In bonds, the history is more mixed. However, Deutsche’s research team notes that, after such a bad year, the next year is normally a strong one. Then again, the nearest comparison we have to now is the 1980s, and it didn’t hold true for much of that decade.

This week, several eurozone countries’ inflation numbers came in lower than expected, causing a rally in risk assets and drops in government bond yields. The iTraxx Crossover closed on Thursday at a mere 449 bps, well inside the general consensus from EHY research houses for end Q1 23 of 600 bps or wider. Typically, bond spreads are much wider in a recessionary environment.

Government bonds are for the first time in years are giving decent positive yields (US T-Bills at 4% or UK 3y Gilts at 3.5% anyone?) so surely you need to be paid more for taking HY risk?

But before you rush in to trim your holdings or short the market, Bloomberg’s Tracy Alloway’s mantra “Flows before Prose” is worth adhering to (or at least for the short-term). If money has to be put to work Momo will cause FOMO, prices can move further than you think and way beyond fair value for longer than you would expect.

Reading through a raft of economic outlooks from investment banks, funds and property agents over the holiday period, the range of projected outcomes for the world economy and financial markets are wider than any time I can remember over the last decade.

Could 2023 be a game of two halves, a poor H1 with a sharp rally in H2?

A key part of the debate is whether rates will remain elevated for longer despite expected reductions in inflation. How important is the labour market in making rate determinations by central banks? Is a soft landing realistic? Does China’s reopening move the dial and how? Will commodities, energy and other input costs remain low, or start to rise again?

Some data is flashing bright red. House prices are starting to crash in many major markets. US consumers, after spending their Covid cheques, are trying to maintain pandemic levels of spending via credit cards, with debt reaching record levels.

At this time last year, it was all about whether you were in Team Transitory or not. This year, it is all about rates expectations, either higher for longer, or sharply lower after a recession-driven pivot.

As Andrew Walker from Yet Another Value Blog notes:

“Interest rates act as financial gravity. There are so many possible answers here (the crypto collapse, FAANG looking vulnerable for the first time, growth tech getting slaughtered, inflation, etc.), but all of them in some form tie back to interest rates. When rates are low, investors can and will underwrite a lot of crazy things. As interest rates rise, competition for capital gets more intense and a whole lot of projects that were in demand at low interest rates suddenly get abandoned.”

With so much uncertainty ahead but current levels looking attactive, I wouldn’t be surprised to see a few LevFin borrowers test the waters in the next few days. As 2022 showed, an open window can close quickly.

Expect lengthy queues for A&E too, with patients trying to avoid the need for corporate doctors and more drastic surgery.

Credit events and sales processes will be closely watched, looking for valuation clues. The art of the possible under loose bond and loan docs will be explored closely by clever lawyers and their high fee-paying private equity sponsors.

Successful outcomes for Matalan and Orpea in January, plus a stressed A&E or two (TUI Cruises and Adler Pelzer perhaps) could easily open the floodgates, or lock the door.

Shopping Around for Bargains

One of the first things on my January to do list every year, is to check in on the level of retail sales as supermarkets and department stores report their Xmas and January sales volumes.

Expectations are that discount retailers will be the main beneficiaries this year, as the cost of living crisis bites. This thesis was reinforced by a strong Q3 trading update (to 24 December) from B&M Retail earlier this week, which also guided higher on FY 23 EBITDA. Its 2028 SSNs peaked at a 9.25% yield in November and are now indicated at around 7.5%.

B&M Retail is a solid BB credit. Arguably it is still competitively priced for HY investors. But it is not a standout bargain, with plenty of names at a steep price discount, such as Groupe Casino and Maxeda, whose SUNs trade at stressed/distressed levels at 35% and 16.5% yields, respectively.

I was going shopping for comps this week, as I edited Emmet McNally’s excellent analysis piece on Ceconomy. The mammoth (revenues over €20bn) Germany-based electronics retailer’s 2026 SUNs trade around 65, a whopping 15.25% yield, placing it nearer to Maxeda than nearest BB comps (it is rated BB and Ba3) such as B&M Retail and Adevinta at sixes and sevens.

Admittedly, Ceconomy remains on watch with Moody’s and investors — though a positive FY 22 call in December should alleviate some concerns about working capital dynamics and cash burn (as Emmet outlines in his report).

The TLDR is that even in a worst case scenario we think that the bonds are fully covered at current levels, in the mid-60s. While FY 23 is likely to be a difficult year, leverage is unlikely to surpass 3x. Shortening payables to 92-days (peer average) from 115-days, the payables balance would reduce to €4.16bn by FY 23 from €5.34bn as of FY 22. Even in this extreme example, the bonds are covered at current prices.

It’s worth noting that its nearest HY peer in terms of business is France’s FNAC Darty (Ceconomy owns a 24.5% stake) whose DPO is 15-days longer. Better rated at BB/BB+ its 2026 SUNs are yielding a mere 4.25%, after a recent refi boost for its 2024s.

Admittedly, Ceconomy has much lower margins, lower cash conversion, and saw a number of management departures in the past year. But the yield differential between the two is very wide, given the 1.5-notch rating difference.

Has the market has got it wrong, as Ceconomy management suggests?

There is a group of single-B retail peers (Alain Afflelou, Arcaplanet, BUT, THOM Europe) trading at 8%-9.5% YTM. At the upper end of this bracket at 9.5%, there would be ~13 points of upside from the current mid-price of ~65, we estimate or ~17 points at ~8%. The upside is even greater if you look at similarly rated peers which trade at 5%-7%.

But in the end, the value of a retailer is what someone is willing to pay for it, as we are finding out at Matalan, whose reported bid multiples are certainly bargain basement.

In making one of his 100 calls a day, Sky’s Mark Kleinman has managed to speak to one of the stakeholders, who may be pushing their agenda to lower price expectations. The article suggests that the first lien lenders are changing tack and are looking to take control of the discount retailer after bids came in below the value of the first and second lien.

We are still trying to verify the accuracy of the report. As we outlined previously we had expressed doubts that bids would cover the second lien (we have £60m ABL, £350m 1L and £80m (outstanding) 2L) and how value on a low case could break in the first lien. It is unclear whether other bidders such as the second lien group and others such as Alteri have reduced their offers following due diligence.

Then again, the first lien taking control could just be the alternative recapitalisation plan as outlined as a Plan B by the company (the 1L had offered £200m of staple finance, and indicated a willingness to extend to 2027) but there also appears to be a new money need (is this partly to repay the ABL?), or are suppliers getting spooked by all the negative press?

Matalan second lien bond prices dropped sharply this week into the 50s, though we would caution that the bonds are very illiquid, so the drop might just be dealers marking down, worried about getting hit.

Don’t discount further developments. This discounted sale will conclude by end January.

French Exit

Those taking a well deserved long seasonal break might have missed Orpea’s announcement on 21 December. It gave further information on impairments to its real estate portfolio, financial receivables and intangible assets.

The results were broadly in line with our expectations, as detailed in our 25 November 2022 analysis of Orpea — searching for equity and asset value — which focused on the implied equity value and asset coverage for investors participating in its restructuring and €1.2bn-€1.5bn capital raise.

Our updated revisited analysis was released between Xmas and the New Year, and is here

In brief, Orpea has increased its real estate impairments for FY 22 to €2.1bn from €1bn — broadly in line with 9fin’s prior expectations. In addition to those, management wrote down €2.7bn of goodwill, €0.4bn on financial receivables and €0.2bn on other balance sheet assets, to bring the total size of the impairments to €5.4bn.

The revaluations leave Orpea with only €6bn of Real Estate value. This does not cover its €6.6bn guided debt at the close of its proposed restructuring — resulting in a massive 109% LTV — close to our original estimate of 101% LTV here

While Orpea’s cap rate is now slightly higher than Korian’s (which hasn’t yet updated its Q2 22 cap rates of 5.3% ), it is worth noting that in the first half of 2022 Korian bought eight assets at a significantly higher 6.3% average cap rate, suggesting that care home operators reported cap rates might come under further pressure in 2023.

The Orpea release gave no further details on the progress on negotiations with creditors over the equitisation of virtually all of its unsecured debt. We would have expected news by now on the €1.2bn to €1.5bn fund raising, given the deadline for binding commitments is due in mid-January.

Regular readers will already know our doubts over whether there is any equity value in the business, even if Orpea is able to execute on its plans and hit its optimistic FY 25 forecasts.

If you want to hear more about our thoughts on Europe’s largest restructuring, myself, Denitsa Stoyanova and Bianca Boorer will be discussing in a 9fin webinar next Thursday Lunchtime.

To register, click here

We understand some subscribers cannot access due to internal protocol issues. Please email sophie@9fin.com if you have problems logging on to zoom and we will ensure you get the replay.

How much of a Flop was 2022?

Earlier this week, we published our latest edition of Top of the Flops, over six months since the publication of the first. In addition to measuring performance in December, it included a year-end report card, the biggest movers and which names suffered a re-rating by investors in 2022.

Despite some degree of recovery in Q4, European High Yield bond returns were still down over 10% for 2022. As our Distressed/Restructuring Preview of 2023 notes, primary pricing has failed to tighten to any significant degree with many borrowers (which can afford the sharp rise in interest costs) still having to pay double digit yields to get deals away.

Which borrowers may struggle to refinance in the next 18 months?

There are 32 European loans from 23 borrowers with maturities up to 30 June 2024, according to 9fin data. Of these 12 from 8 issuers are trading at prices below 90, implying they are unlikely to be refinanced. Another 5 from 5 are at some risk, being priced between 90 and 95.

There are 173 EHY bonds from 121 companies due in the next 18 months. Of these, 21 from 18 borrowers are trading at a spread to worst of over 10%, and unlikely to be refinanced.

Rising rates mean that few bonds now trade above par, with many at significant discounts, meaning that a pull to par and capital appreciation are as important as running yields.

The number of EHY bonds trading below 90 — the traditional level of distress — is 692 bonds from 331 issuers, up from 659 and 326 at end-November, but still significantly lower than the 876 and 387 seen at end-September. Conversely, we had just 141 issuers below 90 in mid-April.

In total, 125 bonds from 82 issuers (out of 1,481 and 535 in total) saw their prices fall by more than 25% during 2022, with 22 from 13 falling by more than 50%

But, price is not a great measure of distress, especially in a sharply rising rate environment.

As at close of business on 30 December, we had 209 bonds from 135 borrowers with a STW of over 800 bps, our measure of stress/distress. This is roughly half way between numbers seen at the end of November (174 and 118 respectively) and end October (257 bonds and 162 issuers).

Looking further back, at the worst point of 2022 in mid-July, we had a whopping 318 bonds from 199 issues at a spread-to-worst of over 8%, which was more than one-in-five (21.3%) of all EHY issues. This figure is now down to ‘just’ one-in-seven at 14.2%.

Part of the improved performance in the past few months is undoubtedly due to the improved risk sentiment towards High Yield. As my colleague Huw Simpson outlines in his Q3 earnings report, on balance, quarterly performance was better than many had feared.

But undoubtedly, we have seen a bifurcated market with spreads widening markedly for some names.

Over the year we saw STW increase by over 500 bps (compared to 225 bps wide for crossover) for 74 bonds from 57 issuers. Filtering our screener by STW (lowest to highest) we see which names have seen the most significant re-ratings into stressed, such as Pure Gym, Carnival, Ardagh, AA, Saga and TalkTalk.

The number of loans trading below 92 (our measure of stressed/distressed) was unchanged at end-December from a month earlier at 207 loans and 128 issuers. This is significantly less than seen at the end of October.

However, there were still a number of big price movers during the month, with 19 loans from 15 issuers moving by more than five points. Technicolor Creative Studios was the biggest mover down -38.3 points, and elsewhere, GTT Communications, Covis Pharma (lender advisors appointed) and Idverde are all down by over 10 points.

In total, 89 loans from 70 issuers have fallen by more than 10 points during the year. The biggest movers (down by more than 30 points) are listed below:

The number of loans trading below 92 (our measure of stressed/distressed) was unchanged at end-December from a month earlier at 207 loans and 128 issuers. This is significantly less than seen at the end of October.

However, there were still a number of big price movers during the month, with 19 loans from 15 issuers moving by more than five points. Technicolor Creative Studios was the biggest mover down -38.3 points, and elsewhere, GTT Communications, Covis Pharma (lender advisors appointed) and Idverde are all down by over 10 points.

In total, 89 loans from 70 issuers have fallen by more than 10 points during the year. The biggest movers (down by more than 30 points) are listed below:

Aptly found in a Christmas Cracker in 9fin’s Laura Thompson’s household:

There was another cracker at the Amex over the New Year with the visit from Arsenal who were impressive in their 4-2 win, but the gooners must have been sweating when Mitoma thought he had made it 4-3 after 88 mins. Your heel being offside when moving away from goal is gaining an advantage?

I was also shocked to see that our Premier League Debt position was so elevated, 5th, higher than our 8th in the sporting table, ouch. Double ouch, Spurs.

But in Tony Bloom we trust.