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Finding value in liquidity

| 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.

With a heavy new issue calendar and earnings season well under way, keeping up with headlines while making investment decisions has become much harder. Initial price talk has many deals coming with a sizeable concession to secondaries, prompting high demand. However, these concessions often get squeezed to a point that some deals are underperforming post launch. This can provide an opportunity to pick up higher quality credits at attractive levels. One metric to look at is spread per turn of net leverage, since net leverage factors in the liquidity of a credit. During this uncertain time liquidity is likely to be more meaningful to spreads than hitting consensus estimates for the quarter and/or a reiteration of full year guidance.

Exhibit 1:  Single-A Food & Beverage Spread Per Turn of Net Leverage

Source: Company Reports; Bloomberg TRACE; Amherst Pierpont Securities

There’s a Smile in Every Hershey Bar

The above chart shows a decent spread concession in Hershey Company (HSY) bonds relative to peers based on net leverage. HSY’s liquidity is further bolstered by the company’s untapped $1.5 billion revolver. Management noted on its last earnings call that they plan to prioritize cash utilization to meet their liquidity needs and believe that liquidity is adequate given the access to the bank line coupled with its ability to issue commercial paper.  While HSY has $350 million of debt maturing next week (5/15/20), the company already prefunded the maturity when it last tapped the market in late October 2019.  After that, HSY has $350 million of debt maturing on 12/1/20.

Snacks a Clear Winner

In particular, we like the trade out of Coca-Cola Co. (KO) 30-year bonds and into HSY 30-year bonds given that the spread pickup per turn of net leverage is 21 bp. HSY fared slightly better than KO when it came to 1Q20 results as KO posted flat organic revenues for the quarter, while HSY saw a bit of an increase at 0.5%. HSY’s move to expand into savory snacks has been positive as the company’s Skinny Pop and Pirate’s Booty snack businesses grew 20% in the quarter and continue to gain market share. PepsiCo Inc. (PEP) also continues to post strong growth from its snacks business. Frito-Lay North America witnessed 7% organic growth in the quarter. This is important for PEP as this business, while smaller than the beverage business in terms of revenues, carries much higher margins (~30% versus 6%). KO has yet to enter the snacks business.

Exhibit 2: BBB Building Materials Spread Per Turn of Net Leverage

Source: Company Reports; Bloomberg TRACE, Amherst Pierpont Securities

A Busy Week for Building Materials

Both Vulcan Materials (VMC) and Owens Corning (OC) tapped the market this week post the release of 1Q results. Martin Marietta Material (MLM) refrained from entering the new issue fray as the company tapped the market mid-March. The credit profiles all look very similar with net leverage falling within the 2.0x-2.5x range. In fact, both VMC and MLM manage leverage to the aforementioned range with short term increases above the range when they make acquisitions. Proceeds from VMC’s issuance will be used to repay its 2020 and 2021 debt maturities, making the deal leverage neutral.  Furthermore it provides them ample runway post the debt repayment as they have nothing then maturing until 2025. OC’s use of proceeds was listed as general corporate purposes. While the deal will add more cash to the balance sheet temporarily, proceeds will likely be used to fund working capital needs, leading to increased leverage.

While OC currently boasts the biggest spread per turn of net leverage, we expect that spread to contract as leverage rises.  We note that Moody’s is currently forecasting OC’s leverage to increase by 1.65x-1.9x by year end 2020 due to the deterioration in revenue and earnings from the pandemic. Moody’s current scenario expects revenue to decline 15% for the year with EBITDA margins contracting to the 6%-7% range (down from nearly 12% in 2019).  Separately, Moody’s is only forecasting VMC’s leverage to increase 0.5x for the year. That said, VMC provides the more attractive option with respect to spread per turn of net leverage.

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