There are potential catalysts for the debt of cruise lines like Carnival and Royal Caribbean, as well as Rolls Royce and Ford, according to Bloomberg Intelligence. BI senior analysts Stephen Flynn and Aidan Cheslin join James Crombie of Bloomberg News in this edition of BI’s Credit Edge podcast to discuss the outlook for US and European credit, identifying situations where their teams’ research differs with consensus. UBS and Jaguar Land Rover have bonds trading wide to peers that could tighten, while others like Disney and Chesapeake face significant headwinds. Flynn and Cheslin also discuss the macroeconomic and geopolitical outlook and risks of a broad credit-market correction. “There seems to be a lack of confidence in the rarefied valuation levels we’re at,” said Cheslin. “That’s something that can unwind pretty quickly.”
Please note: The Credit Edge podcast is going on vacation, and won’t be published Aug. 8. The next episode will be on Aug. 15.
Hello, and welcome to The Credit Edge, a weekly markets podcast. My name is James Crombie. I'm a senior editor at Bloomberg. This week, we're very pleased to welcome Aidan Cheslin and Steve Flynn from Bloomberg Intelligence. How are you doing good? How are you very well? Aiden doing good?
James Harding, excellent.
Excellent, Thanks so much for joining us today. We're excited to get your thoughts on all things credit. Bloomberg Intelligence is part of Bloomberg's research arm of five hundred analysts and strategists, and we're going to dig into the big credit market opportunities and risks for the next few months. Your teams have crunched all the numbers, and I'll just give some words of context on what's going on in the markets today. You know, everyone's very very bullish about credits. Breads are super tight. There's not very much difference between investment grade and when it comes to risk premia. For example, on debt rated single B you're getting paid as much for default risk as you were in two thousand and seven. And the gap between double B and triple B rated bonds I'm talking about the US here hasn't been this tight since before the pandemic, remember the good old days. So let's start with the opportunities. That's basically bonds that are trading wide to industry and ratings peer groups rare to find these days, given how compressed everything has got and how much cash continues to flow into credit markets. But Steve, and on the US side, in terms of investment grade, what's the story there? I noticed one thing on your focus list is Rolls Royce. I'm still saving up for mine. Why they want to watch? Thanks, James.
Yeah, So we have five ideas for investment grade names that we think the spreads may tighten, and one of the first ones is Rolls Royce. Right, So the credit profile is improving, earnings arising, cash flow is increasing, and leverage is declining. Now the company has been upgraded by SMP and Fitch, but we see that there's potential for Moodies to follow, and we see catalysts moving forward as higher cash flow that could fuel debt reduction and like I said, a potential upgrade to investment grade by Moody's.
So Steve US high grade. What's the story that can we start with Rolls Royce to the consumers it's a luxury col brand. But I know for this research you're looking at other parts of the company. Can you just explain what today's you're looking out into the Rolls Rice and why it's a bullish outlook.
Yeah. Sure, So Rolls Royce is part of our aerospace coverage. And what we like about Rolls Royce is that they have an improving credit profile. You have rising earnings, increasing cash flow and leverages declining. Now Rolls Royce has been upgraded to investment grade by SMP and Fitch, and we believe a Moody's upgrade may follow. Catalysts moving forward include higher cares flow available to fuel debt reduction, and like I said, the potential upgrade from Moody's.
But it's the engine making we're talking about. They make engines for who.
They make engines for airplanes. Yes, we believe that forward could outperform expectations. There's the potential for higher operating margins with a shift in sales from their model E into the hybrids, and so the main canalyst there is a potential moving forward for better financial results.
The other one that struck me Blackstone private credit. I mean private credit is a massive theme this year. It's a one point seven trillion dollar market. As we keep saying, everyone's very excited about it. Why is this Blackstone private credit? You know, in terms of what's the opportunity.
That Okay, First of all, the bonds for Blackstone Private Credit Fund trade wider than a lot of other triple B financial peers, and so we see an upward ratings trajectory. Uh. You know, our anos believes that Blackstone is Blackstone Private Credit Fund is key to overall Blackstone. And as you said, there is a large and growing private wealth market with a lot of it focused towards private credit. And you know, the Blackstone Private credit bonds they trade closer to double B than triple B. They are rated triple B by both Moody's and S and P. And we see a potential catalyst there as a possible upgrade from Moody's as there is currently an outlook positive for Moodies.
That's an interest one. It's kind of accessing private credit through the public bond markets. Yes, okay, interesting. The other one, IBM, what's all that about?
So IBM bonds trade wide, So if we look at similar rated bonds, IBM is single a across the board, but the bonds trade closer to triple B plus technology companies, and we see better financial results as the potential catalyst to move those bonds tighter and to trade more comparable spread levels to similarly rated peers.
Is that an AI trade at all?
There's some AI component to IBM as one of your major technology providers, but they do a lot of other different technology services and equipment.
Okay, that's kind of utility correct, Good, All right, So, Aidan, why don't jump in on the European side. Let's start with high grade opportunities over there. I know you've got some banks on your list, you've got others, al still, what's going on there?
Yeah? So, well, starting with the banks, then, since you mentioned it, we've got ubs seniors where our analystsu and Julius thinks that those bonds could tighten on more capital and less supply, so they've got a tidening potential from a higher capital stack. We think less issuance coming in coming years as well than before, with the former maybe going up fifteen to twenty five billion dollars due to increase capital requirements, and we think issuance could fall eleven to twenty three billion dollars to bring its te l act more in line with its peers. So all of that potentially positive technicals for ubs senior bonds.
What about the other ones on your list?
In Alston Alston, Yeah, so our analyst on this one is Stefan Kovichev. He thinks that the company's obviously trip will be minus with a negative outlook, but the company has started to do a lot of actions to strengthen the balance sheet. And when he put on this view originally, I think it was trading like a downgrade to high yield was pretty much a done deal. There's been quite a lot coming that's happened recently. Management has seemed very very keen to hold on to that investment grade rating, which is in line with his thesis, and it started to respond to that. But he still thinks there's this potential for further tightening on Nelston.
Very good, Okay, So that's the investment grade side. What about high yield AID? I'm going to keep it on Europe. There's a few interesting names in there. What's going on in the high yield tide corporate hybrids?
So, by and large, these are high yield bonds issued by investment grade companies, but they trade much wider than senior double B paper for a similar rating risk. We like the sector as a whole. We think there are some land mines in the real estate sector, but that's pretty well flagged now, with companies like Around Town having passed on some of the cubon's last year, we've done some refinancing subsequently. We think most of the the other sectors, like telecoms utilities, that are very frequent issuers in the hybrid space are much less likely to extend extended maturity dates or pass on coupons, and we think that this market can continue to tighten relative to senior bonds and relative in particular to senior high yield bonds.
Are we talking about subordinated or perpetual? What kind of hybrids I'm talking about?
Yeah, these bonds are either extremely long or undated. They're subordinated to everything except for equity, and they have special features like the ability to push coupons and defer maturity. But we think, you know, those risks have been kind of overstated by the market. Over the last couple of years, this has started to play out. We've started to see hybrid yields tighten inside of the HYOD index now and they're starting to close back towards double B senior bonds where they traded through those prior to COVID, and we think actually that's the best comparison, and that these hybrids can trade back in line with double b's where they were before the COVID.
What else do you see in terms of European high yield Jaguar land Rover popped out for me. What's the story there?
Yeah, So Joel Levington, who runs our credit research team, covers autos from the US, and Jaguar land Rover is targeting ten percent EBIT margins by twenty twenty six, which we're constructive on them being able to achieve. That would actually put them more in line with luxury auto manufacturers rather than the sort of likes of Audi and BMW which they are kind of currently being benchmarked against, and it would also exceed what both Moodies and SMP have been looking for at the existing credit rating. That plays into Joel's original thesis where he said he thought that net leverage trend was trending to a better better than rated outcome as well. So several reasons sort of from a fundamental perspective where we think possibly the ratings are too low and that the spreads can tighten.
Is there an electric vehicles element to it too well.
I think a lot of companies in that sector are kind of started moving away from that a little bit. But no, I think generally speaking, the higher margins are kind of supported by things that they're doing within their own business, you know. And when you look at where they are relative to what the rating asines have been expecting, they've kind of been well ahead of the curve of where moody Is and SMP have wanted them to come out, whether you're talking about profitability or whether you're talking about the balance sheet.
So another one to watch there in in terms of high yield opportunities in Europe, Steve going back to the US high yield, What are we excited about out here?
Sure, So there's a couple of names that we are excited about for US high yield. So number one in the consumer sector is Cody. The secured bonds are rated B A two W plus triple B minus, and we believe that there's the company is focused on reducing debt and improving its leverage, and there's the potential for another investment grade ratings. So if Moody's or SMP moved to an investment grade, they'd have two of the three ratings as investment grade and therefore they would, you know, officially move into the investment grade market. And the bonds trade much wider than most triple B rated consumer names, so you know, the catalysts there are continued debt reduction, lower leverage, and the potential for higher ratings and a movement into investment grade.
And what do they do?
This is Cody. This is the consumer company that provides I believe it's mostly consumer products, fragrances and items like that. I believe really hugs our analysts there and she could dive into the details of everything that Cody does.
Okay, what else is the new list?
Sure? So another high yield tightening potential name are the cruise lines. So Jodi Lourie is our analyst there. She's been positive on the cruise lines for some time. The cruise line bonds trade wide of many of their peers, yet the companies are very focused on reducing debt and improving leverage. Each of the major cruise lines. We're talking about Carnival, Norwegian and Royal are on a multi year quest for investment grade ratings, so they've been talking for a while that they want to improve to investment grade. A lot of these companies took on very high coupon, very expensive debt during the pandemic because they had to, and what we've seen over the past couple of years is that they've been refinancing a lot of that very expensive debt with much more reasonable coupon. So that's improved their you know, their interest costs and obviously demand for cruise lines has been very strong. That's helping a lot with their with their fun mentals and so we see you know, lower leverage there, lower debt, and improving bond spreads for the cruise line. So those are names that we like in high yield.
There always a risk that, I mean, we would have to get Jodi back on the show still about this, but the risk that consumers pulled back with seeing a little of pressionnel on consumers, but mainly mainly the low end. But you know, it's probably the first thing you would stop spending on, you know, luxury items like cruises if things do get tough, you.
Would think that, but it's it's you know, consistently strong demand for cruise lines. It's interesting as Comcasts reported, uh the other day, and they were talking about their theme parks business and attendance was down or lower than anticipated for the second quarter. Now, they had a very strong second quarter of the year before. But what they talked about for lower attendance, part of it was a change in consumer spending. So there was a pull forward for theme parks after the pandemic. People you know, ran to theme parks, but they've been losing now share to cruise lines in international travel.
So it's just interesting.
They pointed out that people still really like cruise lines and have moved away from domestic theme parks towards cruise lines. So yes, there is a pullback, but you know, cruisers still love the cruise I guess.
Okay, all right, we'll see how resilient that is if we go into a bit of a downtown. But so those are all the things that we love in terms of high yield and investment grade credit US and Europe. But let's talk about the risks. Things that you know, bonds actually may underperform, they may be priced too tight versus their peers they may actually wide and start with you again, Steve, with investment grade, what are you worried about that?
Sure? So you know, like again, not everybody has a positive view on everything. We're definitely look at both things that maybe trade too wide and companies that trade too tight and risk for concern. And one name I'd highlight is Disney. So Disney is rated single A across the board. The bonds trade much tighter than some ready to appears, for example Comcast, which is also single A across the board. Disney bonds are much tighter than Comcasts. Yet Comcast has lower leverage, so Disney has higher leverage and tighter spreads. And then you have a potential catalyst on the horizon that I think could cause their bonds to watt. Number one, Disney bought out comcasts one third stake in Hulu at the end of last year, and they paid an initial about nine billion dollar payment based on the floor value. Yet there's a go forward valuation process whereby they figure out what the true value or market value of Hulu is, and once that process plays out, we believe that Disney may have to make an additional valuation true up payment to Comcasts, which could be about four billion dollars looking at you know prices, you know, valuation metrics for other streaming companies out there, whether Netflix or names like that. And so four billion dollars going from Disney to Comcast, that's obviously credit negative Disney a positive for Comcasts. And the other issue to worry about with regard to Disney is that legacy media companies have been under tremendous pressure. We're seeing a shift in pay TV viewership right, so people are leaving their subscriptions and moving towards streaming, and so we've seen pressure on traditional media names like Paramount, like Warner Brothers, Discovery. Well, Disney, you know has a large media business. So Disney's media business accounts for sixty percent, we around sixty percent of overall revenue. So you know, as pressure builds in that part of the business, there's a risk that that could impact Disney. So you got Disney bonds a trade very tight, and you have higher leverage and potential for negative catalysts on the horizon. Another group that I'd point out is Spencer Cutter is our man and energy. He believes a lot of the high heeled natural gas providers trade too tight. So if you think about Chesapeake and tiro comstock Resources, all these companies bonds very very tight, and there's a risk with given how low natural gas prices are, you could see weaker financial reports in the future. You could see leverage start to climb, and given how tight they trade, there's the potential for those months to widen. Energy has been one of the best performing sectors in high yield this year. It trade, you know, the sector trades that are option just to spread of about one hundred and ninety four basis points, so one ninety four versus the overall high idled index you know, right around three hundred. So it trades very tight, and there's the potential for leverage suggle wider and for those names to underperform.
So I want to watch an Energy potentially some risks coming up. But I just wanted to go back to Disney for a second. You seem to be talking about the most is the streaming service and a sort of broadcaster, but they do have this massive business of theme pugs and other things, and even cruises. You know, don't go to Disney Cruise or Disney Vacation, shouldn't they derive some strength from what we've been talking about earlier. You know, the cruise lines is doing so well, it shouldn't Disney benefit from some of that demands as well.
Yeah, Disney will benefit. But if you think about again, when I said earlier about Comcast talking about weaker theme park attendants in Orlando, you know Disney has huge exposure there, right, So the exposure to theme parks is much greater than it is for cruise lines. So while cruise lines may be doing better, if they have weakness on the theme park side, that's going to warn offset the strength on the cruise lines. But we'll see what happens when they report fiscal earnings in I think it's early August.
Okay, Okay, so Daiden, I noticed you didn't have that many concerns on your list. Is everything bright and rosy over there in Europe? No problems at all?
Yeah, we're very happy people here.
It's surely not. Come on this credit. We're worried about things all the time. What are you concerned about? Where are the potential risks?
Well's it's just investment grade first one in my world, the tightest trading name in TMT. Investment Grade in Europe is Deutsche Telecom. But one of the problems that I think the market is not pricing in there is that, and this is something we've written about for a while, but it's got worse recently is the amount of structural subordination faced by Deutsche Telecom's European debt. More and more of the consolidated debt at the top level now is accounted for by T Mobile in the US, which puts the European debt in a subordinated position. Given they only own fifty percent of that US business and the debt there would have a priority claim over the cash flows in the US, and that's becoming an increasingly large, increasingly profitable part of their business now. Normally, SMP, in particular of the rating acies in general, start to get concerned when you have a very large amount of what they call priority debt, which sits down at an operating company level. That priority level of debt has actually crossed the fifty percent threshold with SMP, where normally they would downgrade the ratings. They've decided not to do that at this point, but it's still a very real that investors have on the European pod of Deutsche Telecom and that's you know, it's a triple B plus name. It trades significantly tighter than even something like an Orange, which is on positive outlook at the same rating level. So we think that there's a potential for spread widening in that name.
And I know it's not on your list, but I did want to ask you about alties because you know, not longer on this show, you described it as a Jenga tower, tons of debt about to crash down and spread across all markets, spreading you know, real panic and fear. What's the story there. What's the latest on an altis in.
So with art East France in particular, which is the silo that we were discussing. I think you know, there was when when everything kind of blew up earlier this year. It was really when they gave their their updates with the fourth quarter results and they gave an outlook for twenty twenty four where they said that they thought, you know, be a certain percentage deterioration in EBITDA this year, and the market said, oh, well, maybe they're just being conservative because they want to get a better deal in terms of potentially potential haircuts they might need to be to debt, and I think what was what we've seen with the first quarter earnings in particular, as we saw actually things were maybe deteriorating even faster than the company guided, and they revised the guidance even lower again. And I think, you know, if you start to extrapolate that kind of deterioration in ebit DAR, then you start to see leverage heading well above seven times in twelve to eighteen months up towards eight and it just it looks ever less sustainable, and the amount of haircuts you need to take just to stabilize this business seem even greater. So in terms of public publicly sort of released results and things like that, seems that things seems to have been getting worse. I think we're it's it's been a lot quieter in terms of newsflow lately, I think because obviously they're having negotiations with creditor groups, so those things happen kind of behind closed doors, So there's a limited amount of kind of newsflow about that publicly that we see, but clearly from an earning side and a leverage point of view, that the pressure is still building.
Most of Europe takes August off, so it shall we expect some big event in September that triggers something big in lties.
That might be too soon for negotiations to conclude. I suspect it might take longer. They're not under an imminent liquidity threat. They've got really through until at least the end of this year and into next year before they start to come across some of them, or the twenty twenty five maturity, So it could drag on a little longer than that.
I got it. We'll watch out for that. So I want to ask you both from all of these ideas, they're across the board, they're in all industries and sectors, there are lots of them, and it's great research, great stuff. Are there any kind of macro themes that you kind of draw from this? I mean in terms of like let's go home with the consumer for example, or you know, the economy in general, Steve, what do you think about that?
Yeah, So we talked a little bit about the shifting consumer trends. There some weakness overall in the consumer. Yeah, there were some some items and we talked about earlier that really stuck out as as as being resilient so far, including cruise lines, and we've kind of talked about that with some of our ideas, I'd say, you know, digging deeper into the communications sector in high yield kind of off of what Aiden was talking about there. I do think we're going to see a lot of liability management exercises in the sector in the second half of this year. Uh, there's a lot of over leverage capital structures, there's a lot of debt maturities that are going to start creeping up, and there's a lot of very low price bonds. So I think that's something that we could, you know, see as a theme in the back hand for junk communications. Now, communications is by far the widest sector in high yield, it's one of the worst performing sectors in high yield this year. There's a lot of structural issues going on in the industry, between competition for broadband, shifting, video consumption landscape, and just you know, big debt loads. You know, earlier this year we saw loom into a massive debt for debt exchange. Just the other day, AMC Entertainment, the movie theater company, announced a large debt for debt exchange in agreement with lenders. As Adan talked about, with all ties Europe and in the US here, there's been plenty of news stories of just different creditor groups forming creditor groups, companies hiring financial advisors, hiring legal advisors. So I think that is definitely a theme that we'll see in the back half of this year with regard to high YELD communications and.
On your side, aiden that you're looking ahead.
Too, Yeah, I think stated the consumers is the main one. I think, you know, in some sectors you've seen it perhaps a little bit more resilient up until now, but just this last beta results. We're any part way through the earning season here in Europe, but we've very clearly seen some of the earning's tail winds that you know, if I'm thinking about TMT, some of the earnings tail winds that they had on the inflation side have started to erode, and there's a lot of companies walking back on guidance for the rest of this year. So that's something that's still kind of playing out through this this particular earning season. I think it's something that you know, we've seen some very negative price action in the last few days, and I think that that's something that we really need to keep an eye on.
Everyone who comes on this show, is quite concerned about the politics. You know, we've seen a lot of volatility in European politics. We're now going through a bottle hele time in the US. Is there a trade in credit related to that? I mean, we've seen people be as simplistic as by high yield because Trump's got to win. Steve, is there is there anything developing that is it too early to say? Yeah?
No, So listen, US highyield is doing very well. Right so your date return of four point two percent, we're seeing spreads you know to very low levels. All in yield you know has come in. It's it's close to the to the tights for the the lowest for the year. So that seems to be the trade that that that people are are are working with right now is long US junk?
What about in Europe aid and the you know the big swing in the UK political scene as there's been volatility in France. Are there any political trades around what you do or just just stay out of it? No.
I think it's been the same pattern as as Steve described. Really, I think maybe in the sort of utility sector there's the potential for a lot more state involvement. So our analyst Paul Vickers has written an awful lot about Thames Water and the bankruptcy there, so you know the potential for state to start getting involved in a name like that. So I think that's that's probably where you need to look.
Where do we find all this great research we're talking about? Is it BI cred on the Terminal? Is that where we go?
Yes?
If you're going to b I cred on the Terminal, you could, you know, dig down into anything that that you like. There's tons of information, there are tons of research. But within that you should be able to see a list of all of our focus ideas on the credit side. If you're looking for overall Bloomberg intelligence focus ideas, including those from our equity counterparts, you would just type BI Space focus on the Terminal.
Great stuff. Okay, So I'm going to finish up by asking you both what is your biggest fear? A lot of people on this show worry about geopolitics, cybersecurity, economic slowdown, commercial real estate, consumers throwing in the towel, But what do you worry about most? Or when you're chatting to clients, what do they you know, what's already giving them gray hair right now, well covering hild communications.
There is a lot for people to worry about, right like, so I think, you know, I talked about it earlier. The secretor trades really why there's a lot of low price bards. There's a lot of people been trying to catch falling knives this year across the sector. You've even seen an you know, investment grade with what's going on Paramount, some of the risks around Warner Brothers, Discovery and the concerns across the board. So you know, that's the secret I focus on. That's most of what I'm hearing. If you talk about the overall credit markets, I think the topic that you've hit with regard to the commercial real estate exposure and risk there is also a big one anything on yours.
Yeah, So I think from my side, it's just how thin confidence is in current asset valuations. So we've had a strong run, whether we're talking about equities or credit, there's been a kind of a strong run. But it seems like it takes very little negative news to really knock that. Whether it's confidence in banking after what happened last year, whether it's idiosyncratic risk in companies falling over like Thames Water or potentially of some of the communications names we've discussed. And you know, just a few bad earnings as we've seen just lately, can have a very disproportionate impact on equity market valuations as well. So it just seems to be a lack of confidence in the sort of rarefied valuation levels we're at, and I'd say that that's something that can unwind pretty quickly.
On you, absolutely great stuff. Aidan Chesslin with Bloomberg Intelligence in London, Thank you, thank you. And the great Steve Flinn with BI in New York. Thanks very much, thank you. It's been a pleasure having you on the Credit Edge. Check out all of Aiden and Steve's excellent analysis on the Bloomberg terminal. Bloomberg Intelligence is part of our research department, with five hundred analysts and strategists working across all markets. Coverage includes over two thousand equities and credits and outlooks on more than ninety industries and one hundred market industries, currencies and commodities. Thanks so much for listening. Please note we will take off the week of August fifth, so no episode of Credit Edge on August eighth, but full service resumes on August fifteenth, when we will be back with another great show. Please do subscribe to The Credit Edge wherever you get your podcasts. We're on Apple, Spotify, and all other good podcast providers, including the Bloomberg terminal at bpod Go. Give us a review. It makes us easier to be found by other listeners. Tell your friends, or email me directly at Jcrombie eight at Bloomberg dot net. I'm James Crombie. It's been a pleasure having you join us again, next time on the Credit Edge.