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The yields on US trash bonds are at an all-time low. But, according to the market, one factor is working in its favor.
Citigroup
: The possibility of a “vast upgrade tsunami” of “rising stars,” or corporations that are upgraded from trash to investment grade. According to Citi’s high-yield strategists, the market might witness $200 billion in upgrades over the next two years as the economy reopens and hot markets lead to healthier corporate balance sheets. Following the Federal Reserve’s move last year to acquire bonds from companies who were investment grade before the epidemic, the bank believes corporations will be more interested in shoring up their finances to obtain investment-grade ratings.
The strategists stated in a report this week that “this is the highest-quality market we can remember,” and that there is “a large bench of issuers that could make the leap to investment grade.” This is significant because high-yield corporate bonds are sold at a premium. The market is paying a touch higher than 4% yield, which is a new low. That’s the tightest margin on Treasuries since the financial crisis of 2008-09. Even with their heightened sensitivity to interest rates, investment-grade bonds appear to be costly, trading at the smallest spread over Treasuries since the financial crisis. Despite the high valuations, Citigroup sees potential in the highest tier of the high-yield bond market, which includes bonds rated BB+, BB, and BB-, which are one to three rung below investment grade. The BBs, as a group, have a higher credit quality (and upgrade) outlook than they had before the pandemic—and probably any time in the market’s history, according to the bank. According to statistics from Bloomberg, that segment of the market pays 2.2 percentage points more than Treasuries, which is more than the 1.9-percentage-point difference they paid before the Covid-19 debacle.
ICE
Indices. In other words, Citigroup claims that investors are now better paid for the risk of that market than they were before to the epidemic. The bank also identified three types of businesses that may be renovated this year or next. Companies who were downgraded before or during the epidemic but are currently on the road to investment grade as their balance sheets improve are included in the first group. Another group of enterprises that are profiting from the reopening and strength in raw-materials prices is those in the metals and mining industries. The third category is for long-term high-yield bond issuers who are nearing maturity.
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For compliance reasons, the team didn’t name specific companies as possibilities for upgrades, but Barron’s uncovered a couple that were downgraded by ratings firms last year, are rated in the BBs, and weren’t as badly affected by Covid-19 aftereffects as a cruise operator or airline.
Ford Motor Company is a manufacturer of automobiles.
(F) as well as
Heinz Kraft
(KHC) and (KHC) were both reduced to junk status last year, with ratings of BB+, one step below investment grade.
FirstEnergy
(FE), a utility that was embroiled in a political scandal last year, could also be a contender for an upgrade. It was reduced to BB+ last year as well. The utility may fall into a distinct group of companies identified by the bank, namely those that have been “downgraded based on governance problems and potential punitive measures rather than financial or operational deterioration.” “Resolving [those] difficulties should help to consolidate financial positions, and ratings could improve as a result,” Citigroup stated. Citigroup also gave a breakdown of emerging-star sectors, which could provide some insight into the identities of future rising stars. The telecoms and cable sectors have the most outstanding bonds, thanks to a long-term junk-bond issuer.
T-Mobile United States
(TMUS) is a company that operates in the United States. Auto manufacturing and vehicle parts, consumer items, and healthcare are three more big sectors with potential emerging stars. BB+-rated companies in the healthcare industry
Centene
According to Bloomberg, (CNC) just sold a bond with a yield of less than 2.5 percent, the lowest ever for its maturity in the junk market. While that may not be a fantastic bargain for yield-hungry investors, it is almost certainly a market vote of confidence in the company’s credit quality—and could indicate that an upgrade is on the way. Alexandra Scaggs can be reached at alexandra.scaggs@barrons.com.
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