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Technical analysis of 10s/30s credit curves

| March 6, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

In aggregate the widening in investment grade credit spreads over the past two weeks has been a roughly parallel shift across the long end of the curve. However, there are individual issuers/issues where the credit curve has steepened materially in the sell-off. The top and bottom movers in the 10s/30s curve among 300+ issuers are identified so that investors can maximize credit compensation for moving out into 30-year notes in select corporate issuers.

Methodology

The 10s/30s credit curves for all IG issuers that have current 10- and 30-year notes outstanding (>300 issuers) were evaluated to compare the spread available to move out the curve in each individual name before the sell-off (2/19/20, unless new issue) versus the current level. Those analytics provide additional insight on performance within and across sectors, identifying the best opportunities to extend duration and pick up spread. G-spreads are used to smooth any differences in maturities (30-year debt runs from 2044-2051, 10-years are 2028-2031), and the most liquid bonds were utilized for each issuer according to Bloomberg/TRACE statistics. Individual recommendations identify the individual bonds from each issuer that offer the best relative value opportunity. This study is a follow-up to APS – Combing the Selloff, which took a closer look at the anatomy of the sell-off in the corporate bond market. Entire list of 300+ issuers available on request.

Exhibit 1: UST and BBB Corporate Yield Curves – Current vs 2/19/20 and Year-End

Source: Bloomberg

Exhibit 2: BBB Corporate Spread Curves: Current vs 2/19/20 and Year-End

Source: Bloomberg

Generically, the credit spread sell-off has been a parallel shift for the segment (Exhibits 1 & 2) when looking at the aggregate IG market. This implies winners and losers with respect to curve steepness. The average pick-up to extend to 30-year IG corporate debt from 10-year is little changed today (+44) vs before the sell-off (+42), despite the Index widening to +124 from +96. However, the range between max and min for the sample set increased substantially to +187 from +161 before the sell-off. The biggest changes in average 10s/30s spread pick from 2/19 to current are as follows: Energy +11 bp, Nat Gas +14 bp, Consumer Cyclical + 7 bp, Brokers/Asset Mgrs +6 bp, and Technology +4 bp.

While inherently the lower-rated and higher-beta credits appear more likely to see the most steepening in their respective credit curves, this is by no means the sole determinant in how 10s/30s relationships have progressed over the past two weeks. However, several higher rated issuers made their way into the Top 40 results (Exhibit 3). Likewise, some lower-rated names saw their curves flatten. For example, the General Motors (GM: Baa3/BBB) 10s/30s curve steepened substantially, while the Ford Motor (F: Ba1/BBB) curve landed toward the bottom of the list having flattened versus 2/19. While GM is perceived to have a more global footprint, Ford is the weaker credit and one might have expected to see their 10s/30s curve steepen as well.  Instead, the incentive to own long GM vs long F notes has improved by more than +40 bp in aggregate.

Exhibit 3. TOP 50 and BOTTOM 20 – 10s/30s steepeners in credit (since 2/19)

Note: Prior level is 2/19 unless new issue. Source: Bloomberg/TRACE G-spread indications only, Amherst Pierpont Securities

Packaged Food Update: Steep Tyson Curve Provides Attractive Opportunity

Exhibit 4: NA Packaged Food Peer Comparison

Source: Company reports, Amherst Pierpont Securities

A flight to quality coupled with duration needs had us examining the North American Packaged Food curves for relative value opportunities, particularly in light of J.M Smucker’s (SJM) debt offering.  SJM brought $800 million across 10s and 30s this week, pricing with a curve of 55 bp.  That curve has now tightened to 50 bp with the new 30-year outperforming the 10-year. Initial price talk indicated a curve of 60 bp, which was roughly in line with average curve of the combined aforementioned credits. Tyson (TSN), despite being the strongest name in the group from a credit perspective, has the steepest curve. Diving deeper, TSN 2048 bonds offer investors the greatest spread per turn of leverage relative to its peer group, followed by SJM’s new 30-year issue.

Leverage Target Lowest Among Peer Group

While the packaged food peers are largely in debt reduction mode post a spate of acquisition activity, only TSN targets leverage below 3.0x. TSN’s long-term target range for net leverage is 2.0x.  TSN prioritizes debt reduction in their capital allocation strategy and has historically reduced debt quickly post acquisition. This was underscored by its recent repayment of $1 billion of debt within 10 months of the close of its Keystone acquisition. The debt reduction was funded primarily with cash generated during the quarter.  TSN’s strong cash generation should provide for debt reduction of at least $1 billion annually, which should enable them to hit their leverage target by fiscal year-end 2021.

 Turn Up the Volume

Volume growth, or lack thereof, has been a persistent negative theme among the packaged food group. In fact in 2019, volumes for the food and beverage sector fell 0.4%. Price increases to offset increased raw material and transportation costs have largely been met with volume declines.  However, TSN continues to buck the trend and has posted six consecutive quarters of growth. TSN’s retail volume growth was 3.4% in 2019 (5.2% when just looking at TSN’s core business lines). This compares very favorably to its closest peer SJM, which posted growth of 1.9%.

Exhibit 5: NA Packaged Food – 2019 Volume Growth

Source: TSN CAGNY Presentation; Nielsen Fixed Volume EQ Sales (52 weeks ended 12/28/19)

Exhibit 6: Consumer Non-Cyclical

Note: >40 bps only displayed. Source: Bloomberg/TRACE G-spread indications only, Amherst Pierpont Securities

Energy / Basic Materials / Utilities

The Energy segment continues to bear the brunt of much of the coronavirus sell-off so far, with global crude prices selling off roughly 14% since February 19th, and -23% since the beginning of the year. North American pipelines appear unfairly flushed out in this Energy sell-off. While high beta Energy is an easy area for investors to target in periods of global stress, domestic pipeline operators remain comparatively insulated to both foreign events and price fluctuations than Integrated, E&P or Oilfield Services operators. The sell-off appears overdone in these Pipelines names, and investors with higher risk tolerance and the ability to withstand near-term volatility should take the opportunity to increase exposure to this particular subgroup. There is increased spread pick available to move out the curve in the higher-quality names (highlighted in Exhibit 7), such as Dominion Energy Gas Holdings (D), Enterprise Products Operating LLC (EPD), and TransCanada Pipelines, Ltd (TRPCN).

Exhibit 7: Energy

Source: Bloomberg/TRACE G-spread indications only, Amherst Pierpont Securities

Tables covering additional sectors available here.

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