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Comparing risk compensation vs leverage in new issue Industrials

| May 8, 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.

While investor appetite continues to facilitate tremendous volume in the new issue market, selectivity is making it more difficult for certain issuers to get deals off the ground without generous concessions, and many of the larger deals are struggling in the secondary market after launching. Two studies comparing the new IG Industrial deals can help investors gauge where to get the best available risk compensation: the first provides a snapshot of balance sheet liquidity versus near-term cash needs; and the second estimates how much credit spread investors can be paid per turn of net leverage. Most of the deals summarized continue to trade wide of their original pricing.

The investment grade new issue market continues its torrid pace with $86 billion in new debt pricing from Monday through Thursday (5/4/20 – 5/7/20), following a record setting $285 billion in the previous month.

Exhibit 1. Investment Grade Industrial New Issue over the past week

Source: Bloomberg LP, Company Filings, Amherst Pierpont Securities

While Exhibit 2 may be an oversimplification of the complexities of credit quality, net leverage serves as an adequate proxy to quickly gauge the relative value of one deal versus the next. While qualitative factors and event driven concerns undoubtedly weigh on pricing, investors and rating agencies alike are ultimately inclined to place high importance on balance sheet liquidity and the ability of the issuers to meet their debt obligations. One of the biggest takeaways of the study is the vast disparity in risk compensation on a leverage basis between the high profile launches from Boeing (BA: Baa2/BBB-/BBB) and General Electric (GE: Baa1/BBB+/BBB). Both issuers have been facing considerable difficulties and a crisis of confidence from IG investors. While BA’s challenges have considerable political, legal and economic uncertainty, investors are receiving roughly double the spread compensation per turn of net leverage relative to GE, an indication the deal may be undervalued at current trading levels.

Exhibit 2. Risk Compensation: Spread per Turn of Net Leverage

Source: Bloomberg LP, Company Filings, Amherst Pierpont Securities

Before the Fed announced their new primary and secondary credit facilities to purchase corporate debt and the floodgates opened for most IG issuers to come to market to meet their funding needs, there were significant liquidity concerns in the market in early March. Those headwinds motivated several management teams to preemptively draw down their credit facilities to help calm investors.

Exhibit 3. Liquidity Snapshot – Funds Available vs Near-term Maturities

Source: Bloomberg LP, Company Filings, Amherst Pierpont Securities

Among the most notable was BA’s decision to draw down nearly $14 billion from its existing credit facilities. The action preempted their massive debt launch last week, but afforded them considerable flexibility in the interim and took off pressure to panic-launch a debt deal. Management still has nearly $10 billion available in additional revolvers, and BA sits with one of the better liquidity coverage situations for the next three years on the list below. Ryder (R: Baa1*-/BBB/BBB+) has the tightest margin in terms of near-term liquidity of the names that launched over the past week, and is among the worst in risk compensation on the leverage study. Another highlight is Newcrest Mining (NCMAU: Baa2/BBB), which appears to have less liquidity than the group; however, the 10-year and 30-year debt issued this week was itself intended to fund those near-term maturities, and it will see those metrics improve dramatically on completion of its related debt retirement. The NCMAU 10-year notes are among the most attractive on the list of recent Industrial launches.

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