OAO Gazprom: October 19

Management said in late August that the bottom of the global gas markets is now behind, and it delivered an encouraging outlook on 2H20. As such, Gazprom didn’t revise downwards its guidance of sale volumes (at least 170 bcm in 2020, compared with 199 bcm in 2019) and average prices (USD 133/mcm for 2020) to Europe. This said, management recently stated that they expect excess supplies in Europe’s natural gas market to continue in 2021 amid a limited recovery in demand and elevated supply of LNG. We’ve had an “underperform” view on GAZPRU curve since the beginning of this year. While Gazprom has a strong credit profile due to its unique business profile as the leading supplier of natural gas to Europe and a clear support from Russian government, we still believe that the deterioration in credit measures seen this year has not been reflected in its bond prices. Gazprom bonds have been quite resilient so far this year (their price remained unchanged year-to-date) as the market is apparently not concerned by this year’s increase in net leverage towards 3x and the risk of U.S. sanctions on Nord Stream 2 pipeline. We still believe that, when compared to closely rated Russian peers, GAZPRU bonds are unattractive. For instance, LUKOIL 2030 bonds yield 3.1% (spread of 238bps) while Gazprom 2030 bonds yield 3.2% (spread of 253bps) but Lukoil’s net leverage won’t exceed 1x this year. In this context, even the new hybrid bonds, which offer a higher yield (4.4% for the USD-denominated), do not look attractive. We keep our “underperform” stance on GAZPRU curve.

Walgreens Boots Alliance: October 19

…Sales at Boots UK plunged by 29.2% in constant currencies, primarily from significantly lower store traffic. The International segment is showing some improvement but is still unprofitable. Profits in this segment were declining long before the pandemic. The changes in companywide expense and profitability ratios were nearly identical to those of the Retail Pharmacy USA segment. Consolidated gross margin slumped by 200 basis points, only partially offset by a lower SG&A expense ratio, sending operating margin down 130 basis points to 3.2%. It is only fair to note that management estimates the negative impact from COVID-19 was a massive $520 million in the quarter, accounting for a 34 percentage point decline in operating income. This implies operating income would have risen 6% excluding COVID-19, but it is what it is. WBA introduced guidance for fiscal 2021 for a low single digit increase in E.P.S. A tale of two halves is expected, with first half E.P.S. down 20% at the midpoint, and second half E.P.S. rising 35%. Note this does not anticipate the return of widespread lockdowns in the U.S. or the U.K., but neither does it include the benefits from what is likely to be a robust vaccination business. We acknowledge that It takes some guts for a retailer to try to predict earnings these days. On the good news front, WBA’s cash flow generation for the year (up slightly to $5.5 billion) was excellent, especially given a 21% decline in EBITDA. Cash flow benefited by $1.7 billion from working capital, however, which may not be sustainable. After substantially lower capital spending and slightly higher dividends, free cash flow increased to $2.4 billion. Yet net debt scarcely budged. The culprit was share repurchases. The share repurchase program was finally suspended in July, and none are planned for fiscal 2021. In the second half, when repurchases were way down, debt was reduced by nearly $1 billion from free cash flow. Even so, lease-adjusted debt/EBITDAR, already too high before the pandemic, rose to 3.7x, and we are projecting only a modest improvement to 3.5x this year. Walgreens is doing better than nonessential retailers, but its credit profile is unlikely to improve materially. Furthermore, the advent of a new CEO increases event risk. We reiterate our “underperform” (2030 notes at T+165).

Host Hotels and Resorts, Inc.: October 19

…Host’s second-quarter likely is not indicative of future results. Revenue was down 93% to just $103 million and adjusted EBITDA was a negative $550 million swing to -$190 million. Given that many Host properties were closed in the first part of the quarter, results are not surprising. April of 2020, however, may have been the “bottom,” as hotel results improved in May and June. Nevertheless, cash burn in the second quarter (including interest and capex) was $399 million and Host expects the burn to be near $100 million per month in the third quarter. All hotel pro forma EBITDA was barely breakeven for the first half of the year, and we calculate leverage and net leverage on an LTM basis at 7.4x and 4.8x. Host has retained flexibility to acquire well-priced assets using existing liquidity or equity capacity without a requirement to first repay debt, assuming it meets certain minimum liquidity requirements. Although we don’t see the company making many acquisitions, it will continue value-enhancing capex near $500 million this year. Host projects its year end cash position at $2.2 billion, about 21 months of liquidity. Significant group room nights worth about $1 billion in revenue have been cancelled, and management projects the pace for business and group customers remains uncertain in the second half. Therefore, we are lowering our projections a bit and estimate year end net leverage will remain elevated. Free cash flow will be negative, but Host has no significant debt maturity until 2023 when $850 million of notes becomes due. The company’s high quality irreplaceable assets and significant equity trading value underpin the unsecured debt. Bond prices have continued to move up since our last review with the 2026 issue trading at 3.4%. Underperform with limited downside.

Tencent Holdings Ltd.: October 16

The credit remains solid. The total debt is rising, but it is offset by an increasingly large amount of cash, time deposits and investments. Compared to Alibaba or Baidu, Tencent appears better at maintaining its margins and, in the equity stock markets, it will find a route to realize the value of its investments. Some cash will be reinvested into new or existing ventures (there are talks of an investment in video and music businesses to boost the content of Tencent’s platforms), but they will contribute at the same time to increase the value of the Tencent solid footprint in digital media. The cash conversion is strong, with a sharp increase in cash flows from operations in the last quarter and the dividend policy is conservative. The access to the global debt markets remains intact. The total debt ratio slightly increased in 2Q20, but at 1.65x, against 1.5x as of December-2019, it is very manageable. Investors appear to think the same: in June, the company issued $6 billion of senior notes under its Medium-Term Note program, with maturities ranging from 2026 to 2060 at rates from 1.8% to 3.3%. A broad array of investors are participating in Tencent’s capital raising rounds (both debt or equity) and this supports its business growth. The short-term debt remains vey small and is amply covered by the vast amounts of cash sitting on Tencent’s balance sheet. Overall, the liquidity position is solidly anchored. Tencent’s bonds have performed well. TENCNT 3.8% 25s currently yield 1.29% (z-spread: 97bps), or 57bps tighter than our last recommendation and only 20bps wide to its historical tights. This compares with BABA 3.4% 27s at 1.45% (z-spread: 93bps) and BIDU 3.625% 27s yield 1.97% (z-spread: 147bps). The longer-dated TENCNT 3.975% 29s yield 2.03% (z-spread: 143bps), or 32bps tighter. We find the prices too expensive, despite our positive view on the company, in particular in the highly volatile context of the upcoming elections in the US. Change to UNDERPERFORM.

AT&T: October 16

…We project leverage at year-end of 3.1x. Given the sale of DirecTV at multiples near that or just slightly higher, and assuming all of the proceeds were used for debt reduction, leverage would be unchanged to just a tad lower. In fact, after rounding we estimate that leverage would remain unchanged. So a sale really does little to address the issue of too much debt. AT&T is looking to unload other assets. For example, the company just sold its stake in Central European Media Enterprises for $1.1 billion. Unfortunately, that will have a minimal impact on a company with total debt of $169 billion. Sometimes it is easy to forget that AT&T is primarily a wireless operator. In fact, it appears that management has forgotten that at times. AT&T acquired DirecTV for $49 billion five years ago. Now that asset appears to be worth about a third of what it paid. Anyway, AT&T is ready to compete in wireless, where its subscriber gains have paled in comparison to T-Mobile and Verizon. Its promotions for Apple’s new phones are quite aggressive. For example, the company is offering an $800 credit on a new phone with a trade-in of an iPhone 8 or better. It has been suggested more than once that AT&T should consider cutting its dividend, which amounts to roughly $15 billion per year. However, we suspect management is leery of disappointing a huge chunk of its shareholder base. Furthermore, we estimate that AT&T will still generate about $9 billion of free cash flow in 2020. The company passed on the recent CBRS spectrum auction. However, we assume it will be more aggressive with the forthcoming C-Band auction. T-Mobile has an enviable spectrum position following the Sprint deal. Therefore we think AT&T and Verizon will be seeking to close the spectrum gap. Consequently, AT&T could end up using the majority of its free cash flow on the auction. As such, we foresee very little debt reduction in the near term. Hefty declines in revenue, weaker margins, and elevated leverage do not bode well. The potential sale of DirecTV would do little to improve the credit profile. We reiterate our sell recommendation, with the 2029 notes trading at a spread of +121.

AngloGold Ashanti Ltd: October 13

…Looking ahead, we expect AngloGold Ashanti to maintain an annual output of around 3 million ounces in the near term as the sale of South African assets will be offset by the planned completion, in early 2021, of the Obuasi (Ghana) redevelopment project. AngloGold Ashanti has been working on the simplification of its business via asset sales and lower debt levels. The disposal of the remaining South African portfolio is the latest example. Besides, the risks associated with the company’s exposure to countries with quite challenging business conditions is offset by its low leverage ratio. Looking ahead, we expect a continued improvement in the company’s free cash flow generation and further reduction in debt levels this year. Besides, we believe that any improvement in the cash flow conversion from assets in the Democratic Republic of the Congo would be positive for the credit. The expected completion of the ramp up of Obuasi mine in Ghana during 2021 is another driver that will support bond prices in the near term, in our view. The spread on ANGSJ 2022 and 2040 bonds returned to pre-pandemic levels as elevated gold prices contributed to a substantial improvement in the company’s credit metrics. The newly issued ANGSJ 3.75% 2030 now trade at 103.9, a z-spread of 254bps and offer a yield-to-worst of 3.3%. This is broadly in line with closely rated peer GFISJ 6.125 2029 bonds (yield of 3.4%) and compares well with Newmont’s NEM 2.25 2030 (yield of 1.75%). We keep our “outperform” rating on ANGSJ curve as our fundamental opinion on the company is positive, but the upside potential is limited at current pricing levels.

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