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Corporate Bond Market: Summer Starts to Slip Into Fall

Corporate Bond Market: Summer Starts to Slip Into Fall

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Corporate Bond Market: Summer Starts to Slip Into Fall

Activity in the corporate bond market has begun its typical seasonal summer slowdown as market participants gear up to take their remaining summer vacations before school resumes. Even though second-quarter earnings reports continue to be strong and the S&P 500 rose by 0.75% last week, corporate credit spreads ended the week relatively unchanged. The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade market) tightened one basis point to +112. In the high yield market, the BankAmerica Merrill Lynch High Yield Master Index widened one basis point to end last week at +343. Similarly, in the U.S. Treasury bond market, volatility was muted. The 2-year and 5-year Treasury bonds tightened 3 basis points each to end the week at 2.64% and 2.81%, respectively, whereas the 10-year was unchanged at 2.95% and the 30-year rose only one basis point to 3.09%.

In the new issue corporate bond market, according to Bloomberg, the amount of new issuance slipped to $7.8 billion last week as compared with its forecast of $20 billion. While activity was muted, those companies that came to market found a receptive investor base and those new issues were heavily oversubscribed. That allowed those companies to tighten price talk and issue their new bonds on top of the levels where their existing bonds were trading as opposed to typically having to issue new bonds at a concession. The new issue market is expected to remain subdued over the next few weeks as the corporate bond market typically slows down during August.

 


  - source: Morningstar Analysts

 

As we have highlighted in our credit notes over the past few weeks (available at www.morningstarcreditratings.com), second-quarter earnings reports have continued to be robust. Companies in economically sensitive sectors showed the greatest top-line increase, often well into double-digit percentage gains on a year-over-year basis. For example,  Concho Resources (CXO) (rating: BBB-, positive) reported second-quarter operating revenue of $945 million, a whopping $378 million (67%) increase relative to $567 million in the second quarter of 2017. This gain was largely driven by growth in Texas Permian oil sales volumes and higher oil price realizations. Elsewhere in the energy sector,  Anadarko Petroleum (APC) (rating: BBB-, stable) reported a 21% increase in second-quarter revenue to $3.3 billion, largely reflecting growth in U.S. onshore oil sales volumes and higher global oil price realizations. Industrial companies that provide services to the energy sector went along for the ride and also posted double-digit revenue increases. As an example,  National Oilwell Varco (NOV) (rating: BBB+, stable) reported an almost 20% increase in second-quarter revenue to $2.1 billion from $1.8 billion reported in the year-ago quarter.

Similar to the energy sector, the basic materials sector is highly correlated to economic activity and experienced strong growth.  Vulcan Materials (VMC) (BBB-, stable) reported that its second-quarter revenue increased 16% to $1.2 billion for the quarter.  United States Steel (X)’s (B, positive) second-quarter revenue increased 15% to $3.6 billion, and the company subsequently increased its earnings guidance for the year.

However, while an expanding economy lifted all boats in the cyclical sectors, there have been companies that experienced idiosyncratic issues last quarter. To the downside,  Teva Pharmaceutical Industries(TEVVF) (BB, stable) operational woes were evident in the second quarter as total revenue dropped 17.8% to $4.7 billion, mainly from continued tough pricing within the U.S. generic market and erosion of Copaxone sales by 39.6%, including a 46% decline in U.S., due to generic competition. Despite Teva's debt load dropping since the end of 2017, gross debt leverage ticked up to 5.5 times for the latest 12 months versus 5.3 times in 2017. We had recently downgraded Teva to BB from BBB- in March 2018, reflecting the firm’s difficult path ahead as it tries to reverse declining operational performance while handcuffed by high financial leverage.

Morningstar Credit Ratings issues credit ratings on over 250 corporate and financial institutions. For detailed analysis and research, please see our credit notes published under the Research tab at: www.morningstarcreditratings.com.

Weekly High Yield Fund Flows

Investors returned to the high yield market as high yield fund inflows reached $0.8 billion, consisting of $0.6 billion of net unit creation among the high yield exchange traded funds and inflows of $0.2 billion into high yield open end mutual funds. Year to date, fund flows have registered a total outflow of $15.9 billion, consisting of $3.9 billion of net unit redemptions across the ETFs and $12.1 billion of redemptions among the open-end funds.

 


  - source: Morningstar Analysts

 

Morningstar Credit Ratings, LLC is a credit rating agency registered with the Securities and Exchange Commission as a nationally recognized statistical rating organization (“NRSRO”). Under its NRSRO registration, Morningstar Credit Ratings issues credit ratings on financial institutions (e.g., banks), corporate issuers and asset-backed securities. While Morningstar Credit Ratings issues credit ratings on insurance companies, those ratings are not issued under its NRSRO registration. All Morningstar credit ratings and related analysis contained herein are solely statements of opinion and not statements of fact or recommendations to purchase, hold, or sell any securities or make any other investment decisions. Morningstar credit ratings and related analysis should not be considered without an understanding and review of our methodologies, disclaimers, disclosures and other important information found at www.morningstarcreditratings.com.

David Sekera does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.