#Investments — 17.12.2015

A Paradoxical Situation in the Euro High Yield Market - Part 1

Thierry Trigo

Very high yields and default rate still close to zero: are the risks underestimated?


A market context that encourages investors to take more risks

In a context of still very low yields in the Euro-zone (German 10-year yield close to 0.6%), it is legitimate for investors to seek better remunerations and High Yield bonds in Euros, issued by non-financial companies, are among the possible solutions.

However, some simplistic minds could think that, with a default rate close to zero on this market, the risk of non-redemption and non-payment of coupons consequently no longer exists. And pushing this reasoning to its extreme, they could even choose to invest in bonds offering the highest yields, without committing their cash to very long durations.

Such bonds do exist and none of their issuers has been declared in a state of default: 14% yield on a Nyrstar 2019, 19% on a CGG 2020, 30% on a Portugal Telecom 2018, 43% on an Isolux Corsan 2021 and 78% on an Abengoa 2020. Coupons continue to be paid on these bonds.

Although less excessive, there are other exceptional yields: 7.6% on an ArcelorMittal 2020, 9% on a Trafigura 2018, 10.6% on a CMA-CGM 2021 or else 13% on an Eramet 2020.

So very high yields do exist in the Euro-zone and may seduce the most greedy investors. Should they heed the Siren’s song? What are the risks really incurred?

The origin of these issuers’ current difficulties

Issuers with bonds delivering such levels of remuneration do, in fact, have a financial profile that is significantly deteriorating. Their difficulties are therefore very real and mainly of two types: either related to the macroeconomic slowdown in some Emerging countries (1) or related to the fall in commodity prices (2).  For some issuers, both these evils are at work.

The first factor (1) concerns issuers with cyclical businesses and/or which are exposed to emerging countries that are in recession (Brazil and Russia) or whose growth is slowing (China). We can cite issuers like Portugal Telecom (major exposure to Brazil since its merger with Oi), Tereos (sugar and ethanol producer), Isolux Corsan (construction and concessions), Abengoa (industrial construction, environmental services and bioenergy), CMA-CGM (maritime transport), etc. As regards cyclical sectors, we can cite issuers exposed to the construction and public works sector in France, companies such as Rexel (distributor of  electrical material for professionals) and Loxam (industrial plant hire).

Regarding the second factor (2), the list of issuers is longer since much of the Euro High Yield market stems from the Mining & Steel or Oil & Gas sectors. This includes issuers like ArcelorMittal (steel manufacturer), Nyrstar (producer of zinc and other metals), Eramet (nickel and manganese producer), Tereos, CGG (subsurface exploration), Vallourec (drill pipes for the oil industry), etc.

Finally, there are particular difficulties for issuers like Bombardier (aircraft and train manufacturer) because of the delay in marketing their C-Series aircraft and AREVA (nuclear energy) owing to the post-Fukushima situation and the additional costs required to finalize the delivery of EPR nuclear power stations.

The intensity of difficulties is different for each of these issuers. But globally, they are experiencing difficult times. A first indicator is the fall in their revenues.  Cash generated through their daily business is also diminishing. Some issuers (Bombardier for instance) are even in a situation of cash consumption. Consequently, their leverage is increasing significantly and translating into their credit ratings being downgraded (increasing insolvency) and so probably into greater difficulty to raise money on the bond market and/or to borrow from banks.

Therefore investors have to remain cautious towards these special situations that are becoming more numerous, as the price of these bonds is highly volatile. However, some issuers are succeeding in stabilizing their financial profile. But others are really close to a default (Abengoa). We’ll see these points in details in a forthcoming comment.