Back to Business; New Issue Market Provides Some Attractive Opportunities
It was back to the grind last week as traders and portfolio managers returned to their desks after the holidays for the first full trading week of the year.
It was back to the grind last week as traders and portfolio managers returned to their desks after the holidays for the first full trading week of the year. The average credit spread in the Morningstar Corporate Bond Index was unchanged at +118, its tightest level since the 2008-09 credit crisis. As market participants returned to their desks, the new issue market sprang back to life and provided a few opportunities to put money to work at attractive levels. Hewlett-Packard (HPQ) (rating: BBB+, narrow moat) tapped the market last week, issuing new bonds for the first time in nearly two years. The firm placed $2 billion of 5-year floating- and fixed-rate notes, with the fixed-rate tranche launching at +102 basis points. The notes have traded well in the secondary market, with a bid of +99 basis points seen. We believe fair value is in the range of +85-90 basis points, leaving the bonds still modestly undervalued. Over the past two years, HP has reduced its debt load to $22.6 billion from $30.6 billion while increasing cash on hand 50% to $12 billion. As a result, consolidated net leverage has been cut in half to 0.8 times from a peak of 1.6 times in early 2012. HP faces a heavy slate of debt maturities in 2014, including $4.5 billion that comes due during the first half of the year. The fact that the firm only placed $2 billion of shorter-term notes seems to signal that HP will steadily bring gross leverage down for the foreseeable future. That said, future debt reduction probably won't be as rapid as it has been recently. Net operating company leverage, which excludes debt used to support the financing business, fell below zero last quarter, meeting one of management's goals for the balance sheet. We expect the firm will begin looking at smaller acquisitions that bolster its technology position in the critical enterprise hardware segment.
While most deals performed well in the secondary, a few deals struggled. As credit spreads have tightened across the board, many companies' bonds have tightened more than warranted for their credit risk. For example, Mondelez International (MDLZ) (rating: BBB, wide moat) issued 5-year and 10-year bonds to fund a tender offer. We thought the whisper talk on the 10-year was more than fully valued at +115 and recommended that investors pass on the offering if the final pricing was any tighter. The 10-year bond ended up pricing at +105. By the end of the week, the company's bonds were offered at the new issue spread and were bid a few basis points behind. Adding to the credit risk inherent in the company's operations, activist shareholder Nelson Peltz has taken a large stake in Mondelez. He has been prodding the company to take actions to bolster shareholder value. His plans range from cutting costs to improve operating margins to selling the company outright. Mondelez has stated its goal is to increase margins by 500 basis points over the next five years, and we suspect it is more interested in being an acquirer than being acquired. We would not be surprised to see Mondelez conduct large, debt-funded acquisitions in the future that could pressure the firm's credit rating.
David Sekera does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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