The global corporate bond market is looking a little risky to investors as the debt levels of compa...
The global corporate bond market is looking a little risky to investors as the debt levels of companies rise to unsustainable levels.
Steven Logan, investment director at Scottish Widows Investment Partnership, believes leveraged buyouts are a potential cause for concern with regard to the smaller telecom players, but there are exceptions. For example, an acquisition of 02 is more likely to be achieved by trade buyers (witness the recent rumours of Deutsche Telekom & Holland's KPN's interest) due to the cost synergies they should be able to extract. These synergies are absent with a pure leveraged owner.
Logan is presently overweight telecoms in the UK and Europe. The likes of France Telecom, Deutsche Telekom and Telecom Italia have learned the lessons from their debt-fuelled acquisition binge during the TMT bubble. Companies have repaired balance sheets receiving credit upgrades, are increasingly cash-rich and benefit from utility-like characteristics.
In Europe, Mark Kiesel, head of investment grade corporate bond desk at PIMCO, is favouring the strongest European banks, telecom and tobacco companies.
He says: "If US economic growth slows sharply next year, default rates should pick up. If that should transpire, we would expect rising defaults to show up first in the high-yield market, given the lag effect of looser underwriting standards and covenants. As defaults pick up, corporate bond spreads should widen over time.
"Because we expect default rates to rise over time, our global corporate bond portfolios are heavily weighted in companies with strong asset quality and pricing power. Strong assets help maintain a company's profitability and provide financial flexibility should the economic climate turn more challenging. In the event of default, strong asset quality also helps to ensure high rates of recovery."
Logan points out Moody's and S&P expect higher defaults in the first quarter of 2006, although these are expected to be focused in the sub-investment grade area. The defaults are expected to come from companies that were involved in leveraged buyouts two or three years ago and whose balance sheets were geared too aggressively. Signs are already emerging that some companies are struggling to sustain their balance sheets. Logan says SWIP forecasts slowing global growth is likely to put additional pressure on corporate profitability.
One such example Logan gives is the auto sector, which has been under a great deal of stress. GM and Ford have both been downgraded to junk status this year as sales have plummeted on their SUV models. Their problems are compounded by the overly generous pension and healthcare benefits they have promised their past and present employees and the intense competition of the Asian manufacturers which has severely diminished their market shares.
The airline industry is also under enormous pressure, Logan believes. In Europe, the national flag carriers, and in the US the major domestic air carriers, are losing market share to the more efficient budget airlines. The industry has also been hit in recent years by the decline in air travel following September 11, the Sars virus and the Iraq war.
PIMCO has been positioning its portfolio towards sectors of the economy that tend to be more resilient when consumer spending slows, such as energy, pipelines, media/cable and utilities. These industries also tend to have higher historical recovery rates in the event of default.
Leveraged buyouts a cause for concern with regard to small telecoms.
Default rates expected to rise over time, particularly if US growth slows sharply.
Slower global growth is putting pressure on company balance sheets.
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