Friday, October 05 07:34:00
Heavily indebted euro zone firms are reaping the benefits of the European Central Bank's pledge to pull the region out of crisis, allowing them to borrow more cheaply and draw investors back into their shares. In the aftermath of the 2008 credit crunch, Portuguese power company EDP and Italian peer Terna were among the companies refinancing large debt burdens in the face of a complete collapse in faith in borrowers. That has changed, firstly with the sovereign debt crisis - which made banks and governments the main sources of lenders' distrust - and now with central banks' moves to head off the euro zone's turmoil and support economies with ultra-low official interest rates.
The result is a boom in corporate borrowing which drove the largest monthly issuance ever of "high-yielding" corporate bonds in September. Major European companies can now borrow in dollars and euros at all-time average lows of 2.84 percent and 2.43 percent respectively compared to 5 percent or more three years ago and the knock-on effect for their balance sheets is beginning to reflect in share prices. That also hangs out the hope of a competitive advantage as the rise in available funds offers them the option of investing or spending more. "If things keep improving on the funding front, these companies could do better as they benefit the most from lower cost of financing," said Emmanuel Cau, strategist at JP Morgan, which has reversed its 'underweight' stance on a basket of Europe's most highly leveraged companies.
Sovereign debt yields for Italy and Spain have come down steeply since the European Central Bank signalled in July it would not allow a euro zone collapse, and followed that up this month with a plan to buy bonds. That in turn should feed through into lower borrowing costs and better sentiment for corporates. "We are still cautious about economic fundamentals in Europe but we see the recent shift in ECB policy as a game changer because it makes the region investable again," said Cau. Companies are already starting to cash in. EDP, Italian bank Intesa and Spain's Santander are among those to have pushed through debt issues last month in the afterglow of ECB's pledge. "It is ... our view today that Europe is stronger and the market agrees," said Antonio Mexia, chief executive officer at EDP, one of the top 10 of most highly leveraged companies in the MSCI euro zone index.
The utility last month became the first Portuguese company to tap international debt markets in over a year, borrowing 750 million euros in a bond issue that was ten times oversubscribed and even cost less than the 5.875 percent demanded by investors 18 months ago, soon after the country had sought international aid. That is good news for Portugal's largest company, which saw first half net profit dented by rising financing costs and which had net debts of 18 billion euros at the end of June - more than the 2011 gross domestic product (GDP) of Iceland. Others are benefiting too, with the yields even dropping on the bonds of beleaguered French car maker Peugeot, which has slashed jobs and seen sales tumble.
Now that the tensions around corporate debt have eased, investors can start paying more attention to valuations. Terna, an 'overweight' top pick for JP Morgan whose shares have jumped over 20 percent since July, has a price to earnings ratio at 18.6 times, below the utilities sector average of 20.4. Its earnings per share, dividend yield and return on equity are double its peers' while its expected net debt will be 2.2 times greater than its book value in 12 months, according to Thomson Reuters Datastream Spanish toll road operator Abertis, which has been selling off assets to pay debts and still has 3.4 times leverage, is rated 'buy' or 'hold' by all but one of the analysts in the Thomson Reuters Eikon database.
Equity returns and dividend yields are especially key for investors looking for alternatives to negative real returns on sovereign government bonds. The sector mix of the most highly leveraged companies also plays in their favour in terms of being well-placed to benefit from ECB bond purchases and any positive feed through into economic growth and improved risk appetite. Of the 30 most highly leveraged stocks in the euro zone, 12 are utilities, eight are telecoms and the rest are industrials, consumer discretionary or consumer staples - all likely to reap the dividends of any improvement in the euro zone economy.
"The end game is to get government bond yields down, which would in turn bring the cost of borrowing down for corporates so they should be beneficiaries," said Kevin Lilley, European equities fund manager at Old Mutual Asset Managers. Following the stimulus pledges from the ECB, economists have turned more upbeat on euro zone gross domestic product (GDP) growth, raising their forecasts for 2013 to 0.5 percent from 0.3 percent a month ago, according to a Reuters poll. Such close links to the fate of the euro zone, its most struggling member states, its economy and its sovereign bond yields, does mean that the highly-leveraged companies remain at risk of being hit anew if thing turn for the worse again.
Ed Shing, strategist at Barclays, said that for such companies to really outperform, economic improvement would need to become visible and high 'beta' stocks - the riskier, more volatile ones which tend to rise and fall in tandem with the market but in much bigger moves - would need to rally. But by then, the valuations are likely to be less attractive, so those willing to take the risk may be better off going in before the rest of the market catches on to the trade. Players say the corporate bond markets themselves have already reached the point where there may not be much further to go. "If you want to get exposure to what should benefit the most from reducing euro zone stress, it's worth considering the high-leveraged companies given their sharp underperformance of the past months," said JP Morgan's Cau. ( C) Reuters