Market Wrap

Friday Workout - Flat curve conspiracy; Tesla-nomics; Bottlenecks and Reverse Bullwhips

Chris Haffenden's avatar
  1. Chris Haffenden
14 min read

Yesterday, the European High Yield earnings season kicked-off, with several names reporting their third-quarter results. This round, given concerns on headwinds, investors should flip to the management discussion and analysis rather than fixate too much on the headline numbers. What clues are there on rising energy and raw material costs? Can supply chain issues be mitigated in upcoming quarters? 

If you are a UK-focused business, you also have the Brexit effect to deal with. The Office of Budget Responsibility yesterday admitted lost growth would be 6% of GDP, higher than the impact of the pandemic – Beleaguered Boparan Bondholders will be well aware of this, but we will have to wait, their earnings were delayed until 25 November.   

According to FactSet, for the S&P 500 index, 107 companies mentioned ‘supply chain’ in their earnings calls in the past month. But that doesn’t seem to matter to the meme economy, with Tesla this week adding $100bn of market cap to join the $1trn club after announcing a $4bn Hertz order! If you thought that was an impressive multiple, that was Trumped by the very stable genuis’ ShellCo-squared SPAC hitting more than $200bn, and a canine crypto rising 710% in October to achieve a larger market cap than Deutsche Bank. 

As FT journalists would say – this is nuts, where’s the crash?

Flat curve conspiracy

But contrary to equities, bond markets are sounding the alarm, with Govvie yield curves around the world flattening sharply in recent days. The bear flattening is due to concerns over policy errors, that central banks might be forced to hike rates too fast and too far as inflationary pressures fail to subside.

The Bank of Canada on Wednesday ended its quantitative easing earlier than expected and signalled that rates would be hiked soon, leading to its two-year yields spiking by 21bps. The next day the Reserve Bank of Australia unexpectedly failed to participate in a two-year bond auction sending yields dramatically higher. Prior to the auction, the notes were yielding 0.25%, with the RBA expected to take down the new issue to push rates back to its Yield Curve Control target of 0.10%. Yields spiked to over 0.50%, when it failed to play. As Deutsche Bank analysts outlined in a client note yesterday, this was a six standard deviation event. The moves in Canada were the largest since 2009 and a four standard deviation event. 

US two-year yields rose above 0.50% yesterday - the first time in 19-months, with fed funds futures now pricing a 70% chance of a rate hike by next June. The Bank of England is widely expected to raise rates next week, but most importantly, the Fed should announce its QE taper. Let’s hope it handles the implementation better than the aussies did yesterday. 

George Saravelos from Deutsche says the “general flattening of curves is backed up by the very late-cycle dynamics of the global economy plus our pessimistic view on r*  (global natural rate of interest) and extreme excess saving.” But he adds, “what is happening now runs beyond macro, it is a plain and simple Value at Risk (VaR) shock driven by positioning and the inability to appropriately calibrate central bank reaction functions in such an uncertain environment.”

Flattening yield curves typically result in lower risk appetite. 

Deutsche points out excess savings and a low r* reflect a mix of elevated precautionary saving and very low terminal rates – which might “neatly help explain why asset prices are booming and bond markets are not selling-off more aggressively despite huge inflation surprises and hawkish central bank repricing.”

Elevated savings should be good for asset prices, but negative supply shocks that constrains growth and forces hawkish central banks should be bad for risk, notes Deutsche. 

How this plays out will be interesting in the coming weeks. I would add other potential risks, such as rising stagflation fears, amid slowing global growth driven by a sharp drop in Chinese GDP as leverage from their property sector is unwound. The risks of a disorderly festive season as stretched supply chains finally break is also understated in my view (more on supply chains later). 


I don’t pretend to be a crack credit analyst, but even I can see that a $4bn order shouldn’t result (in itself) in a $100bn increase in equity valuation. Yes, Tesla’s 100,000-vehicle order from Hertz by end of 2022 is impressive, but Tesla’s margins are around 26% - but this includes higher margin X and Y variants and regulatory credits (S&P has 18% excluding these) - without any price discounts, that is less than $1bn of profit. Wowsa, that is some value multiplier, over 100x. 

Hertz appears to have got ahead of the car rental pack, with its shift to EV cars. But it is worth remembering that VW, likely to be automotives major EV producer (in Europe at least) is about to buy Europcar which will help it to shift a lot of iD3s. As the Wall Street Journal points out there is a 30% tax credit for ‘qualified commercial electric vehicles’ which could have drove the deal and negated the need for significant price discounts to list prices. 

As Wolf Richter points out, where are these cars coming from – the order is 10% of annual capacity – with the current expected delivery date of a Model 3 being end-June 2022. Were they reserved already and dare I say that might have boosted production figures for the latest quarter? 

Car manufacturers don’t normally crow about car rental sales, as these are typically low margin deals. Often, they have to buy back their cars when their useful lives as a rental cars ends after 12-24 months, to avoid a large number of vehicles flooding the market and depressing used values. This could impact the secondhand values for Tesla cars and the assumptions for those buying on credit. 

Crowing about this deal is good news for Hertz, however. Its stock price jumped on the news, no doubt to the satisfaction of the hedge funds which own most of its stock following its restructuring, whose market cap has doubled since its emergence from Chapter 11. 

Tesla edged closer to Investment Grade this week after S&P raised its rating to BB+ with probably the world’s biggest equity cushion for a Junk Borrower – it has around $8.1bn of short and long-term debt. I have to begrudgingly admire the ability of Elon Musk to convince investors to fund the business to after several years to be finally cash-flow positive without relying on regulatory credit sales. 

Source: Tesla presentation

Tesla’s valuation, however, bemuses me. It’s solar panels and self-driving aspirations appear ever distant, and the CyberTruck and Semi Truck remain just mock-ups, with the specs for the former removed from the website, suggesting that it might never be made. Tesla’s energy storage business has failed to grow sequentially in the past two quarters and lags well behind ambitious company forecasts. Therefore, almost all of its profits are delivered from its automotive division, and cash flow conversion is not as impressive as operating cash flows. FCF has failed to increase this year, which isn’t great for shareholder value. The shares are valued on a 200x FCF multiple, this increases to 400x if you strip out stock-based compensation. 

Tesla is projected to deliver 1.5m vehicles next year, from around 900k in 2021. The global light vehicle market is around 75m. What market share by 2030 does Tesla need to justify its valuation?

Supply chain management

One of the more interesting modules on my MBA course was operations management and in particular understanding process management and supply chain management. 

One of the more interesting concepts is the bullwhip effect, where distortions are created along the supply chain by large demand distortions. All affected points in the supply chain will then keep buffer stock to avoid being unable to supply. Also known as the Forrester effect it is “the observed propensity for material orders to be more variable than demand signals and for this variability to increase the further upstream a company is in a supply chain,” hence the name bullwhip as the amplitude of a whip increases down its length. 

But there is also a reverse bullwhip effect where disruption in supply can cause distortions in demand further up the supply chain. Arguably the current supply chain crisis started from difficulties in meeting supply arising from distortions in demand as we emerged from lockdowns. But now, the supply chain is being stretched to breaking point, witness the record 100 ships moored off Long Beach in California and automotive plant shutdowns as chip shortages stop production. 

Often the issues can be amplified by capacity issues, potential bottlenecks, critical paths, and co-dependencies – don’t worry, I will stop with the academic theories now, this fantastic tweet from Ryan Petersen shows how it works in practice. He rented a boat with a Flexport partner and toured the Long Beach port complex – here is part of his thread:

This is creating a negative feedback loop. As Ryan insightfully points out “When you're designing an operation you must choose your bottleneck. If the bottleneck appears somewhere that you didn't choose it, you aren't running an operation. It's running you.”

As Deutsche points out, the bottleneck is not getting better. 

This doesn’t bode well for fourth quarter earnings. 

We had a taste of the potential effects from the Q3 earnings release for Diebold Nixdorf, the ATM manufacturer. “Despite solid market activity and due to continued global supply challenges, $90m of revenue modelled for the third quarter has been deferred to future periods. Additionally, we experienced $10m of non-billable logistics inflation during the quarter. The deferral of revenue and non-billable inflation reduced third quarter gross margin by approximately $33m.” It added a revised outlook for 2021 includes a $75m unfavourable impact to 2021 gross margin from year-end revenue deferral and full-year inflationary pressures. The FY21 Adjusted EBITDA forecast was revised from $455-475m to $415-435m as a result. It also reduced its FCF forecast by $40m to $80-100m. 

In a trading updateOntex, the Belgium-based manufacturer of branded hygienic and disposable products, saw its EBITDA fall 29% during the quarter, despite stabilising revenue with “significantly higher raw material prices, the main driver for the decline.” The Adjusted EBITDA margin of 7.8% was down -344 bps versus prior year. 

Last week, Matalan management went into a lot of detail about the upcoming headwinds to the business, most notably delays in deliveries for its Autumn/Winter stock, delayed by five-six weeks. Management said the stock delays were not just caused by supply chain issues, but also because pandemic effects are lingering in countries where stock is manufactured. The company also cited well-documented UK specific factors, such as increases in minimum wages and labour shortages, while raw material cost rises for cotton thread and viscose are another headwind. “This has led to some of the most challenging conditions that we’ve ever experienced,” management said. 

The runway for Matalan to refinance expensive second-lien debt is reducing, with The Times at the weekend suggesting Deloitte’s restructuring team was recently hired to advise. This raised eyebrows at 9fin Towers, as Deloitte no longer has a restructuring business, with their team spun out of into Teneo. Following further investigation, we understand this is a debt advisory mandate sitting at Deloitte, with a refinancing still the most likely option. 

In brief

Adler Group announced another portfolio sale this week. a second term sheet signed with an undisclosed ‘leading alternative investment firm’ to sell another ~14.3k units from its yielding portfolio, in mid-sized cities in Eastern Germany. This announcement is hot on the heels of an LOI signed with LEG for the sale of around 15.5k units earlier this month (our bitesize report is here). 

We produced another bitesize report for the second sale to flesh out the molecules of information provided in a first and secondpress release by Adler Group and a subsequent releaseby Adler RE, and look at how Adler’s remaining yielding portfolio and LTV ratios may look post-transaction. 

Bloomberg subsequently disclosed that the third-party investor was KKR. The company said that this would conclude asset sales, save from non-core development portfolios. It should drop the reported LTV below 50%, but you are left with the more bubblicious top 7 German cities and riskier development portfolio, noted one distressed analyst. 

We also released our Stressed QuickTake for Adler available here.

Lowen Play bonds fell by as much as five-points to 88, earlier this week, as the German arcade and casino operator issued an update, interpreted as a cleansing presentation, and a sign that refinancing plans were struggling. The bonds have recovered to 91.50. We had forecast that refinancing would be tough as regulatory and tax changes impacted the bottom line, in our deep-dive from February

Moving onto the pain in Spain:

No fireworks, but Codere has pushed out the effective date of its restructuring from 5 November to 10 November. Our Restructuring QuickTake is available here.

Naviera Armas last week filed for Homologacion to seek court approval for its restructuring plan, according to a source close to the situation, our QuickTake is available here.

Travel has recovered in the third quarter, but remains below expectations for many, particularly those reliant upon air travel, where the skies are still relatively unfriendly. Heathrow has received some leeway from the Civil Aviation Authority, it said in its Q3 update, but it wants more. Monthly cash burn per month has reduced to £88m from £170m, but it needs more from government and regulators, it says. 

Under the base case scenario passenger traffic for 2021 will decline 2.7% compared to 2020, to 21.5 million passengers (a decrease of 73.4% compared to 2019). Despite this decline, Group EBITDA is expected to increase 23% to £332 million in 2021. The base case passenger numbers for 2022 forecast an improvement in passenger numbers with a graduated return to pre-pandemic levels over the following years with a return to pre-pandemic levels not expected until 2026. Recent bond issues will fund the airport group until 2025 under the base case, and even under the most extreme scenario of no revenue until at least February 2023. 

Getlink decided to tap the bond market again this week, to bridge itself to a recovery in traffic. A week earlier, it said that Q3 revenue in 2021 was €223.1m down 13% compared to the same period in 2020, due to the continued impact of the crisis.Their summer season was strongly impacted by very tight travel restrictions with France being placed on the ”amber plus” list. Car traffic picked up in September with 6% growth boosted by the British government’s announcement to relax travel rules in mid-August. In Q3 2021, Le Shuttle’s car market share remained above 71%. The cross-Channel car market contracted by 38.7% in the third quarter of 2021. 

In contrast, Europcar had a very strong quarter, raising its guidance for FY 2021 EBITDA to above €150m from above €110m, but still well down from €278m in 2019. In their accompanying presentation, they gave a timeline on the offer from VW, to be launched in the fourth quarter and closing in the first quarter of 2022. 

What we are reading this week

At 9fin, we pride ourselves on our pun game. Our CEO Steven Hunter set the bar high with his original loan preview of IVC, the Petcare business. The 9fin loans team turned the puns up to the max for the latest add-on for the fur-miliar name with paw-sitive growth. 

There was no hair on IVC, there was certainly a lot of hair on troubled oil services group Petrofac, with one of the strangest use of proceeds – to pay a Serious Fraud Office fine after fraud payments were made by executives.

Matt Levine can’t wait for the prospectus for Trump’s SPAC to land with the SEC, especially the “Background of the Transaction.”  Levine says: “I cannot tell you how excited I am to read this prospectus. I have read some good comedy SEC filings in my time, but my comedic expectations for this one are absolutely sky-high. I assume a lot of plaintiffs’ lawyers are also very excited to read it for reasons of their own.”

Less column inches on Chinese property this week, but there has been some movement on Evergrande with the Chairman forced to pledge his luxury property in Hong Kong to meet bond payments. NDAs have been signed by advisors to the offshore bonds, kicking off restructuring talks. But his fortune is unlikely to be enough to meet other maturities due in the next few months, and the Chinese Property Sector unwind will be painful.

Foreign Policy outlines why China’s supply chains are breaking down, while Barron’s thinks the solution to America’s supply chain woes lies in automation. One FinTwit  has another idea:

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