightening in credit spreads as macro recovers.
We’ve had more than what could be deemed a spate of issuance, too, with €3.8bn HY debt issued in the euro-denominated market, although we did have Sappi pull their deal as market volatility abruptly ended their ambitions. We don’t doubt that they will be back.
The corporate bond market has made a good comeback of late, mostly evident in the investment grade primary sector. The issuance pace is running at record levels and while April’s monthly deal flow was in itself a record (€57bn), May’s current total suggests it could even surpass that.
Importantly, the reopening of the investment grade market has provided somewhat of a boost to high yield primary. After having drawn a complete blank in the Feb 20 – 15 April period, we’ve since had around €5bn of issuance. Verisure reopened the market, but the likes of Netflix, Stada, Nokia and Synlab have followed.
The BoE has forecast a 14% contraction in the UK economy for 2020 and as much as a 30% in Q2 before roaring back into life in 2021 with a 15% bounce back. So, a painful, temporary collapse but a V-shaped recovery. Across the Eurozone and US, we are witnessing similar patterns with manufacturing and services activity at record lows.
Risk markets have already started to look beyond the economic malaise which will be inflicted in Q2. Equities are holding relatively firm, taking on the incoming macro and corporate earnings data on the chin somewhat. The credit markets have seen record levels of monthly issuance IG and we are seeing the beginning of a thaw in the high yield primary markets.
Credit spreads generally recovered hard following the initial pandemic-driven lockdown weakness, but even in the high yield market, the weakness was nowhere close to the levels seen at the height of the 2008 financial crisis. So we appear to have found a floor reflecting the expectation that markets will recover into H2 as lockdowns are relaxed and we hopefully avoid a second-wave virus shock. High yield spreads/prices have barely moved for several weeks.
Trading into that narrative, we took a look at the NewDay bonds and added a position to our holdings of HY debt, for the reasons listed below. The 18% yield to maturity was also a driver for our investment.
Also see: Our bond portfolio
NewDay (ticker: NEMEAN) is a leading UK credit card issuer – specialising in ‘near-prime’ and prime customers. ‘Near-Prime’ is defined as those who may find it difficult to access credit from mainstream lenders, and it is estimated that between 10-14m UK adults are ‘near-prime’ which is approx. 20-25% of the UK adult population.
100% of the company’s revenues are generated in the UK. Competition for the ‘near-prime’ segment comes from Capital One and Vanquis Bank. NewDay is regulated by the Financial Conduct Authority (FCA).
The group operates ‘own-brand’ credit cards – issued from NewDay’s brands ‘Aqua’ and ‘Marbles’ and ‘co-brands’ credit cards – which are cards issued via corporate partners.
These ‘co-brands’ are often issued by retail stores and online retailers (House of Fraser, Debenhams and Arcadia Group: which includes Topman, Topshop, Miss Selfridge, Burton, Dorothy Perkins and Amazon).
Historically, revenues between ‘own brand’ and ‘co-brand’ have been slightly skewed towards ‘own brand’ but over the past 3 years, its share of FY revenue has been decreasing: FY17 (61% of revenues attributed to ‘own brand’), FY18 (60%) and FY19 (58%).
NewDay is owned by private equity firms: CVC (45%) Cinven (45%) with management owning the rest of the company (10%). It was acquired by CVC and Cinven in October 2016 from Varde Partners for £1bn.
NewDay FY19 results: +15% growth year-on-year on receivables to £3,026m from £2,623m in FY18. Adjusted EBITDA increased to £144m for FY19 from £82m in FY18. Income increased 14% year-on-year, mainly driven by own-brand cards (£676m in FY19 from £591m in FY18.
Net leverage decreased to 1.9x from 2.6x in Q3’19. Provisions also decreased to £20.9m for FY19 from £35.7m in FY18.
The credit market is recovering admirably. We look to have passed peak-virus, even if we are nowhere close to being in the clear. The stimulus packages are helping. But Q2’s earnings numbers are going to be awful in terms of earnings and macroeconomic activity continues to be depressed. But we look beyond that – and the potential for a V-recovery, at worst a shallow W-shaped return to health.
The tone is already improving. Playing into that, there is the rising tide of better equities lifting other markets. Credit spreads have already started their recovery trajectory and we see further potential for a high/low beta compression trade to continue. It’s laboured, admittedly, and will likely stay that way until we get a better handle on the recovery dynamics.
That brings us to the Saga 3.375% May 2024s. A punt? Given the devastation in the travel – and especially the cruise industry, yes. The headline risks are not to be understated. We have taken only a small position based on the view that (for the moment) the group still benefits from a good liquidity position, has suspended dividends with debt holiday/covenant waivers being negotiated for their cruise business (30% of EBITDA).
As a sophisticated investor, we have done this by adding the Saga sterling issue into our new investment portfolio through the WiseAlpha platform.
Also see: Our bond portfolio
These are the reasons why we’ve chosen this Saga bond:
Established in 1950, Saga (ticker: SAGALN) is a provider of insurance and travel products for the over-50s in the UK (100% of revenue is generated in the UK FY16). Insurance products include motor insurance and home insurance policies whilst the travel business offers cruises and package holidays – Saga owns two cruise ships: Saga Sapphire and Spirit of Discovery (delivered in June 2019 at a cost of €380m).
The firm has ordered a third cruise ship – Spirit of Adventure – which is due for delivery in 2020. The entire business is focused on the over-50s and this a wealthy, growing demographic (ONS 2018 Wealth Report). Further, as part of its business involves insurance – the group is regulated by the Financial Conduct Authority (FCA).
The high yield market will likely see a re-opening in primary through Verisure, suggesting that investors are ready to re-enter the market, initially on a cautious and selective basis. That deal is for just €150m and a 5NC1 structure. Nevertheless, it’s the first throw of the dice for a sector otherwise bereft a new deal since 20 February.
The news flow around the sector has been difficult and the market has been in defensive fashion since the coronavirus pandemic hammered risk assets. The recent equity market revival and the Fed stimulus package which has boosted US high yield has had a positive impact on the market in Europe.
Spreads, as measured by the index have recovered almost 30% of their weakness, leaving the iBoxx index at B+646bp (-270bp). The market remains very illiquid, the ability to transact at a reasonable price on the way up or down is poor, but there are pockets of liquidity emerging and opportunities presented as a result.
We have taken a look at the UK retail/food sector and, while high yield rated entities in this sector have come under pressure as a result of the weaker sentiment towards high yield per se, the food sector has had a better time of it as the population has hoarded ahead of – and into – the lockdown.
As a retail investor looking for sub-par paper which should be ‘money good’ (in our view) offering a very good yield, at creditmarketdaily.com we have decided to take a position. We have done this by adding the Iceland sterling issue into our new investment portfolio through the WiseAlpha platform.
Also see: Our bond portfolio
These are the reasons why we’ve chosen Iceland:
A UK-based food retailer, with 1,013 stores (976 UK ‘Iceland’ Stores and 119 ‘Food Warehouse’ stores). The business positions itself at the value-end of the retail market and currently holds 2.2% of the UK grocery market. Competition comes from established grocery supermarkets such as Tesco, Asda and Morrisons and value-end discounter retailers such as Aldi and Lidl.
87% of Iceland’s customers are C1, C2 and DE demographic (clerical, junior administrative jobs, skilled manual workers, semi-skilled and unskilled manual occupations and unemployed) – the most of any other food retailer – therefore it occupies a unique space in the grocery market.
Generally, the business revenues are split into three (LTM-June-2017) equal segments:
In the frozen food segment – ICELTD holds a 15.4% market share. This is the second-largest in the UK and is a key in the company’s strategy to position itself as a differentiated value offering – in essence, in between established supermarkets and discount retailers.
63.1% owned by Brait (first stake acquired in March 2012). 36.9% owned by management.
Net Leverage 5.5x (up from 4.9x y-on-y) as of January 2020.
Revenue increased +2.5%, but it was a challenging quarter as a result of the UK general election. Gross profit was -14% lower at £99m (from £113m in Q3 FY19).
EBITDA declined by 8% for the same period, to £81m. Net leverage increased to 5.5x from 4.9x at Q3 FY19 (last year) to Jan 2020.
There was a large working capital outflow of £33m and this was attributed to trade payments going forward. The company said that will increase going forward as the Swindon Warehouse (which will cost an additional £6m in working capital next year) is opened, but this does add additional capacity for increased sales.
FY2020 will be less than that last year at around £50m (FY19 £63.5m). Please note these results were pre-COVID19 lockdown.