Demand for Corporate Bonds Stronger Than It Appears
Of the issues that we followed in the secondary market, each was trading higher last week.
The average credit spread within the Morningstar Corporate Bond Index only tightened by 2 basis points last week to 134 basis points above Treasuries. However, based on new issue market demand, we think the corporate bond market is stronger than indicated by the indexes.
For example, Avon Products (AVP) (BBB-) brought a new $1.5 billion deal to market with several different maturities. Initial whisper talk on the 10-year tranche of bonds was a spread over Treasuries in the mid-300s, which would equate to a 5.375%- 5.50% yield. Due to strong demand, the official price guidance was decreased to the low 300s basis points above Treasuries, and the bonds were priced at 313 basis points over Treasuries. We thought the bonds were very attractive for the credit risk at the whisper talk. Unfortunately, the underwriters priced out much of the upside to investors, so we consider fair value for the bonds to be near 300 basis points above Treasuries. While we are skeptical that the execution missteps that have plagued the company are fully resolved, we continue to think that the firm has the ability deliver excess returns over time. We view Avon as having a narrow economic moat based on a respected--but bruised--brand, extensive geographic reach, and an underlying business model that requires little invested capital.
David Sekera does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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