October 2017 – Cincinnati Asset Management

30 Oct 2017

High Yield Quarterly, Market Commentary Rich Balestra - Portfolio Manager 0 comment

Q3 2017 High Yield Commentary

During the third quarter of 2017, albeit at a slower pace, the High Yield Market continued the positive return trend of the first and second quarters. The Bloomberg Barclays US Corporate High Yield Index return was 1.98% for the third quarter. Positive returns of 2.70% and 2.17% were posted for the first and second quarters of 2017, respectively. Year to date the Index has returned 7.00% which leads many asset classes in the fixed income world. As seen in the first quarter of 2017, the lowest quality cohort of CCC rated securities once again outperformed their higher quality counterparts. The widely discussed reach for yield was once again on display. It is important to note that during 2008 and 2015, the lowest quality cohort of CCC rated securities recorded negative returns of 49.53% and 12.11%, respectively.
We highlight these returns to point out that with outsized positive returns come outsized possible losses, and the volatility of the CCC rated cohort may not be appropriate for many clients’ risk profile and tolerance levels. While the 10 year US Treasury finished the quarter essentially where it started, the Index spread tightened 17 basis points moving from 364 basis points to 347 basis points over Treasuries. While the Index spread continues to grind tighter toward the multi‐year low of 323 basis points reached in 2014, it is still a ways off from the 233 basis points reached in 2007. Each quality cohort participated in the spread tightening as BB rated securities tightened 21 basis points, B rated securities tightened 21 basis points, and CCC rated securities tightened 33 basis points.

The Energy Sector was back to its winning ways of 2016 during the third quarter of 2017. The Independent Energy and Oil Field Services Industries provided the tailwind that the Energy Sector needed after the negative returns posted in the second quarter. The Transportation, Utility, and Industrial Sectors were other top performers. The Communications Sector had a bit of tough time during the quarter as the Wireline Industry was the major drag on performance. Finally, the Consumer Non‐Cyclical Sector was one of the bottom performers as Amazon’s takeover of Whole Foods injected much uncertainty into the future landscape of the Supermarket Industry. Additionally, the Healthcare Industry saw more credit specific weakness in some of the hospital operators.

During the third quarter, high yield issuance continued to be fairly robust at $79.8 billion versus $98.7 billion and $77.2 billion during the first and second quarters, respectively. For the third quarter, issuance by broad rating category was essentially divvied up in line by market size of each broad rating category. Year to date issuance stood at $255.6 billion. This pace is very likely to exceed 2016’s total issuance of $286.2 billion.

Even as the Federal Reserve has increased the Federal Funds Target Rate twice this year, yields on intermediate Treasuries have declined with the 10‐year Treasury at 2.33% at September 30, roughly flat from 2.31% at the beginning of the quarter and down from 2.45% at the beginning of the year.

Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. Although the revised second quarter GDP print was 3.1%, the consensus view of most economists suggests a GDP in the 2% range with inflation expectations at or below 2%. It is easy to understand that the “search for yield” that we have witnessed continues and that the high yield market is benefitting from that search.

The most recent FOMC meeting was on September 20th 2017. While the Committee voted to maintain the current Fed Funds Target Rate, they did note that they will initiate a balance sheet normalization program in October i. We expect the program to be a very long and slow process as to best mitigate the risk of riling the markets. The Fed’s current “dot plot” is projecting one hike in December and three additional hikes in 2018. While not all of the projected hikes might come to fruition, the Fed continues to move in the direction of easing up on the accelerator. This is unique relative to the other major central banks. The ECB, BOE, and BOJ have all continued to increase their balance sheets since 2015.

As we have discussed previously, high yield spreads continue to tighten at the same time the restrictive covenant protections contained in the indentures became more relaxed. The weakening of covenant protections has made its way to the loan market as large companies are increasingly able to finance their business with covenant‐lite terms ii. Additionally, weakened covenants are not simply a US phenomenon. International debt deals are increasingly covenant‐lite as well iii. This type of activity is not without consequences. J.Crew Group took advantage of covenants in their indenture to remove collateral value from some creditors. This type of activity is not happening across the board. Some creditors are successful in pushing back against companies while other creditors are not as lucky iv. More and more, a professional manager is needed to select bonds of quality – bonds that compensate the investor for the risks he undertakes in a high yield portfolio.

Being a more conservative asset manager, Cincinnati Asset Management remains significantly underweight CCC and lower rated securities. This underweight contributed to our High Yield Composite performance lagging the return of the Bloomberg Barclays US Corporate High Yield Index (1.66% versus 1.98%) during the third quarter. Over the quarter, we continued to be cautious in our investment strategy, maintaining higher cash balances as we become more selective in our security purchases. Given the positive market performance, these cash balances served as a drag on our performance. We were also underweight the Energy Sector which was the best performing sector for the third quarter. On the other hand, some top contributors of our performance were our credit selections across the Capital Goods Sector as well as the Technology Sector.

The Bloomberg Barclays US Corporate High Yield Index ended the third quarter with a yield of 5.45%. This yield is an average that is barbelled by the CCC rated cohort yielding about 8.5% and a BB rated cohort yielding about 4%. These yields are being earned in an environment that is fairly attractive. There has been a significant amount of central bank stimulus. High Yield has displayed a fundamental backdrop that is stable to improving. The default rate of 1.27% is significantly below the historical average and expected to remain low over the next year. Additionally, the default volume during the third quarter was the lowest amount since the fourth quarter of 2013v. Due to the higher income available in the High Yield market, it is still an area of select opportunity relative to other fixed income products.

Over the near term, we plan to be rather selective. Changes to the Affordable Care Act are on the back burner at best, but tax reform is now front and center. Tax reform does have the ability to be a positive factor for the High Yield Market. That said, the continued tightening of credit spreads needs to be carefully monitored to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. It is important to focus on credit research and buy bonds of corporations that can withstand economic headwinds and also enjoy improved credit metrics in a stable to improving economy. As always, we will continue our search for value and adjust positions as we uncover compelling situations.

This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.

i FOMC Statement September 20, 2017
ii Bloomberg September 26, 2017: “That Junk Loan is Now Basically a Junk Bond”
iii Bloomberg September 29,2017: “High Yield Investors Sweat for Return in Europe Sellers Market”
iv Wall Street Journal September 21, 2017: “Deal to Save J.Crew from Bankruptcy Angers High Yield Debt Investors”
v J.P. Morgan October 2, 2017: “Default Monitor”

30 Oct 2017

Investment Grade Quarterly, Market Commentary Josh Adams - Portfolio Manager 0 comment

Q3 2017 Investment Grade Commentary

The third quarter of 2017 was a reprise of what we experienced in the first two quarters of the year investment grade corporate bond yields were lower and credit spreads were tighter. As far as fundamentals are concerned, the majority of investment grade corporate issuers are displaying earnings growth and balance sheets are generally in good health. Demand for investment grade bonds has been robust in 2017, and issuers have responded in kind by issuing $1.06 trillion in new investment grade corporate bonds, though this pace of issuance trailed 2016 by 5%. During the quarter, the A Rated corporate credit spread tightened from 0.88% to 0.80% (down 8bps), the BBB rated corporate credit spread tightened from 1.41% to 1.31% (down 10bps) and the Bloomberg Barclays US Investment Grade Corporate Index credit spread tightened from 1.09% to 1.01% (down 8bps)ii. To provide some context, the all‐time tight for the Bloomberg Barclays US IG Corporate Index is 0.54%, last seen in March of 1997, while the all‐ time wide is 5.55%, last seen in December of 2008.

As you can see from the chart above, credit spreads are near multi‐year lows. During times like these, when spreads have continued to move tighter, our experience shows that our client portfolios are best served by investing in high quality companies with durable earnings and free cash flow. In other words, we would rather forgo the extra compensation afforded from a lower quality credit and instead focus on investing in a stable to improving credit. Preservation of capital is a key tenet of our strategy, and we do not feel that the current level of credit spreads is providing adequate compensation for the riskier portions of the investment grade corporate bond market. At CAM, we focus on bottom up research through the fundamental analysis of individual companies and we do continue to see pockets of value in the investment grade market, particularly in the higher quality portions of the market.

While credit spreads tightened during the quarter, the movement in Treasury yields was modestly higher as the 10 Year Treasury yield began the quarter at 2.31% and ended it at 2.33% (up 2bps). The 10 Year Treasury started the year at a yield of 2.45%, so while short term rates have increased as the Fed has implemented two rate increases so far in 2017 (i.e. the 2 Year Treasury ended the quarter 27 basis points higher from where it started the year), intermediate Treasury yields remain lower on the year. When short term rates increase and intermediate/long term rates stay stable or decrease, we refer to this as a flattening of the yield curve. This continuation of lower intermediate Treasury yields and tighter credit spreads resulted in lower corporate bond yields at the end of the quarter, relative to where yields started the year. The Bloomberg Barclays US Investment Grade Corporate Index returned +1.34% for the quarter, outperforming the Bloomberg Barclays US Treasury 5‐10 year index return of +0.46%iii. The CAM Investment Grade Corporate Bond composite provided a gross total return of +1.23% for the quarter which slightly underperformed the Investment Grade Corporate index but outperformed the US Treasury index.

See Accompanying Footnotes

New issuance in the quarter saw issuers price nearly $350 billion in new investment grade corporate bonds, bringing the YTD total to $1.06 trillioniv. We have now eclipsed the $1 trillion mark for the sixth straight year, which speaks to the persistent, global demand from investors searching for yield and income for their portfolios. With low‐ to‐negative yields in global fixed income securities, the US Investment Grade corporate bond market still provides a good alternative for global investors (see chart)v.

The Federal Open Market Committee (FOMC) opted not to raise rates at its September meeting, with the market focused squarely on the December meeting. During its September meeting, the FOMC did provide the long awaited details on its program to gradually reduce the size of its balance sheet. The FED is merely reducing the reinvestment of principal payments from the Federal Reserve’s securities; it is not actively selling its holdings. The FOMC has provided a roadmap of its policy normalization efforts along with a schedule of how it plans to gradually reduce its balance sheet over time (see chart)vi. Like most policy actions, the FOMC has showing a willingness to be flexible, pending new information and economic data, so time will tell if the securities reduction schedule is actually implemented as planned.

While the FOMC has begun a gradual effort to tighten monetary policy, the ECB too has discussed scaling back its monetary easing as soon as January 2018, but the plan is vague at this point and the world will be watching closely for more details when they meet again near the end of October. Meanwhile, the BOJ recently pushed back the window for achieving its 2% inflation target for the sixth time; to around fiscal year 2019, meaning the bank will not embark on policy tightening in the near termvii. Bottom line, we are only in the very early innings of a more concerted effort to tighten monetary policy by global central bankers.

A recurring theme for us in our quarterly notes this year has been the lack of market volatility thus far in 2017, and the third quarter of the year was no different from the previous two in that volatility remained low (previous commentaries can be found at www.cambonds.com). Volatility is a fact of life in the capital markets and we know at some point it will return to the forefront. We feel that the best way we can position client portfolios is to focus on the risks that are within our control –namely the quality of the companies in which we invest. While volatility in See Accompanying Footnotes

credit spreads or interest rates is difficult, if not impossible to predict, it is important to understand the impact that higher yields would have on the corporate bond market especially as it relates to a corporation’s balance sheet, cash flows and credit quality. Corporate bond investors are compensated for two risks; interest rate risk and credit risk. In our experience, investors spend a large portion of their time focusing on the risk they can’t control ‐ interest rate risk, and very little time on the risk that can be controlled – credit risk. We as a manager believe that we can provide the most value in terms of assessing credit risk. In our view, the key to earning a positive return over the long‐term is not dependent on the path of interest rates but a function of: (1) time (a horizon of at least 5 years), (2) an upward sloping yield curve (not only the treasury curve but also the credit curve) ‐ to roll down the yield curve, and (3) avoiding credit events that result in permanent impairment of capital. Understanding and assessing credit risk is at the core of what Cincinnati Asset Management has provided their clients for nearly 28 years.

i Bloomberg September 28, 2017 “Investment‐Grade Issuance Total”
ii Barclay’s Credit Research: Daily Credit Call
iii Bloomberg Barclay’s Indices
iv Bloomberg September 29, 2017 “Robust High‐Grade Bonds Sales of September Likely to Fade” v Federal Reserve Flow of Funds
vi Federal Reserve Bank of New York September 20, 2017 “Statement Regarding Reinvestment in treasury Securities and Agency Mortgage Backed Securities”
vii Japan Times July 20, 2017 “BOJ delays window for achieving 2% inflation target”

27 Oct 2017

Investment Grade Weekly, Weekly Insights Kathryn Bailey 0 comment

CAM Investment Grade Weekly Insights

Fund Flows & Issuance: According to Wells Fargo, IG fund flows on the week were $3.2bln. This brings the YTD total to +$277.152bln in total inflows into the investment grade markets. According to Bloomberg, investment grade corporate issuance for the week was $33.71bln, and YTD total corporate bond issuance was $1.163t. Investment grade corporate bond issuance thus far in 2017 is down 3% y/y when compared to 2016.

(Nikkei Asian Review) Abe’s coalition retains two-thirds majority in Japan election

Japanese Prime Minister Shinzo Abe’s ruling coalition held on to a two-thirds majority of the seats in Japan’s lower house after Sunday’s general election, putting the prime minister in a position to move toward revising the country’s pacifist constitution.
Abe’s Liberal Democratic Party and coalition partner Komeito easily saw off a challenge from a divided opposition, gaining 313 seats of the contested 465 seats.
Abe’s victory gives the prime minister a fresh mandate to pursue his cherished goal of reforming Japan’s postwar constitution and to continue his economic-stimulus measures. If he wins a fresh three-year term as LDP leader at a party congress next year, he could govern until 2021, making him Japan’s longest serving prime minister since World War II.
Following the coalition’s victory, Abenomics will get a new start. In the coming months, the prime minister will prepare a 2 trillion yen policy package that is to include making education free.

(TheStreet) Charter and Comcast Shares Get Punished for Cord Cutting

Over-the-top video services such as Netflix and Amazon Prime are eating away at pay-TV’s customer base, but Comcast says cord-cutting isn’t the end of the world.
Comcast badly wants to hold onto its video subscribers, although Chairman and CEO Brian Roberts told investors during a Thursday morning investor call that the cable operator has been preparing for the world of cord cutting.
“We anticipated this shift,” Roberts said. Comcast invested in its Emmy-winning X1 entertainment operating system that allows users to watch Netflix or Alphabet’s (GOOGL – Get Report) YouTube via its platform, developed a remote control that recognizes voice commands and launched the Xfinity streaming app, among other initiatives that enhance its video service.
When customers cut the cord to Comcast’s pay-tv offering, Roberts and other executives suggested, they don’t kill the cable operator’s model.
“Broadband connectivity, both residential and business — that’s now a $20 billion-year business,” Roberts said.
“That is a big portion of our company. That’s growing at double-digit revenue growth, and it is very accretive to our margin.” Over the next five years, he added, broadband usage will only increase with the growth of the Internet of things, smart home applications, virtual reality, 4K video, smart electrical grids and other applications.
Cord cutting actually improves some of Comcast’s metrics, cable unit CEO David Watson told investors.
While Comcast still wants customers to buy a package of video, mobile phone service, home security and other services, as the company has said that the bundle of services reduces customer defections. Or course, the package also boosts revenues. At the same time, though, Comcast actually has higher profit margins if consumers cut out other services. “The economics are very encouraging if they do select broadband only,” Watson said, noting not only the higher profit margins but also the lower cost to deliver just broadband.

(TheStreet) Coca-Cola Proves It’s Not Irrelevant

Coca-Cola Co. reported better-than-feared third-quarter earnings on Wednesday, Oct. 25, as the beverage company continues to reinvent itself for more health-focused consumers.
While Coca-Cola continues to “drive relevance” in its core brands like Coke, CEO James Quincey told analysts on the conference call that expanding its portfolio of smaller brands is crucial to the company’s success.
“The consumer landscape is changing,” he said. “We see an increasing number of smaller, faster competitors” catering to consumers seeking more variety. “In order to thrive in this kind of environment, we need to be more entrepreneurial and agile.” The Topo Chico acquisition is one such effort at “growing our portfolio multiple ways.”
Topo Chico, part of Coca-Cola’s venturing and emerging brands unit, will follow the same playbook Coca-Cola used after acquiring Honest Tea, maintaining the brand’s entrepreneurial spirit while rapidly expanding its reach.
“Growing premium beverage such as adult craft beverages,” like mixers, is another priority, Quincey added. Coca-Cola introduced a premium mixer brand, Royal Bliss, in Spain, and also relaunched Schweppes mixers in the U.K.
Strong North American performance came after Coca-Cola’s biggest competitor, PepsiCo Inc. , reported weak results in the region. Quincey downplayed the comparison, saying that in the highly competitive North American market, “it’s not just one large competitor we face-there are lots of competitors, large, medium, and small.”

(Bloomberg) Lear Full Year Sales Forecast Beats Highest Estimate

Lear forecast sales for the full year; the guidance beat the highest analyst estimate.
- Sees FY sales $20.4 billion, estimate $20.06 billion (range $19.61 billion to $20.33 billion) (Bloomberg data)
- 3Q net sales $4.98 billion, estimate $4.84 billion (range $4.65 billion to $4.95 billion) (BD)
- 3Q adjusted EPS $3.96, estimate $3.74 (range $3.42 to $3.97) (BD)
- Boosts Yr Views for Sales, Earnings, and Free Cash Flow
Lear’s credit profile may continue to be among the strongest of the auto suppliers covered by BI Credit in 2017. Downturn analysis shows the company’s profile weakening, but remaining well within raters’ targets and its maximum leverage covenant. Maintenance of current credit metrics may be sufficient for further upgrades of Lear’s bonds, based on rating providers’ comments. The company’s bonds trade wider than Delphi and BorgWarner, despite having outperformed them over the past year. (Bloomberg Intelligence – 09/25/17)

(Bloomberg) U.S. Notches Solid 3% Economic Growth, Despite Hurricanes

The U.S. economy grew robustly in the third quarter despite two hurricanes, propelled by steady spending from American businesses and households.
Gross domestic product, the broadest measure of goods and services made in the U.S., expanded at a 3% annual rate in July through September, the Commerce Department said Friday. Economists surveyed by The Wall Street Journal had projected a 2.7% gain.
Output expanded at 3.1% rate in the second quarter. This marks the economy’s best six-month stretch since mid-2014.
The third quarter’s strong growth is particularly impressive because two hurricanes—Harvey and Irma—temporarily shut down major population centers in Texas and Florida in August and September. The Commerce Department said in its report Friday that the storms likely suppressed business activity such as oil and gas extraction in Texas and agriculture production in Florida. But the agency added, “it is not possible to estimate the overall impact of Hurricanes Harvey and Irma on 2017 third-quarter GDP.”

27 Oct 2017

High Yield Weekly, Weekly Insights Kathryn Bailey 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$0.1 billion and year to date flows stand at -$7.3 billion. New issuance for the week was $4.3 billion and year to date HY is at $229 billion, which is up 22% over the same period last year.

(Bloomberg) US Issuers to Look to European High-Yield Bond Market in 2018

Banks are anticipating more U.S. companies to tap the European market in a bid to diversify funding and capitalize on the region’s low interest rates in light of ongoing U.S. rate hikes.
“U.S.-based issuers with a desire for euro- or sterling-denominated debt liabilities are increasingly interested in issuing directly in euros or sterling given the relatively low interest rate and tight spread environment that continues to prevail in Europe,” said Mathias Blumschein, co-head of high-yield debt capital markets at ING Groep NV. The economics of issuing in dollars and swapping back into euros have become less attractive, he said.
Bond sales from Diversey Inc, Aramark and Netflix Inc have helped take year-to-date European issuance of high-yield bonds by U.S. firms to a record 11.0 billion euros-equivalent, according to data compiled by Bloomberg. This has already eclipsed the previous highest full-year total of 9.7 billion euros-equivalent in 2016, the data show.

(Pittsburgh Post-Gazette) Arconic Reports Earnings and Announces CEO

Arconic shares tumbled 10 percent Monday after the company reported a third-quarter earnings miss, raised its full-year sales estimate and named a veteran General Electric executive CEO.
The aluminum and titanium parts maker said third-quarter profit fell 28 percent to $119 million, or 22 cents per share, vs. earnings of $166 million, or 33 cents per share, in the year ago quarter. Sales totaled $3.24 billion, up 3 percent from year-ago levels.
Arconic said Charles “Chip” Blankenship, 51, will take over as CEO, effective Jan. 15. Mr. Blankenship formerly led GE’s commercial engine operations and was the president and CEO of its appliance business before the unit was sold to Haier Co. last year. He will also become a member of Arconic’s board.
Arconic said it now expects to report sales of $12.6 billion to $12.8 billion for the year, up from its previous forecast of $12.3 billion to $12.7 billion. The company affirmed its full-year guidance that adjusted earnings will be $1.15 to $1.20 per share.
Arconic was formed in November when Alcoa broke into two companies. The mining, refining and smelting businesses maintained the Alcoa name while the businesses that make aluminum and titanium parts for the aerospace, automotive and other industries became Arconic.

(PR Newswire) International Paper and Graphic Packaging Create Leading Consumer Packaging Platform

International Paper has signed a definitive agreement to contribute its North America Consumer Packaging business to Graphic Packaging in a transaction valued at $1.8 billion. IP plans to use $660 million in cash proceeds from a loan being assumed by Graphic Packaging to pay down existing debt. IP will also receive a 20.5% ownership interest valued at $1.14 billion in a subsidiary of Graphic Packaging that will hold the assets for the combined business. The transaction is expected to close in early 2018, subject to the receipt of regulatory approval and certain other closing conditions.
“After evaluating a range of strategic options, we believe this transaction represents excellent value for IP’s shareholders,” said International Paper Chairman and CEO Mark Sutton. “Investing in Graphic Packaging gives IP the opportunity to benefit from a much stronger value-creation consumer packaging platform, while allowing us to remain focused on growing value in our core businesses. Our North America Consumer Packaging business has a talented team, very good assets and great customers, and I am confident of the results the combined business will achieve.”
International Paper’s North America Consumer Packaging business is a leading producer and converter of solid bleached board used in a variety of fiber-based foodservice products such as hot and cold cups, cartons, paper plates, food containers and liquid packaging. The transaction includes 3,900 Coated Paperboard and Foodservice employees located at 10 locations in the United States and United Kingdom.

(Tech Crunch) Netflix is raising $1.6B in debt as its content costs balloon

Netflix raised a very large lump of debt for the typical laundry list of uses though, the timing comes as its content costs may hit as much as $8 billion next year.
The announcement comes off a strong earnings report last week, where Netflix once again beat expectations for its subscriber growth. The company also said it expects to spend between $7 billion and $8 billion on original content in 2018, up from around $6 billion on original content this year. To be sure, original content — and racking up those Emmy awards — is critical to Netflix’s future as it looks to convert those high-quality shows into new subscribers.
Original content is also going to be increasingly critical as it grows internationally, where it’s acquiring the majority of its new subscribers. Netflix said it would raise its prices earlier this year, and that may temper some expectations for domestic growth. The company’s future may rest on making sure that original content is strong, and also expanding into internationally-oriented original content like its original show 3%. (That show is quite good, by the way, and does a good job of demonstrating that internationally-focused content could perform well domestically as well.)

20 Oct 2017

High Yield Weekly, Weekly Insights Kathryn Bailey 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$0.4 billion and year to date flows stand at -$7.2 billion. New issuance for the week was $2.2 billion and year to date HY is at $224 billion, which is up 21% over the same period last year.

(Bloomberg) Refinancings Boost Corporate High Yield Primary Markets

Corporate high yield debt issuers have been active this month as credit spreads touched three-year lows. Most of the deals are refinancing-related, with the energy sector particularly active on firming oil prices.
Primary markets for U.S. corporate junk bonds have been remarkably active in October, totaling $16 billion through Oct. 15, and will likely surpass the month’s $18 billion historical median volume. Deals linked to refinancings account for about 80% of issuance, a large portion considering just half the total debt tracked by the Bloomberg Barclays U.S. Corporate High Yield Bond Index is refi-related. The index option-adjusted spread to Treasuries touched 341 bps in October, the tightest level in three years.
Issuers in the energy sector lead October sales of new dollar corporate junk bonds, accounting for over a third of the $16 billion sold vs. a 14% share of the total debt outstanding in the Bloomberg Barclays U.S. Corporate High Yield Bond Index. Most were refinancing deals as companies took advantage of oil prices firming above $50 a barrel and demand for high yield debt to extend maturities and strengthen balance sheets.

(PR Newswire) DaVita Provides Additional Information Regarding Patients Receiving Charitable Premium Assistance

DaVita believes that charitable premium assistance will continue to be available to dialysis patients.
In the unlikely scenario that charitable assistance were no longer available to any of its patients, DaVita estimates that the total negative impact to its annual operating income – after related cost offsets – would be in the range of $100 million to $250 million.
DaVita believes that elimination of charitable assistance entirely is unlikely due to the tremendous negative impact on tens of thousands of patients and the fact that it has been part of a stable dialysis ecosystem for decades. In addition, DaVita believes that the fact that most commercial patients would likely retain commercial coverage even without charitable assistance reduces not only the downside to its operating income but also the likelihood of such a scenario materializing in the first place.

(CNBC) Netflix adds 5.3 million subscribers during third quarter, beating analysts’ estimates

Netflix continues to grow, adding 5.3 million net subscribers this past quarter. And it’s willing to spend the money to continue that trajectory, with a new content budget of between $7 billion to $8 billion for next year. The figure is up from the $7 billion figure chief operating officer Ted Sarandos previously said to Variety.
“While we have multi-year deals in place preventing any sudden reduction in content licensing, the long-term trends are clear,” the company said in a letter to shareholders. “Our future largely lies in exclusive original content that drives both excitement around Netflix and enormous viewing satisfaction for our global membership and its wide variety of tastes.”
Netflix latest earnings report beat analysts’ estimates, mostly on the back of its high number of subscription additions. Revenue: $2.98 billion vs. $2.97 billion expected Thomson Reuters consensus estimate
The company now has about 109.3 million subscribers globally. Netflix said it added 850,000 subscribers in the U.S., ahead of the 810,000 Street Account estimate for the quarter. It boomed internationally, signing up 4.45 million subscribers versus the 3.69 million Street Account estimate. The subscription additions were up 49 percent year over year.

(Business Wire) HCA Previews 2017 Third Quarter Results

HCA anticipates revenues for the third quarter of 2017 to approximate $10.696 billion compared to $10.270 billion in the third quarter of 2016. Adjusted EBITDA for the third quarter of 2017 is expected to approximate $1.776 billion compared to $1.957 billion in the previous year’s third quarter.
During the third quarter of 2017, the Company incurred additional expenses and experienced losses of revenues estimated at approximately $140 million associated with hurricanes Harvey and Irma’s impact on our Corpus Christi, Houston, Florida, Georgia and South Carolina facilities. This amount is prior to any insurance recoveries which the Company may receive.
Also, results for the third quarter of 2017 include a negative impact to operating results related to the Texas Medicaid Waiver program of approximately $50 million. This reflects final settlement amounts related to the program year ended September 30, 2017.
Same facility admissions for the third quarter of 2017 increased 0.6 percent, while same facility equivalent admissions increased 0.3 percent, when compared to the third quarter of 2016. Same facility emergency room visits for the third quarter of 2017 increased 0.3 percent from the prior year’s third quarter. The Company estimates that hurricanes had unfavorable impacts of 30 basis points on same facility admissions growth, 80 basis points on same facility equivalent admissions growth and 30 basis points on same facility emergency visits growth during the third quarter.
HCA anticipates reporting its complete financial and operating results for the third quarter of 2017 on, or about, October 31, 2017.

13 Oct 2017

High Yield Weekly, Weekly Insights Kathryn Bailey 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.5 billion and year to date flows stand at -$5.9 billion. New issuance for the week was $7.3 billion and year to date HY is at $222 billion, which is up 20% over the same period last year.

(Bloomberg) OPEC Says ‘Extraordinary’ Steps Needed for Stable Market in 2018

Oil producers are succeeding in re-balancing an oversupplied market, though they may need to take further steps to sustain the recovery into 2018, OPEC Secretary-General Mohammad Barkindo said.
Saudi Arabia and Russia are currently leading consultations between the Organization of Petroleum Exporting Countries and other major suppliers about the future of their agreement to cut oil output, Barkindo said Sunday in New Delhi. The pact expires in March, and oil producers are debating whether to extend it later into the year.
“There is a growing consensus that, number one, the re-balancing process is underway,” he said after meeting with Indian Oil Minister Dharmendra Pradhan. “Number two, to sustain this into next year, some extraordinary measures may have to be taken in order to restore this stability on a sustainable basis going forward.”
Barkindo didn’t elaborate on what those additional measures could be and if they would include the main proposal currently on the table — an extension of the existing cuts by up to nine months — or something else. Venezuela has suggested making deeper cuts, but that’s considered unlikely given the political challenges of getting all members to agree unanimously.

(Phone Arena) Sprint and T-Mobile expected to announce merger details this month

Rumors about the Sprint/T-Mobile merger continue to make headlines, but that won’t go for too long now. Apparently, the carriers are currently ironing out the final details of the deal, so we could have an official announcement laying them out sometime this month.
The companies have reached the point where they need to decide on the exchange ratio that will determine Sprint’s valuation, one of the last steps before the merger could be officially announced.
Sprint and T-Mobile continue to discuss non-cash items, such as the location of the HQ that will shelter the leadership of the new entity resulting from the merger.
People with knowledge of the matter claim that a traditional breakup free will most certainly not be included in the final agreement as to avoid the risk of US regulators rejecting the merger, much like the merger deal between Comcast and Time Warner Cable Inc.
Last but not least, both carriers want to go ahead with the merger as quickly as possible and finalize a deal agreement that can be released at the same time with the quarterly earnings, which is meant to help them avoid confusion over the status of the deal.

(Bloomberg) Callability and Duration Characteristics of HY Market

Over $500 billion of high yield bonds trade above their next call prices, reflecting the market’s extended rally. Communications and consumer staples debt leads subindexes with about $197 billion of the total, including debt from Altice, Charter and T-Mobile US. Health-care names, including Valeant and HCA, are among the non-cyclicals with the highest amount of debt trading above call.
The current environment, with modified duration to maturity at almost 120% of effective duration, historically portends a high probability for negative price returns in subsequent months. Partly that’s because the relationship is largely driven by changes in effective duration and, in turn, the negative convexity characteristics of the high yield market, given widespread use of call features. Periods of negative total returns are rarer given the impact of overall carry.
In negatively convex environments, the relationship between prices and yields changes: bonds become less sensitive to further spread or rate compression, but more sensitive to extension risk should the market-required yield widen substantially.
Almost 60% of the bonds in the Bloomberg Barclays U.S. Corporate High Yield total return index with a duration of less than three years may be sensitive to potential extension risk should spreads widen significantly. On a yield-to-worst basis, these are bonds where the embedded call feature has resulted in the effective duration being at least one year less than the modified duration to maturity. In dollar terms, this is a little over $300 billion, more than half of which has an effective duration below one.

(Bloomberg) Trump Cuts Off Health-Insurer Subsidy, Threatening Obamacare Chaos

President Donald Trump’s administration took its most drastic step yet to roll back the Affordable Care Act, cutting off a subsidy to insurers hours after issuing an executive order designed to draw people away from the health law’s markets.
Late Thursday, the administration said it would immediately stop paying what are known as cost-sharing reduction subsidies. The payments — which are the subject of a legal dispute — go to health insurers in the Affordable Care Act to help lower-income people with co-pays and other cost sharing. Without them, insurers have said they’ll dramatically raise premiums or pull out of the law’s state-based markets.
The White House said the Department of Justice and the Department of Health and Human Services concluded that there is no appropriation for cost-sharing reduction payments to insurance companies under Obamacare.
The payments will stop immediately, with no transition period, Acting HHS Secretary Eric Hargan and Centers for Medicare and Medicaid Services Administrator Seema Verma said in a statement. The next payments were due next week.

06 Oct 2017

High Yield Weekly, Weekly Insights CAM 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $1.1 billion and year to date flows stand at -$6.5 billion. New issuance for the week was $9.9 billion and year to date HY is at $215 billion, which is up 18% over the same period last year.

(Company Report) United Rentals Completes Acquisition of Neff Corporation

United Rentals, Inc. announced that it has completed its previously announced acquisition of Neff Corporation for a total purchase price of approximately $1.3 billion. The purchase was funded primarily through newly issued unsecured debt.
The acquisition will augment the company’s earthmoving capabilities and efficiencies of scale in key market areas, particularly fast-growing southern geographies, and is expected to lead to attractive revenue synergies through the cross-selling of United Rentals’ broader fleet, including its specialty offerings. The assets acquired with Neff include approximately $867 million of fleet based on original equipment cost, and 69 branch facilities serving end markets in the infrastructure, non-residential, energy, municipal and residential construction sectors.
Michael Kneeland, president and chief executive officer of United Rentals, said, “We’re excited to complete the Neff combination and begin leveraging the many areas where we’re stronger together. Today we welcome approximately 1,200 new colleagues who share our focus on safety and customer service.”
The company plans to update its 2017 financial outlook to reflect the combined operations when it releases financial results for the third quarter.

(Company Reports) US Concrete makes several acquisitions

U.S. Concrete has acquired the assets of two independently owned and operated ready-mixed concrete operations, Harbor Ready-Mix and A-1 Materials. The acquisitions include two ready-mixed concrete batch plants and 23 mixer trucks. The acquisitions also include the assets of L.C. Frey Co., Inc., a landscape materials business related to A-1’s operations.
Both ready-mixed concrete operations serve the commercial and residential sectors in the Peninsula and South Bay areas of San Francisco. These favorably located plants give U.S. Concrete increased capacity to serve an expanded customer base in the Northern California market.
U.S. Concrete also acquired the assets of Action Supply Co, which supplies the Philadelphia metropolitan market with high-quality, high-strength ready-mixed concrete to commercial and infrastructure construction projects. Action’s proximity to U.S. Concrete’s aggregates production facility, Corbett Aggregates Companies, LLC, offers immediate synergies from the vertical integration of fine aggregates.
For 58 years, Action has been known for its service and innovation in the delivery of concrete. Action is Pennsylvania Department of Transportation approved and has the capabilities to meet stringent specifications. Action’s well-known projects in Philadelphia include Lincoln Financial Field, Citizens Bank Park, FMC Tower and the South Street Bridge replacement.
Finally, U.S. Concrete has entered into an arrangement agreement with Polaris Materials, pursuant to which U.S. Concrete will acquire all the issued and outstanding common shares of Polaris for C$3.40 per share in cash by way of a statutory plan of arrangement. The price per share implies an aggregate fully diluted equity value for Polaris of approximately C$309 million.
“We believe that Polaris is an ideal strategic fit and enables a replication in California of our vertically integrated business model that we successfully operate in New York” said U.S. Concrete’s President, CEO and Vice Chairman William J. Sandbrook. “The acquisition of Polaris will provide U.S. Concrete with long-term, high quality aggregate reserves and is expected to deliver meaningful synergies and strengthen the Company’s strategic position in the highly attractive, aggregate supply-constrained Californian markets. Following completion of the acquisition, U.S. Concrete expects to have the capability to self-supply a large majority of its market leading ready-mixed concrete operations’ aggregate requirements in Northern California and to drive increased production volumes at Polaris’ Orca Quarry.”

(Reuters) Seagate to give $1.25 bln of $18 bln deal to buy Toshiba chip unit

Seagate Technology said it would contribute up to $1.25 billion towards the purchase of Toshiba Corp’s chip unit by a consortium led by Bain Capital LP.
Toshiba said it had signed an $18 billion deal to sell the unit to the group, overcoming a key – albeit not its last – hurdle as it scrambles for funds to stave off a potential delisting.
Seagate also said it expects to enter into a long-term supply agreement with the unit, Toshiba Memory Corp.
Besides Seagate, Bain’s consortium includes Apple Inc , South Korean chipmaker SK Hynix, Dell Inc and Kingston Technology.

(Barrons) CenturyLink-Level 3 Gains DOJ Approval

The merger of Level 3 Communications and CenturyLink cleared a key hurdle Monday afternoon when the U.S. Department of Justice gave its approval for the deal, subject to some conditions.
For the deal to close, it still needs court approval of some provisions and it remains subject to approval from the Federal Communications Commission and the California Public Utilities Commission.
The muted response of the stocks may reflect that investors had already priced in that the deal would close.

06 Oct 2017

Investment Grade Weekly, Weekly Insights CAM 0 comment

CAM Investment Grade Weekly Insights

Fund Flows & Issuance: According to Wells Fargo, IG fund flows on the week were the 4th largest inflow on record, at $6.3bln. This brings the YTD total to +$248.232bln in total inflows into the investment grade markets. According to Bloomberg, investment grade corporate issuance for the week was $16.15bln, and YTD total corporate bond issuance was $1.077t. Investment grade corporate bond issuance thus far in 2017 is down 5% y/y when compared to 2016. October issuance is off to a slow start, relative to what we have seen through much of 2017, but this can be attributed to earnings blackout as well as the timing of the release of employment data.

(Bloomberg) Disney-Altice Deal Shows Operators Will Still Pay for Sports

Walt Disney Co. and cable provider Altice USA Inc. reached a preliminary programming agreement that will enable 2.4 million New York-area pay-TV subscribers to continue to get ABC, ESPN and the Disney Channel.
The two sides “have extended the deadline accordingly to try and finalize the terms,” according to a joint email on Sunday. No details were included in the statement. The preliminary terms were struck at the last minute, as Disney was about to cut off broadcasting to Altice subscribers Sunday night.
Disney won price increases for its major channels, though not as much as the Burbank, California-based entertainment giant originally asked, according to two people familiar with the terms who asked not to be named because the discussions are private. Altice also agreed to pick up two collegiate sports networks, the people said.
The agreement, if finalized, shows that pay-TV operators are still willing to pay for pricey sports channels even in an age of video streaming and declining viewership. The talks were seen as a litmus test of the business model that’s fueled Disney’s profit for years: charging ever-higher fees for ESPN even though many consumers don’t watch sports, and using the network’s popularity to force pay-TV providers to carry other programming.

(WSJ) Monsanto Boosted by Continued Adoption of New Products

Monsanto has been introducing soybean varieties that are genetically engineered to resist a more powerful combination of herbicides. More than 20 million U.S. acres were sown with the new seeds, the company said Wednesday, and it expects to have the supply for 40 million acres across next year’s planting season.
For the quarter Monsanto reported income of $20 million, or 5 cents a share, up from a loss of $191 million, or 44 cents a share, a year ago. Revenue grew 4.8% to $2.69 billion. On an adjusted basis, earnings were 20 cents a share.
The positive adjusted profit was far higher than the loss of 41 cents that analysts had projected. Monsanto said the better-than-expected results were due to tax benefits and a pretax benefit of $200 million due to corn licenses in Brazil.

(Bloomberg) PepsiCo Makes E-Commerce Bet as Amazon Roils Food Industry

The food-and-beverage giant has created a 200-person business unit that’s tasked with spurring online growth in a fast-evolving grocery landscape. So far, it’s working. PepsiCo is on pace to hit $1 billion in annualized e-commerce sales this year, Chief Financial Officer Hugh Johnston said in an interview.
That’s about double the rate a year earlier, even if it remains a small piece of the pie. PepsiCo has total revenue of about $63 billion a year.
“That business is just really growing like crazy,” said Johnston, who also serves on Microsoft Corp.’s board. “We run it more like a tech company than we do a consumer-products company, and it’s a real star of the portfolio for us right now.”
To further set the online business apart, it’s located in midtown Manhattan — about an hour from the company’s suburban headquarters in Purchase, New York.
The group is focused on marketing and packaging PepsiCo’s products for online sellers, including Amazon.com Inc. and Boxed Wholesale, as well as traditional brick-and-mortar grocers that are trying to boost their digital footprint. The division was founded about two years ago, but PepsiCo has been quiet about it until now.
PepsiCo faces more pressure to go big in e-commerce because grocery sales of soft drinks have weakened, especially in North America. And the overall food industry is bracing for a wave of change. Grocery companies have been rocked this year by Amazon’s $13.7 billion purchase of Whole Foods Market, a deal that sent shares of traditional supermarkets tumbling.

(WSJ) Corona is the New King of Beers

U.S. beer sales are in a funk, but Americans are still clamoring for Mexican suds.
Constellation Brands Inc., STZ the U.S. distributor of Corona and Modelo, reported a 13% jump in beer sales in the summer months. The gains come as market leaders Budweiser and Bud Light are hemorrhaging volume and even craft beer—which until two years ago was growing in the double digits—is experiencing a shakeout.
“It’s a little bit of a misnomer to think that the growth in the beer category, to the extent that there is any, is coming from imports” from around the globe, said the company’s chief executive, Robert Sands, on a conference call Thursday to discuss the latest results. “It is not. It is coming from Constellation’s portfolio of Mexican beers.”
The company has expanded beyond its roots as a bulk wine distributor, adding well-known brands such as Robert Mondavi and spirits like Svedka vodka. It now gets two thirds of its revenue from the beer division, which also includes Ballast Point, a craft brewer it acquired for $1 billion in 2015. In the latest quarter, Constellation purchased the small Florida craft brewery Funky Buddha.
Constellation plans a national launch next year for a new version of Corona called Corona Premier, as well as a rollout of a product called Corona Familiar in major Hispanic markets—a key demographic for the brand.
Constellation attributed 60% of its growth to expanded distribution, and Mr. Sands said Thursday that he’s still unsatisfied on that front. “We don’t have the distribution that we ought to have as a company,” he said. “There’s a big growth runway ahead of us.”

(Bloomberg) Lilly Jumps to Two-Year High After Cancer Drug Patent Upheld

Eli Lilly’s patent for its lung cancer drug Alimta was upheld, the Patent Trial and Appeal Board said in an opinion. Shares rise as much as 2.5% to the highest since September 2015.
- Patent expires in May 2022; Alimta is LLY’s third-biggest drug behind Humalog and Cialis, making up $532.9m or 9.1% of total pharma sales in 2Q: Bloomberg data
- Teva, Apotex, Neptune Generics and others had filed the challenge; other companies later joined the petition
- The PTAB decision can be appealed to the U.S. Court of Appeals for the Federal Circuit, which had already upheld the validity of the patent in January

(WSJ, Press Release) Teva Comments on Anticipated At-Risk U.S. Launch of Generic

Teva Pharmaceutical Industries Ltd. today commented that any launch by Mylan of a generic version of COPAXONE(R) 40mg/ml (glatiramer acetate) prior to final resolution of the pending patent appeals and other patent litigation should be considered an “at-risk” launch, which could subject Mylan to significant damages among other remedies. Additionally, Mylan also announced approval of a generic glatiramer acetate 20mg/mL.
“We have planned for the eventual introduction of a generic competitor to glatiramer acetate,” said Dr. Yitzhak Peterburg, Teva’s Interim President and CEO. “We remain confident in patient and physician loyalty to Teva’s COPAXONE(R) due to its recognized efficacy, safety and tolerability profile, and we will continue to promote and support the product. As we are closing the third quarter, it is too soon to officially comment on any change to our full year business outlook.”
Two appeals will be argued before a single panel of judges of the U.S. Court of Appeals for the Federal Circuit. In the first case, Teva is appealing the December 2016 inter partes review decisions of the Patent Trial Appeal Board that found all of the claims of three COPAXONE(R) patents to be unpatentable. In the second case, Teva is appealing the January 2017 decision of the U.S. District Court for the District of Delaware, which declared certain claims of four COPAXONE(R) patents invalid. The two appeals have been fully briefed and await the scheduling of oral arguments. In additional litigation, Teva brought suit against five Abbreviated New Drug Application (ANDA) filers, including Mylan, for infringement of a patent covering a manufacturing process for glatiramer acetate product.
Due to the anticipated launch of another generic 20mg glatiramer acetate product and the anticipated launch of a first generic 40mg glatiramer acetate product, Teva’s early assessment of the impact of these launches to its earnings for the fourth quarter ended December 31, 2017 is that it could be affected by at least $0.25 cents per share. These conditions are subject to change based on the discount; adoption rate; and other factors of the competitive products. Teva will provide additional details on its 3(rd) Quarter Earnings Conference Call on November 2, 2017.

(Bloomberg) Hurricanes Wash Out More Than Payrolls in September

U.S. payrolls fell 33k in September, considerably weaker than the consensus estimate, which called for an 80k increase. The month of August was revised to a rise of 169k (previously estimated to have been a 156k gain). The two-month payroll net revision was -38k. The 3Q average of 91k currently stands less than half the 2Q average of 187k, and weaker than the 12-month average of 148k.
The hurricanes had an outsized impact on employment. Absences from work due to bad weather (1474k) and weather-related curtailments of average weekly hours (2934k) significantly exceeded their respective historical averages (10-year averages stood at 44k and 236k, respectively, before the report). Average hourly earnings were also vulnerable to storm-distortion. Acute demand for utility workers resulted in a spike in average hourly earnings in the sector, large enough to influence the overall outcome. Average weekly hours for utility workers also jumped. The leisure and hospitality industry bore the brunt of the storms’ impact on employment.