Vedanta Resources PLC: April 19

The capital structure has weakened but maintained levels that allowed the issuance of a public bond in January. Gross debt continued to rise, driven by the additional borrowing for the delisting of the Indian business and increased debt at Zinc India. But the tender offer for the notes due 2021 has reduced the short-term refinancing risk, while some breathing space has been obtained under the debt covenants. Debt maturing in 2021 (to September) was $1.2 billion, including $500 million at the holding level (of Vedanta Resources Ltd), against $7 billion in cash and liquid investments. Investors are demonstrating their faith in Vedanta’s future performance. The benchmark bond launched at the end of February was initially touted at a yield of 9.375% but was able to price well inside the price guidance, at 8.95%, with a size of $1.2 billion, demonstrating some strong interest from investors. We expect net leverage to fall slightly in the current fiscal year. Vedanta bonds have performed well since our last recommendation to keep at “outperform”. VEDLN 7.125% 2023s have continued to rally and now yield 12.2% (z-spread: 1,187bps), against 18.7% (z-spread: 1,849bps) when we updated our view in December. The 6.125% 08/24s yield 13%, against 18% in December and VEDLN 6.375% 07/2022s 9.3%, against 15.9%. The most attractive bond is the VEDLN9.125% 04/26, at a yield of 13% (z-spread: 1,214bps), given its long duration. We expect the recovery to continue on the back of the recovery from the COVID-19 weakness. Change to BUY.

Citigroup: April 19

…In October 2020, Citi entered into consent orders with the Federal Reserve and the Office of the Comptroller of the Currency, which require it to submit plans to the regulators detailing its efforts to improve practices related to risk management and internal controls. The bank’s weaknesses in this area were evident last year when it mistakenly paid $900 million to Revlon creditors (and later lost a court bid to recover $500 million that was not returned). Citi paid a $400 million civil money penalty as part of the consent order with the OCC and spent about $1.0 billion last year on beefing up its risk control and compliance systems. As part of the OCC’s order, Citi must obtain a non-objection from the regulator before making any significant new acquisitions, but the bank is not subject to an asset cap like the one imposed on Wells Fargo. During the first quarter, the company returned $2.7 billion to shareholders in the form of dividends and buybacks (35% of earnings). Capital ratios are strong, with a CET1 ratio of 11.7%; the supplementary leverage ratio (SLR) ended the first quarter at 7.0%. The allowance/loans ratio adds an extra cushion (3.29% of loans, with the allowance/nonaccruals ratio at 425%.) Citi’s retail network in the U.S. is small compared to Bank of America and JPMorgan, but while acquisitions may make sense in the future, we expect the company will remain focused on simplification and regulatory compliance over the near term. Our credit score is stable. The 2.572% notes due 6/3/31 are seen at T+96. Opinion: buy.

Dell Technologies Inc.: April 16

…The bad news is that Dell will be losing its best-performing asset. VMWare delivered revenue growth of nearly 9% in fiscal 2021, which was far better than the 4.1% decline in Infrastructure Solutions and superior to the 5.5% increase in Client Solutions. In fiscal 2020, VMWare posted a top line increase of almost 20%. We estimate that VMWare will continue to grow at a much faster pace than the other two segments. We expect revenue in Infrastructure Solutions to drop roughly 1% this year, which represents a nice recovery from two consecutive years of declining revenue. We expect revenue in Client Solutions to rise more than 5%. With more people working from home, we anticipate strong demand for notebooks and desktops. However, we expect demand to begin subsiding in the latter half of the year, as consumers satisfy their computing requirements. If a substantial number of employees return to the office, Dell could benefit from the corporate refresh cycle. But we are not convinced that people will begin returning in droves. Consequently, growth on the commercial side may not be as robust as hoped. We project fiscal 2023 revenue growth will be minimal at best, and a decline is possible. This would not be the case if VMWare was still in the portfolio, particularly since a good portion of its revenue is recurring. VMWare generated operating margins of more than 30% last year, almost triple the 11.6% margins recorded by Infrastructure Solutions. Furthermore, those margins dwarfed the 6.9% margins produced by Client Solutions. Therefore, overall margins are likely to decrease when the spin-off is completed. Moreover, margins are likely to be pressured this year because of higher costs for LCDs and ICs, as well as operating costs that will return such as 401k matches, and merit raises. The shift in mix toward PCs will also hurt margins. VMWare was a very strong contributor to free cash flow so FCF will be diminished going forward. Dell should still generate plenty of free cash flow. However, we suspect a good portion of it may be directed to share repurchases if the company receives upgrades to investment grade status by the rating agencies. Meanwhile, we are not likely to see the EBITDA improvement that we have witnessed recently. The deal makes sense if the industry conditions remain strong. However, should a downturn ensue, we think credit metrics will be pressured, with a potential re-rating to non-investment grade. We could see pressure for acquisitions if revenue growth pauses. Admittedly, the five-year commercial agreement between the firms is a positive factor, but the direct revenue synergies will be lost. We maintain our sell recommendation, with the 2030 secured issue trading at a spread of +113.

Thermo Fisher Scientific: April 16

…Our slightly more cynical view is that TMO needed to do something big. Its revenues and profits have benefited enormously from the pandemic (to the tune of some $6.6 billion in revenue last year) primarily from its testing related products and instruments, but are likely to taper off sharply once things return to normal. Its balance sheet could be considered underleveraged, with 2020 net debt/EBITDA of only 1x. It failed to complete its last acquisition. It needed to find another big transaction that will provide growth to offset the eventual diminution of COVID-19 related revenues. It’s worth noting, however, that its “base” business (i.e., non COVID-related), returned to growth in the second half and is projected to grow a respectable 7% this year. But in 2020 organic revenue growth was a whopping 25%. Let’s all hope those days are gone. Although TMO ended the year with enough cash (over $10 billion) to finance the majority of the cash portion of the PPD purchase price, one needs to make some adjustments for subsequent uses of cash. Since the end of the year, TMO has completed and announced cash transactions worth $1.3 billion, repurchased $2 billion of stock, and paid down $2.6 billion of short-term debt. We estimate cash (not counting free cash flow generated in the first quarter) has diminished to about $4 billion. Therefore, we are assuming the company will need to borrow about $14 billion (again, excluding free cash flow generated before the year-end closing). This would increase pro forma debt/EBITDA from less than 2x to 3.4x. PPD generates a tiny amount of free cash flow, but we estimate pro forma free cash flow for the combination of $6.2 billion, even as TMO increases capital spending by over 50% to support growth. Assuming share repurchases are halted and flat EBITDA, reducing debt by $6 billion would send leverage below 3x, which is where management says it will be at closing. Taking into account TMO’s enormous financial flexibility afforded by its free cash flow, its excellent track record of reducing leverage after major acquisitions (although sometimes more slowly than we would like), modest business risk enhancement from the PPD acquisition, and the opportunity for synergies, we view the transaction as credit neutral. Therefore, we reiterate our “outperform” (2030 notes at T+66).

Ooredoo Q.S.C.: April 16

…Ooredoo ended 2020 with a net leverage of 1.7x, well within its long-term target of 1.5x to 2.5x. Ooredoo also had a comfortable liquidity position with QAR 15.7 billion of cash and QAR 3.3 billion of unused credit lines while it has no debt to repay this year (after the redemption of the bonds maturing in February 2021) and approximately QAR 1 billion of debt scheduled for repayment in 2022. The company announced last month that its Indonesian company Indosat (65%-owned by Ooredoo) signed a sale and leaseback agreement for more than 4,200 telecommunications towers for USD 750 million (QAR 2.7 billion). Ooredoo still owns more than 20,000 towers and plans to continue to monetize these assets to move to a more efficient and flexible asset light model. Besides, late last year, Ooredoo announced being in talks with CK Hutchison Holdings to combine their Indonesian telecom subsidiaries. The terms of this transaction weren’t given as talks are still ongoing but the goal here is to create a stronger challenger to the state-owned PT Telkom Indonesia. The new QTELQD 2.625 2031 bonds now trade at 101.4, a z-spread of 94bps (20bps above underlying sovereigns) and offer a yield-to-worst of 2.46%. From a global sector perspective, QTELQD bonds now trade broadly in line with international peers. Verizon 2.55 2031 bonds (Baa1/BBB+) yield 2.43%, AT&T 2.75% 2031 bonds (Baa2/BBB) yield 2.66%, Vodafone 7.875 2030 (Baa2/BBB) yield 2.45% and Orange 8.5% 2031 (Baa1/BBB+) yield 2.43%. The company has a strong and defensive credit profile, but we do not see any substantial upside potential for its bonds at current trading levels. We therefore keep our “underperform” stance and wait for more attractive levels.

Vale S.A.: April 13

The exposure to Samarco’s difficulties remain manageable, given the size of Vale (and BHP)’s global operations. As of the end of Dec-2020, Vale had $14.2 billion of cash, cash equivalents and short-term investments. Its net leverage was reported at (0.1)x meaning that its “expanded” net debt, inclusive of as much as $9 billion of provisions for Samarco and Brumadinho, the two dam disasters that hit the mining group, was less than the amount of cash it had on its books. It is understandable that bond investors holding Samarco’s bonds have been looking at any judicial action to recoup the money they lost on their investments. And this is only half of the story: BHP Billiton held $9.3 billion in cash at the same date, although its total debt outstanding was much higher, at $22.7 billion. We never assumed that the Samarco disaster would quickly resolve itself with a return to normal production levels. Given the recent decision to file, we expect Vale (and BHP) to continue to be affected by the legal proceedings. Yet, with the price of iron ore back to historical highs, their operations continue to be highly profitable. SAMIN 4.125% had rallied from mid 30s in 1Q20 to as much as $83 in early 2021. We expect that they would drop further, as investors who had banked on a return to normalcy look to cut losses. VALEBZ 6.25% 08/2026s are yielding 2.2% (z-spread: 122bps), against 3.5% (z-spread: 229bps to their call date in Oct-2027) for BRAZIL 4.625% 01/2028s. In the industry sector, SCCO 3.875% 04/2025s are much tighter, offering a yield of 1.3% (z-spread: 50bps) and VOLCAN 5.375% 02/2022s 2.4% (z-spread: 217bps). While the price of iron ore continues to be at record levels, the perspectives for a strong 2021 are encouraging. But pricing remains unfavorable for bond investors. Keep at UNDERPERFORM.

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