The Long and Short
Finding relative value beyond financials
This material is a Marketing Communication and does not constitute Independent Investment Research.
With investment grade corporate bond spreads continuing to trade at the tight end of their 5-year range, even in the face of recent US Treasury volatility, investors should take a close look at relative value. Financials still look like the most attractive broad sector. But media entertainment, cable satellite, aerospace/defense and automotive also look appealing. And each sector includes at least a name or two that clearly stand out.
Financials still look relatively attractive
For the past several months, financial sectors have traded between the 22nd and 32nd percentile of their 5-year spread range (Exhibit 1). Other sectors have traded much tighter. Basic industry, for example, trades at the 0th percentile of it 5-year range, meaning it trades at the tightest spreads in the last five years. Other sectors trade similarly tight. Others only modestly wider. However, by drilling down a layer deeper, investors can find attractive corners of the non-financial market.
Exhibit 1: Investment grade sector spread percentile ranks
Note: Data show absolute current OAS and OAS as a percentile of its 5-year range.
Source: Santander US Capital Markets LLC, Bloomberg/Barclays US corporate sector indices
Outside of financials, media, cable and others look appealing
A vast amount of non-financial subsectors are registering zero or near-zero percentiles, demonstrating that comparative spreads are trading at or near their five-year historical tights (Exhibit 2). A few segments are still offering a degree of value relative to historic performance. Among the top-ranking subsectors are media entertainment, cable satellite, aerospace/defense and automotive. Although construction machinery lands among the Top 5 by this metric, its collective nominal option-adjusted spread (OAS) lands at the lowest of any other segment within the investment grade landscape, and therefore is excluded among the top relative value picks for the purposes of this study.
Exhibit 2: Non-financial subsector spread percentile
Note: Data show absolute current OAS and OAS as a percentile of its 5-year range.
Source: Santander US Capital Markets LLC, Bloomberg/Barclays US corporate sector indices
Within media entertainment, Warner Bros. Discovery
Much of the spread valuation that appears to be reflected in the media entertainment segment is being generated by spread weakness is Paramount Global (PARA: Baa3/BB+/BBB-), which is currently teetering on the brink of IG and crossover. There is significant event risk in the form of multiple suitors (Apollo, Skydance and others) reportedly seeking a deal with the media conglomerate, with uncertain outcomes for bondholders. A more stable credit opportunity in the segment is offered by Warner Brothers Discovery (WBD: Baa3/BBB-/BBB-), which saw spreads gap out during the strikes of late 2023 but has been steadily recovering in more recent months. Management appears committed to debt reduction, and maintenance of solid investment grade credit metrics appears a much more certain outcome for bondholders.
Exhibit 3: Media entertainment spread curve
Source: Santander US Capital Markets LLC, Bloomberg/TRACE YAS G-spread indications only
Within cable satellite, Charter Communications
Similarly, in the widest trading credit in the cable satellite segment, Charter Communications (CHTR: Ba1/BBB-/BBB-) also continues to be on what appears to be a course correction as management also remains committed to the maintenance of IG credit ratings for the secured debt obligations. CHTR is the second largest cable company to CMCSA in the US and maintains leverage at the secured level in the 3.0-3.5x range, which is only a modest roughly half turn of leverage above of their larger competitor, which trades at considerably tighter spread levels.
Exhibit 4: Cable satellite spread curve
Source: Santander US Capital Markets LLC, Bloomberg/TRACE YAS G-spread indications only
Within aerospace/defense, L3Harris Technologies
Like the media segment, much of the perceived spread opportunity in aerospace/defense is being generated from one specific credit – not surprisingly that credit is Boeing (BA: Baa2*-/BBB-/BBB-), which continues to face an onslaught of issues related to safety concerns and more recent reductions in orders from the larger carriers. Alternatively, L3Harris Technologies (LHX: Baa2/BBB/BBB) is currently in the process of deleveraging its balance sheet after making a string of acquisitions (Tactical Datalink, Aerojet and others) in previous years. Management is seeking to bring leverage down below 3x from more than 4x and has shareholder remuneration on temporary hold until it can achieve that target. The rating agencies negative outlooks (since late 2022) would be resolved after management makes good on its commitment to improve the balance sheet.
Exhibit 5: Aerospace/Defense spread curve
Source: Santander US Capital Markets LLC, Bloomberg/TRACE YAS G-spread indications only
Within automotive, Ford and GM
Within the automotive segment, the domestic OEMs have started to generate significant operating moment that could translate to notably stronger credit stability. Overweighting those names relative to the rest of the peer group appears the best means to maximize spread opportunity in one of the few non-financial segments trading meaningfully above their five-year tights. Ford (F: Ba1/BBB-/BBB-) has provided upbeat guidance for full-year 2024 in key categories that could eventually see them achieve the elusive third IG rating from Moody’s over the near-term. Likewise, General Motors’ (GM: Baa2/BBB/BBB) full-year guidance beat expectations and appears to be turning a corner in EV categories.
Exhibit 6: Automotive spread curve
Source: Santander US Capital Markets LLC, Bloomberg/TRACE YAS G-spread indications only
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