The Long and Short
Focus on names dancing on the debt ceiling
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. This material does not constitute research.
With the debt ceiling looming over the markets, investment grade credits with the most exposure to government contracts should come into focus. These credits have the most to lose should negotiations break down and the current debt ceiling remain in place. While aerospace and defense contractors have some of the most exposure, there are a handful of healthcare and pharmaceutical credits with a significant percentage of premiums derived from Medicare and Medicaid contracts or significant revenues from government reimbursements. Other sectors such as building materials and waste management are exposed through a variety of sub-contractors. The company with the most exposure, Leidos Holdings Inc. (LDOS), falls in the technology sector. However, LDOS’ largest customers include the US Department of Defense, the US Department of Homeland Security, the Federal Aviation Administration and a variety of state and local government agencies.
Although most of the market has focused on the US ability to service its debt without a lift in the debt ceiling, all government programs could see a delay in payments due. This is particularly true with a government running a deficit, which the Congressional Budget Office in February projected at $1.4 trillion for fiscal 2023. That budget includes payments to Social Security, Medicare and Medicaid, the military, veterans, defense contractors and others. If the federal government cannot borrow, it cannot make projected payments.
Any shortfall in government payments should fall most heavily on credits with a significant share of revenue derived directly or indirectly from government programs (Exhibit 1). The longer the debt ceiling stays in place, the bigger the impact. Of course, a much broader set of credit would likely feel the impact from a sharp contraction in fiscal spending.
Exhibit 1: Selected IG credits with US government contract exposure
Source: Company 10Ks, Bloomberg; Santander US Capital Markets
The year-to-date equity performance of most credits heavily exposed to government spending shows some material equity deterioration. Although, a couple of outliers remain including Humana Inc. (HUM) and the Boeing Company (BA). HUM is expected to benefit this year from strong Medicare enrollment as Baby Boomers are expected to drive this tailwind through the end of 2029. However, that growth could put pressure on spreads if Medicare payments are delayed. BA, on the other hand, has been on a huge recovery trajectory after making a comeback from the 737 Max crashes in 2018 and 2019. Most recently, BA won a significant order from Ryanair, for up to 300 737 Max jets valued at $40 billion.
Both building materials and waste management companies also have witnessed strong equity performance year-to-date. Companies that specialize in aggregates, including VMC and MLM have witnessed solid growth this year largely from pricing actions. Aggregates are also expected to benefit from the Infrastructure Investment and Jobs Act, which will expand federal highway spending by nearly 60% by 2026. While neither company has direct government exposure, roughly 40% to 55% of their aggregate shipments are used in publicly funded construction projects. Waste management companies have long been viewed as a recession resistant sector, which has supported performance this year. However, government exposure rests with the multitude of municipalities that they serve.
REIT equity performance has largely been positive. However, REITs with the largest exposure to skilled nursing facilities have the most exposure to government reimbursements. While spread performance in the REIT sector has been pressured due to the current interest rate environment, healthcare REITs could face even further pressure as the debt ceiling looms.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
