The Big Idea
Lessons learned in corporate credit in 2023 II
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.
One resounding theme in corporate credit this year was the strong technical in the market based on the shape of the Treasury curve. This technical created an insatiable demand for on-the-run issues, leaving relative value by the wayside. Many were willing to forego excess yield for liquidity. That said, the primary market garnered most of the focus with secondary trading flows taking a backseat to primary issuance.
Hit: T-Mobile US Inc. (TMUS) spreads should collapse closer to AT&T Inc. (Published 1/6/23)
TMUS spreads had been trading wide to its wireless peers AT& T Inc. (T) and Verizon Communications Inc. (VZ) at the start of the year despite maintaining better leverage than T and outpacing its peers in subscriber growth (Exhibit 1). At that time, TMUS’ net leverage was at 2.8x, relative to their 2.5x target, and was a tick behind VZ while four ticks better than T. Furthermore, EBITDA margins were outpacing peers as management rolled out its 5G network roughly a year ahead of VZ and T. Wireless additions had outpaced T for the last two quarters of 2022 and were significantly higher than VZ for the entirety of 2022.
Exhibit 1. US Wireless Spread Curve (2Y-10Y) (Published 1/6/23)
Source: Bloomberg TRACE; Santander US Capital Markets
As TMUS continued to outpace its peers in 2023, the spread dislocation became clear. With sizeable on the run issuance, after tapping the market three times in 2023, spreads began to collapse much closer to T. In fact, TMUS trades on top of T in some parts of the curve now (Exhibit 2). TMUS has witnessed double-digit EBITDA growth based on its performance as well synergy capture. In fact, management noted on its last earnings call that merger synergies are expected to be $7.5 billion this year, achieving its full run rate synergy target one year ahead of time. Furthermore, TMUS boasts the highest free cash flow conversion in the industry, providing for significant growth opportunities.
Exhibit 2. US Wireless Spread Curve (2Y-10Y) (Current)
Source: Bloomberg TRACE; Santander US Capital Markets
Hit: Value in Warner Brothers (WBD) on recent widening (Published 9/28/23)
After the company reduced full-year guidance when it reported fiscal 2Q results, WBD spreads widened more than its peer group. The guidance revision reflected the pressure on revenues associated with WGA and SAG-AFTRA strikes. Spreads widened roughly 10-20bp across the curve which seemed like a bit of an overreaction, particularly as management increased free cash flow guidance and reiterated leverage targets. The widening presented an opportunity to enter/add to the credit as there was little risk of the company issuing debt with sizeable concessions that would widen the curve further. WBD remains in debt reduction mode and has repaid $12 billion of debt since its combination with Discovery last year. Furthermore, WBD has repaid almost all of its floating rate debt issued to fund the deal.
Since the publication, WBD spreads have outperformed its peer group (Exhibit 3). While fiscal 3Q earnings saw management caution on its longer-term leverage target of 2.5x-3.0x by year-end 2024, management will remain in debt reduction mode. WBD noted that on average, they have $3.0 billion of debt maturing each year for the next five years. Free cash flow generation of roughly $5.0 billion per year supports full repayment of debt maturities while further investing in the business. An real improvement to EBITDA will need to come from a turnaround in the TV advertising market.
Exhibit 3. WBD Spread Curve vs. Peer Group (9/8/23 vs. 12/12/23)
Source: Bloomberg TRACE; Santander US Capital Markets
Miss: Value in the long end of Tyson Foods (Published 1/27/23)
After coming off record performance in 2022 and boasting strong credit metrics for the ratings, TSN’s long dated bonds appeared well positioned to collapse closer to similarly rated peers, such as McCormick & Co. (MKC). Productivity investments led to stronger EBITDA margins than at the start of the pandemic and management’s focus on debt reduction kept leverage below its long-term target. Furthermore, the company made considerable market share gains across key retail categories as well as the food service business which positioned TSN well for 2023.
However, as 2023 progressed, the protein sector witnessed substantial headwinds which saw operating profit deteriorate at its chicken, pork and beef businesses. The sheer drop in EBITDA, which was down over 60% for fiscal 2023 pushed leverage above the company’s long-term target of 2.0x. In fact, over the course of 12 months, TSN’s leverage climbed two turns to 3.2x. TSN bonds have been the worst performer in the Investment Grade Food & Beverage index. As seen in Exhibit 3, TSN’s curve steepened relative to MKC, with bonds trading in line to wider than lower rated Conagra Brands (CAG).
Exhibit 4. Investment Grade BBB Food & Beverage Curve
Source: Bloomberg TRACE; Santander US Capital Markets
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