#Investments — 21.12.2015

Euro High Yield Issuers Are Working at Stabilizing Their Financial Profile - Part 2

Thierry Trigo

Some cases of defaults could occur going forward


Some issuers on the Euro High Yield market are facing a particularly difficult operational context. This was described in our article of 17/12/15. Solutions are being put in place: no way do these companies want to let their debt skyrocket. This could call into question their capacity to have access going forward to new financings from banks or from bond investors. Cash flows have to be rapidly generated. How can they do that? What are the most risky cases to be avoided?

Major efforts made by some issuers to stabilize their financial situation

After the 2008/2009 recession, several cyclical companies already had to take radical measures. The latter are still in place for generating these famous cash flows that their business is much less able to generate. The capacity to generate cash flows remains the key factor scrutinized by creditors (who includes bondholders). Therefore, industrial groups have undertaken restructurings (overseas diversification for Loxam), capex has been cut or halted (ArcelorMittal, Eramet …), dividend payments have been suspended (ArcelorMittal), acquisitions postponed, non-core activities disposed off (Faurecia), particularly in emerging countries (e.g. Rexel and its subsidiary in Brazil), and expenditure (employee costs) and likewise working capital requirements have been reduced (CMA-CGM).

The management of these industrial groups has made real efforts, leading their financial profiles to be stabilized. They are somehow managing to keep creditor/investor confidence.

And last chance operations for others

But when the remedies cited above prove to be insufficient, fresh cash has to be found. This is what makes people say that the worst can always be avoided and real cases of well-known issuer default are finally very seldom. Fortunately, it’s true. But investors have to be aware of the current challenges that have to face some companies.

As a consequence, several issuers are currently seeking to increase their capital with, very often, a new financial partner taking a stake.  This disadvantageous solution for existing shareholders (dividend dilution effect) is efficient from a credit viewpoint although the immediate positive effect may not resolve the fundamental problem linked to the weakness of activity.

Issuers like AREVA (recapitalization by the French state and possible entry of a Chinese partner), Nyrstar (recapitalization by Trafigura, specialised in oil trading and commodity transportation), CGG (possible entry of big clients from the oil sector into the capital) would like to use this solution to regain the confidence of lenders (banks or bond investors). Likewise, Wind Telecom (mobile telephony in Italy) should shortly merge with its competitor 3Italia, which will result in a new group with less leverage.

However if, at some point in time, the current macroeconomic trend or simply the deterioration in the daily business environment of these companies is not reversed, cases of real default will eventually arise. We are maybe not very far from this situation for some issuers whose bonds are currently boasting the highest yields:

- Brazil’s economic and political situation should remain depressed for several quarters yet.

- Global commodity inventories are still abundant and demand remains weak: the financial profiles of Eramet, CGG, Vallourec, Anglo-American will continue to be under pressure. ArcelorMittal needs to renew its efforts against competition from the Chinese steel industry and the fall in iron-ore prices.

- These expected capital increases have still to be finalized: but recently, because of the volatility on financial markets, some IPOs and capital increases (Abengoa) had to be cancelled.

For the High Yield bondholder exposed to these names, it is not yet the Hell of default, but the situation already closely resembles a Purgatory of big worries. Abengoa bonds lost 88% of their value in just 6 months!

Consequently, meticulous issuer selection is now crucial on the Euro High Yield bond market. It is essential to understand every underlying story and to assess the chances of success of measures taken by these companies.  At the same time, it is also important that an investor limit his aspirations in terms of the yield sought when such yield is totally removed from the market reality. The yield to maturity is always the reflection of a risk level. And this risk could now materialize by real defaults.