Almost Daily Grant's

Angel eyes

Recap May 22

Yellow ledbetter

Wishing well

QE progress report

Recap May 20

Risk management 2.0

Paper pushers

Northern exposure

Recap May 20

Pounded dough

57 days later

Recap May 19

Noises off

Depreciation day

Correction:

Recap May 18

Shelf life

King me

Recap May 15

She said it

Rock center

QE progress report

Recap May 14

Some type of synergy

Liquid courage

Recap May 12

Bed check

A ripple in the desert

Recap May 11

He said it

Break on through

Recap May 8

Mr. Market's Wild Ride

QE progress report

Recap May 7

Learning by doing

Solar city

Pressed juice

Recap May 6

Green thumb

A closer look at “whatever it takes.”  This morning, a German constitutional court asked the German government to audit the European Central Bank’s asset purchases to determine whether the Frankfurt-headquartered ECB has exceeded its legal authority. In reversing a prior pro-QE ruling by the European Court of Justice in 2018, the Karlsruhe court ordered German authorities to provide a so-called proportionality assessment, which will determine whether “economic and fiscal policy [side] effects” of large-scale asset purchases outweigh the ECB’s mandated policy objectives, within the next three months.  

By way of response this evening, the ECB offered no indication that it will change course: ”the Governing Council remains fully committed to doing everything necessary within its mandate to ensure that inflation rises to levels consistent with its medium-term aim and that the monetary policy action taken in pursuit of the objective of maintaining price stability is transmitted to all parts of the economy and to all jurisdictions of the euro area.”

Some monetary mandarins couldn’t hide their displeasure over the legal challenge. Former ECB vice president Vítor Constâncio asserted on Twitter that the court made a “ridiculous distinction between monetary policy and economic policy.”

The size and scope of those asset purchases is a key point of contention, as the European Court of Justice cited the ECB’s self-imposed constraints on sovereign bond purchases (which included proportional limits on a member state’s contribution to the ECB’s capital, as well as a 33% cap on a given country’s total eligible debt) in upholding the status quo back in 2018.  Yet the ECB said it would waive those capital restrictions and consider relaxing size limits when launching the newfangled Pandemic Emergency Purchase Programme in March.

Aggressive buying of sovereign debt has long been standard operating procedure. In February 2018 (10 months before the European Court of Justice affirmed the asset purchase schemes) ECB executive board member Benoît Coeuré told an audience in New York that global central banks may hold as much as 90% of all German bunds.  

With supply so thoroughly constrained, Coeuré reasoned, “investors are willing to absorb new bonds without requiring much higher compensation. . . In these circumstances, only very large changes in the expected supply of bonds can cause yields to rise more meaningfully. . . Once the ‘crossover point’ has been reached, additional purchases become less necessary to contain the term premium at low levels.”

Mission accomplished?

 

Just add water

The Mortgage Bankers Association reported yesterday that the share of U.S. homes in forbearance rose to 7.54% during the week ended April 26, up from 6.99% in the week prior.  Still that widespread distress has yet to take a visible toll on the housing market.  According to the National Association of Realtors, the median U.S. home price rose a cool 8% year-over-year in March to $280,600.

While sales fell 8.5% sequentially in March, units for sale dropped 10.2% year-over-year according to the NAR, and real estate brokerage Redfin reported that total listings of homes for sale declined to its lowest in five years.  “Demand absolutely got a kick in the gut, but at the exact same time, so did supply,” Skylar Olsen, senior principal economist at Zillow Group, tells The Wall Street Journal.

Some of the more speculative market players are ready to dip their toes back in the water.  So-called instant homebuyer (i.e., house-flipper) Opendoor Labs, Inc. CEO Eric Wu told Bloomberg in an interview yesterday that his company will resume operations in Phoenix this week, followed by planned reopening in 20 different markets in coming months.  Opendoor, which paused operations and laid off 35% of its staff in early March, counts SoftBank’s Vision Fund as an investor and raised money in March 2019 at a $3.8 billion valuation.

Fortune favors the bold?  For more on risks and opportunities in the housing market, including a bullish analysis of an industry mainstay, see the April 3 edition of Grant’s.

 

Recap May 5

Stocks enjoyed another rally, with the S&P 500 finishing nearly 1% in the green despite a late downdraft to close to within 16% of its late-February highs.  A strong rally in the energy patch pushed WTI and Brent crude back above $24 and $31 a barrel, respectively, while another round of Treasury steepening saw the 30-year yield rise to a three-week high above 1.31%.  Gold edged higher to $1,708 an ounce, and the VIX fell below 34.

- Philip Grant

Model X

Call it Uber diets.  This morning, Uber Technologies, Inc. announced that its Uber Eats unit will exit seven international markets, including Saudi Arabia and the Czech Republic.  The move is part of the company’s previously announced plan to be the leader or runner-up in all markets in which it operates, divesting from the rest.

While Uber retrenches from points afar, delivery giant GrubHub, Inc. (GRUB on the NYSE) is reportedly making hay during this interminable lockdown.  Last week Blueshift Research relayed an upbeat assessment of GrubHub, reporting that “food delivery orders have increased significantly in April” relative to a prior update on March 24, with three sources reporting that orders doubled on a sequential basis in April. Mr. Market is likewise feeling his oats:  GRUB shares have jumped some 50% from their mid-March lows, narrowing losses to 23% since a bearish analysis in the Sept. 20 edition of Grant’s.

Pickups in business aside, the high-commission delivery model faces a multi-fronted legislative assault. On April 24, Seattle’s city council implemented an emergency order capping delivery fees at 15%, following a similar move from San Francisco two weeks earlier. On the east coast, the New York City council debates a bill potentially to cap delivery fees at 10% (for context, GRUB’s commission had ranged as high as 30% of an order).  That bill will soon pass, sponsor Francisco Moya (D-Queens) assured the Gotham Gazette yesterday.  In an email to customers protesting those moves, GrubHub claimed that the law “will increase your fees by $5 to $10 per order and immediately cripple delivery orders, outweighing any potential benefits when takeout is the only option restaurants have to stay open.”  

A wider implementation of California’s Assembly Bill 5, which would force so-called gig economy companies to classify their workers as employees instead of independent contractors (thus putting the employers on the hook for healthcare expenses as well as their share of Social Security and Medicare taxes), stands as a further risk for GrubHub and its ilk.

Some eateries are looking to cut out the middleman entirely.  Anecdotally, several restaurants across Manhattan and Brooklyn are now including inserts urging diners to order directly via telephone or the restaurant website, in some cases offering generous incentives to those who do so.  At the same time, competitors are getting more aggressive.  On April 17, Postmates ran promotions promising unlimited free delivery for three months for new signups.  As the delivery industry is an interchangeable, commoditized service, entrants compete primarily on price.

Then, too, last year’s revelation that GrubHub had improperly charged restaurants for fielding customer phone calls, irrespective whether those calls led to an order through the Grubhub website, continue to linger.  While GRUB announced plans to refund restaurants for overcharges, a February survey from the NYC Hospitality Alliance found that 91% of restaurants who had been wrongly charged had yet to receive their refunds.

According to an April 23 report from Eater New York, that “business practice” continues unabated.  The culinary publication found that one restaurant near Columbia University took 54 phone calls via the delivery portal between Jan. 4 and April 20, with only three of those calls resulting in orders.  Yet GrubHub charged the establishment commissions ranging from $6.20 to $7.17 for each of those 54 calls.

Despite such legal and reputational risks, GRUB investors continue to give the company the benefit of the doubt. Grub’s  enterprise value stands at a princely 32.6 times last year’s adjusted Ebitda, double that of the S&P Restaurants Index.  

While investors continue to price in future success via a fancy valuation, management is a bit more circumspect. Last fall, CEO Matt Maloney had this to say on GRUB’s third quarter earnings call:

Extremely large delivery/logistics companies can generate slim margins, but only because of the hub and spoke efficiencies they gain at substantial scale. The point-to-point nature of our business mostly eliminates that aspect of operating leverage.

Fellow directors seem to sympathize with Maloney’s bearish assessment of GrubHub’s business model, as the c-suite has unloaded some 42,000 shares this year for proceeds of $2.09 million. The last insider open market purchase, by board member Keith Richman last November, came when GRUB shares traded some 28% below their current levels.
 

Recap May 4

Stocks rebounded from early losses, with the S&P 500 grinding higher throughout the session and closing 40 basis points in the green, near its best levels of the day.  Treasurys saw some modest steepening as the long bond rose to the upper end of its three-week range near 1.29%.  Energy caught a bid with WTI crude rising above $21 a barrel,  gold remained just north of $1,700 an ounce, and the VIX slipped below 36.

- Philip Grant

Thanks for nothin'

Here are credit strategists from Bank of America in a research note this morning:

Note to Fed: a lot of investors (including non-credit ones) have bought IG corporate bonds the past two months. . . on the expectation they can sell to you. So would be helpful if you soon began buying broadly and in size.

 

Codependency credit

Torrents of red ink down Mexico way.  State-owned oil giant Petróleos Mexicanos  (a.k.a. Pemex) reported a MXN 562 billion ($23.6 billion) net loss for the first quarter.  That compares to a $1.5 billion loss in the same period a year ago and $17 billion shortfall for full-year 2019.

While Pemex has long sported wobbly financials (the company has been cash flow negative each year since 2009), that escalation is alarming. Yet management professes to remain unfazed. Chief financial officer Alberto Velazquez declared that Pemex “will continue with the best operational and financial (plans) implemented since the beginning of this administration.”   As for the Mexican government’s determination to support its energy champion, Velazquez described it as “absolute.”   

To be sure, President Andrés Manuel López Obrador (AMLO) has made returning Pemex to glory a top priority in his left-wing populist platform, routinely criticizing the relatively market-friendly policies undertaken by his predecessor, Enrique Peña Nieto.  “We will sow oil . . . and reap self-sufficiency in food,” AMLO declared last fall.

To that end, Mexico has continued to shovel aid Pemex’s way. Earlier this week, the administration rolled out an additional $4.6 billion worth of relief, following a series of similar infusions throughout 2019. For its part, the company said it will prioritize lower cost production in hopes of cutting down on capital expenditures.
While the recent swan-dive in oil prices can largely explain those ballooning first quarter losses, Pemex has long contended with a pair of potentially debilitating problems: Namely, a punishing $152.4 billion debt load inclusive of operating lease and pension liabilities (more than 7 times trailing Ebitda) in tandem with a long-term production decline, as output has slumped to 1.76 million barrels a day in the first quarter, half that of the glory days of 2004. 

In light of those grim figures, it’s no surprise that Pemex now carries the dubious distinction of being the world’s largest “fallen angel.”  Thanks to a downgrade to junk status from Moody’s earlier this month (along with a pair of recent cuts from Fitch), Pemex’s $59 billion in dollar-denominated marketable debt has been foisted onto the junk bond market.  Mexico’s sovereign credit has likewise come under the rating-agency chopping-block, with Moody’s and Fitch cutting their ratings to triple-B and triple-B-minus from triple-B-plus and triple-B, respectively. 

Mr. Market has received the message loud and clear.  Since a bearish analysis in the March 23, 2018 edition of Grant’s, spreads on Pemex’s dollar-pay, senior unsecured 6 3/4 notes due 2047 have widened to 888 basis points from 390 basis points.  The Mexican 4.6% sovereign dollar-pay bonds due 2048 now trade at a 398-basis point pickup over Treasurys, compared to 198 basis points as of March 2018.

Some observers see opportunity in the carnage, as analysts from Citigroup wrote on April 23 that Pemex’s longer-duration bonds appear attractive: “We do believe the company will, in the end, be supported by the government.”  

But the implicit government support has its drawbacks.  In an April 19 report, CreditSights identified a trio of fundraising limitations faced by Pemex: “Asset sales remain off the table, there are no dividends to cut, and we assume that secured debt is not an option owing to a reticence to grant liens to foreign investors.” 

Then too, political capital is increasingly hard to come by. According to a poll conducted by market research firm Consulta Mitofsky in mid-April, AMLO’s approval rating had declined for 15 consecutive weeks, to 46% from 60% at the beginning of the year. 

Indeed, Pemex and Mexico’s sovereign credit are intertwined: Is that a good thing?
 

Recap May 1

The second-largest selloff since April 1 left the S&P 500 lower by 3% to erase this week’s gains, while the Treasury curve flattened a bit as the long-bond rallied to a 1.26% yield.  Gold rebounded to $1,700 an ounce, WTI crude approached $20 for its best close since April 20, and the VIX rose to 37, extending its two-day rally to 19%.

- Philip Grant

Credit check

Delta Air Lines, Inc. came to market earlier this week with a $3.5 billion in triple-B-minus-rated, 7% senior secured first-lien bonds.  The bonds, which were upsized from a planned $1.5 billion offering thanks to an order book that reportedly exceeded $10 billion, quickly broke higher and last changed hands at 101.75 cents on the dollar, for a yield-to-worst of 6.54%.  

The enthusiasm with which creditors shower Delta with funds contrasts with the grim current reality.  On last week’s first quarter earnings call, CEO Edward Bastian forecast a 90% plunge in the top line for the second quarter relative to a year ago.  Yesterday, Bloomberg reported that only 110,913 people went through U.S. airport security screening, down 95% from a year ago, and that Delta has asked the Department of Transportation to suspend flights to nine airports, including one (Worchester, MA) which has only ferried a single passenger on a daily basis in recent weeks.

No revenue, no problem.

 

Security master

This morning, the Federal Reserve announced that it will expand the scope of its $600 billion Main Street Lending Program to include companies with up to 15,000 employees and/or $5 billion in revenue, up from prior restrictions of 10,000 and $2.5 billion in revenue, respectively.  In addition to opening the program to larger operators, the Fed also relaxed financial criterion for accessing the funds, including the stipulation that the borrowers total debts do not exceed six times “adjusted 2019 earnings before interest, taxes, depreciation, and amortization.”  In the prior iteration of the program announced April 16, borrowers were capped at four times last year’s unadjusted Ebitda.

While the monetary authorities widen the scope of their interventions (and adopt the forgiving methodologies now common on Wall Street), a pair of recent media entries underscore the current state of play.  In an opinion piece for Bloomberg yesterday, former New York Fed president William Dudley identified some of the pitfalls to extending credit to small- and medium-sized businesses:

Keeping bad businesses afloat just makes it more difficult for more viable companies to survive and prosper. The second is terms that ensure banks will lend and viable businesses will borrow.  It will be hard for the Fed to thread this needle.

Consider what it will take for lenders to extend credit that's consistent with the Fed’s and the Treasury’s risk tolerance. If the loan is truly an attractive credit, there's little reason to farm it out to the Fed. Why not just keep the loan on its own books or syndicate the credit with other lenders? 

Yet that mentality was nowhere to be found in other recent crisis-response maneuvers.  Yesterday, the Financial Times detailed the successful lobbying efforts of Marc Rowan, co-founder at private equity mainstay Apollo Global Management:

In a presentation circulated among investors late last month, and in private correspondence with President Donald Trump’s son-in-law, Jared Kushner, Mr. Rowan urged an expansion of the Fed’s purchases of securitized debt in order to unfreeze the capital markets, according to people familiar with the discussions.

In early April, with unemployment soaring to levels not seen since the 1930s, the U.S. authorities announced interventions that were even bolder, in some ways, than what Mr. Rowan was suggesting. With equity from the Treasury as a backstop to cover any losses, the Fed would buy securities linked to some junk-rated corporate bonds, leaving few taboos unbroken in Washington’s effort to resuscitate the economy.

QE progress report

To infinity, and beyond! Reserve Bank credit (i.e., the Fed’s sum total of interest-bearing assets) jumped to $6.598 trillion, up $146 billon from last week’s reading and 62% year-over-year.  On an annualized three-month basis, Reserve Bank credit is up 446%, compared to 362% last week and 90% four weeks ago.
 

Recap April 30

Stocks pulled back with the S&P 500 dropping 1% to narrow its weekly gain to 2.7% so far, while the VIX jumped nearly 10% to 34.

The Treasury curve steepened thanks to weakness at the long end, as the 30-year yield rose to 1.29%, its highest in more than two weeks.  WTI crude ripped higher to $19 a barrel, while gold fell to $1,685 an ounce. 

- Philip Grant

State of nature

Yesterday, New York governor Andrew Cuomo had this to say regarding the Empire State’s ability to pay out unemployment claims to the legions of newly jobless: “[The] federal government has to provide funding, we don’t have money.”

The municipal bond market appears to be taking the governor’s blunt warnings in stride. New York’s general obligation 3 1/4 notes due 2045 last changed hands at 104 cents on the dollar, priced-to-yield 3.02% (or 5.10% on a tax-equivalent basis). That is virtually unchanged from a bearish analysis of New York’s municipal debt in the Jan. 10 edition of Grant’s.  

Red ink is old hat for creditors of the high-tax and free-spending New York, despite the salutary effects of a 10-year business expansion and accompanying Wall Street boom. Last fall, the state increased the projected deficit in fiscal 2021 (which began April 1) to $6.1 billion from $4 billion, while expected pre-virus shortfalls for 2022 and 2023 were upsized to $7.5 billion and $8.5 billion from $4.1 billion and $4.7 billion, respectively.  

Then, too, population trends were going the wrong way long before the bug bit.  Last year, 77,000 New Yorkers left the state in search of greener pastures according to the Census Bureau, topping the 51,000 population loss from Illinois for the unwanted title of the state with the largest outflow of people. Adjusted for total population size, the 0.4% departure rate was also the worst in the U.S.

With the economy now in screen-saver mode, those trends do not look set to reverse anytime soon. In an April 7 letter to state lawmakers, Cuomo projected a $10 billion to $15 billion loss in revenue as a result of the shutdowns, or 6.7% of last year’s total revenues using the midpoint of that range. The State Division of Budget pencils in $61 billion of government revenue losses through 2024 and a total $243 billion in statewide economic losses “over the course of the full recovery,” equating to 14% of state GDP.  If the past holds, fiscal 2021 could be particularly ugly. David Friedfel, director of state studies at the Citizens Budget Commission, found last year that during the past three recessions, tax revenues declined by 3.7% in the first year of a contraction, followed by an average 6.4% shortfall in the subsequent year.

The rating agencies are getting nervous, as Moody’s lowered New York’s outlook to negative on April 1. Fitch Ratings followed suit on April 10, citing “[the] expectation that longer-term economic and revenue growth may slow from historically robust levels. Slower growth began to emerge before the coronavirus pandemic hit, and if it is sustained would be likely to make matching recurring expenses to recurring revenues more difficult.” 

Meanwhile, impacts from the virus could pit states against one another.  Bloomberg reports today that with suburban employees who normally commute forced to work from home, a regional showdown may loom as New York taxes those out-of-state workers who commute.  “States don’t have a good track record on coordinating tax policies,” noted Jeffrey Friedman, partner at law firm Eversheds Sutherland. “You could see two states claim withholding on the same income.  Without state coordination, it could be a disaster.”

While the prospect of interstate revenue squabbles could complicate life for New York’s creditors, a cold shoulder from Uncle Sam stands as a potentially far more severe risk. In the 2019 Financial Condition Report published in October, New York State comptroller Thomas DiNapoli noted that federal funding last year footed to $66.3 billion, up 8.1% from the prior year and more than one-third of total receipts.  DiNapoli cautioned: “The potential for substantial reductions to federal aid for health care and other programs, driven in part by burgeoning federal deficits, could threaten the state’s ability to maintain essential services.”  Meanwhile, U.S. Senate majority leader Mitch McConnell (R-KY) took a dim view of the notion of more federal funding for states last week. “I think this whole business of additional assistance for state and local governments needs to be thoroughly evaluated,” he said.

The investment conclusion, from that Jan. 10 edition of Grant’s: 

New York State, home to American high finance (and to this journal of high finance) is a beautiful place and was once, in more enterprising times, a strong and growing one. It may yet thrive again. However, for now, sell its bonds.
 

Recap April 30

Stocks edged lower as the S&P 500 couldn’t hold its early gains after a fifth consecutive gap higher to open the trading day,  while Treasurys caught a bid with the 10- and 30-year yields falling to 0.61% and 1.2%, respectively.  WTI crude slipped below $13 a barrel,  gold pulled back to $1,709 an ounce, and the VIX rose to 34, breaking a four-session losing streak.

- Philip Grant

Liquidity check

On Friday, investment firm Franklin Templeton announced it will close six India-based mutual funds after asset value declines sparked a rush of redemptions. The credit-focused funds, which were valued at $4.1 billion as of March 31, prominently featured debts issued by energy and mining companies, as well as nonbank lenders, according to The Wall Street Journal.

The situation is an outlier according to the Association of Mutual Funds in India, which assured the public that local fixed-income funds feature “superior credit quality securities and. . . have appropriate liquidity to ensure normal operations.”  Growth has not been a problem for the industry:  India’s total mutual fund assets footed to $326 billion at the end of March according to the AMFI trade group, more than double that of five years ago.
 

Something shiny

Retail buyers of gold bullion coins are now paying premiums of roughly $135 on a per-ounce basis, Robert Higgins, chief executive officer at Argent Asset Group LLC, tells Bloomberg.  That is more than triple the premiums quoted two months ago.

Higgins reports that his wholesale business transacted more than 6.5 million ounces of gold in March, compared to 1 million to 1.5 million ounces of gold in a typical month. “Until the world catches up with the imbalance and gets back to a normal balance of supply and demand, the premiums will stay,” he predicts.
 

Smoke 'em if ya got 'em

On April 17, Howard Willard, CEO of tobacco giant Altria Group, Inc. (MO on the NYSE) abruptly retired.  Apart from a COVID-19 affliction, the executive was also dealing with a case of corporate buyer’s remorse: In December 2018, Altria coughed up $12.8 billion for a 35% stake in e-cigarette company Juul Labs,  an investment which has come a cropper in recent months.  On April 1, the Federal Trade Commission sued to unwind the deal, alleging anticompetitive motivations on Altria’s part.  Surely, Altria wished it could go back in time to do the same.

Thanks in large part to the vaping-related health scare last fall, Altria had already taken write-downs of nearly two-thirds of the initial investment, as sales have disappointed and lawsuits piled up.  Initial returns on Altria’s $1.8 billion purchase of a 45% stake in cannabis company Cronos Group, Inc. from late 2018 are also less than stellar, as Cronos currently sports a market capitalization of just $2.3 billion, suggesting an $800 million mark-to-market loss for Altria.

With diversification efforts thus far stalling, it is back to the basics for Altria and peer Philip Morris International, Inc. While the secular prospects for the increasingly reviled tobacco industry appear to be poor, pricing power helps mitigate the seemingly inexorable contraction. Cigarette shipment volumes in the United States registered at 101.8 billion units last year, down a meaty 7.3% from 2018’s levels. Yet Altria’s net revenues fell by only 80 basis points, to $25.1 billion. Phillip Morris’ net revenues rose 3.8% on a constant-currency basis, despite a 2% year-over-year decline in total volumes to 766 billion units.  

The decidedly non ESG-friendly pair trade at undemanding multiples of 9.5- and 14.2-times last year’s earnings, generate solid free cash flow ($7.6 billion and $9.2 billion in 2019), and offer robust dividend yields of 8.5% and 6.3%, respectively. Each carries net debt of between two- and three-times last year’s Ebitda, while Altria could cut its debt load to less than two times trailing Ebitda if it opts to sell its 10.1% ownership stake in Anheuser-Busch InBev S.A./N.V. upon the expiration of a lock-up agreement in October 2021.

Since a bullish analysis in the Oct. 4, 2019 edition of Grant’s, the pair has remained in place, matching the performance of a similarly unchanged S&P 500 over that period.

A surprising development may bolster the bull case. Last week, the U.K Guardian reported that a study conducted by researchers at the Pitié-Salpêtrière hospital in France: “suggested the nicotine might stop the virus from reaching cells in the body preventing its spread,” according to Jean-Pierre Changeux, who reviewed the data. The researchers conclude: “Our cross-sectional study strongly suggests that those who smoke every day are much less likely to develop a symptomatic or severe infection with Sars-CoV-2 compared with the general population.”

That follows a Chinese study published in the New England Journal of Medicine in March, which “suggested only 12.6% of 1,000 people infected with the virus were smokers.”  For comparison, roughly 28% of the Chinese population smokes.

The vice treatment?
 

Recap April 27

A 1.5% rise in the S&P 500 pushed the broad index to its best close since March 10 and narrowed the year-to-date losses to less than 11%. The Treasury curve steepened notably thanks to weakness at the long end, with the 10- and 30-year yields backing up to 0.65% and 1.25%, respectively.  WTI crude was hammered by more than 20% to $13 a barrel, gold fell 80 basis points to $1,715 an ounce and the VIX closed below 34 for the first time since March 4.

- Philip Grant