Credit Suisse Group: May 10

…Absent Archegos, Credit Suisse would have reported strong earnings for the quarter ended 3/31/21, with good results in the Swiss and Asia/Pacific markets and an 80% increase in investment banking revenue. Excluding Archegos, the investment bank earned $2.2 billion, on strength in fixed income and equity sales and trading, capital markets (helped by leveraged finance issuance), and advisory revenues. The hedge fund losses cannot, of course, be excluded. The evidence of Credit Suisse’s poor risk controls suggests at least the possibility of other risks lurking in the portfolio, while the plan to de-risk some businesses means that it may be difficult to sustain the recent revenue trends, which were also helped by ebullient markets. As a result of the first quarter loss (combined with an increase in risk-weighted assets), the CET1 ratio dropped by 70 basis points in the first quarter, to 12.2%, from 12.9%. The bank cut the annual dividend to CHF 0.2926 per share, to CHF 0.10 per share, and has suspended share buybacks. To restore the ratio to the target level of 13.0%, Credit Suisse has already raised new capital by issuing CHF 1.7 billion (US$1.85 billion) of mandatory convertible notes (MCN), adding 55 basis points to the CET1 ratio and about 17 basis points to the CET1 leverage ratio. The issuance of the MCN is dilutive to shareholders, but beneficial for bondholders since it stabilizes capital levels. Credit Suisse also plans to reduce investment banking leverage exposure by at least US$35 billion, and to maintain investment banking risk weighted assets no higher than the year-end 2020 level. While the capital actions are credit-positive, the bank continues to face risks which may weigh on the relative performance of its bonds in coming months. Even as the prime brokerage industry is re-evaluating concentrated risk exposures in the aftermath of Archegos, competitors such as Goldman Sachs are moving in to poach Credit Suisse clients. The funds tied to Greensill/supply chain finance are being liquidated, but only about $4.8 billion (US) has been paid to investors so far, out of the prior stated net asset value of $10 billion. Investors, not the bank, are directly at risk for losses related to the funds (aside from a $90 million bridge loan), but there will be prolonged shareholder/investor litigation related to both Greensill and Archegos, as well as the potential for regulatory penalties. The 1.305% notes due 2027 are seen at T+99. Opinion: underperform.

JBS S.A.: May 10

Corn prices continue to rise to unprecedented levels. The drought across Brazil is causing harvests to be under threat, while the dry weather in the Northern Hemisphere is also putting the early crop at risk in Canada and the Northern part of the United States. On the Chicago Board of Trade, the futures corn contract for a delivery in July is continuing to rise, up +33.5% against the last day of March, when it was already 14% higher than the previous year-end, and approaching the highs last seen in 2012. China has been buying huge quantities of corn to feed its large hog herd, part of which has been culled by the African swine flu. Corn is a major feeding resource for beef, pork and poultry, all of which represent a major business segment for JBS. While EBITDA levels have been high due to a rise in volumes, the margins have already seen some erosion. 2021 will see an impact from higher feeding prices, undermining EBITDA margins in JBS’ several businesses. The credit metrics have improved during 2020. Despite an FX-driven +24% growth in gross debt, the higher cash position and the jump in EBITDA have resulted in a sharp fall in the net debt leverage ratio. Given that 91% of the debt is denominated in US Dollars, total and net debt actually fell, when measured in that currency (-3.6% and -17%, respectively). At the start of the year, the debt maturity profile is also solid: there are only small repayments due over the next three years, while the high cash position amply covers all the short-term liabilities. The bonds issued by JBS have continued to rally with the global markets. They are now priced tighter than the other three Brazilian meat packers we cover: JBSSBZ 7% 01/26s yield 2.2% (z-spread: 202bps), while BRFSBZ 4.35% 09/26s yield 3.5% (z-spread 260bps), Minerva’s BEEFBZ 5.875% 01/28s yield 3.2% (z-spread: 298bps) and MRFGBZ 7% 05/26s yield 2.3% (z-spread: 210bps). Given the balance of risks, we continue to find JBS’ bonds expensive. Reiterate at UNDERPERFORM.

XPO Logistics: May 10

…First quarter revenue rose 24% to $4.8 billion from a combination of 18% organic growth, 3% from the acquisition of a contract logistics operations in the U.K. and Ireland, and 3% from favorable currency translation. Transportation revenue was up 22% to $3.0 billion on strong growth for truck brokerage and increased North America LTL tonnage per day. Transportation adjusted EBITDA increased 36% to $343 million. Logistics revenue rose a healthy 27% to $1.8 billion from gains in e-commerce, outsourcing, and demand for warehouse automation. Logistics adjusted EBITDA gained 28% to $155 million. On a consolidated basis, the first quarter adjusted EBITDA margin improved 70 basis points from favorable operating leverage and cost reduction actions initiated last year with adjusted EBITDA increasing 33% to $443 million, easily beating the $387 million consensus estimate. LTM adjusted EBITDA of $1.5 billion covered interest 4.7x with net leverage of 3.1x, sequential improvement from 4.3x and 3.3x. XPO ended the first quarter with $1.7 billion of liquidity and no bond maturities until September 2023. First quarter free cash flow (cash flow from operations less net capital spending) declined $26 million to $69 million as higher earnings were more than offset by increased net capital spending and working capital usage, resulting in LTM FCF of $528 million. This FCF, along with cash on hand, was used to reduce year over year total debt by $776 million to $5.3 billion and reduce total debt by $1.5 billion sequentially. In January, the company retired the $1.2 billion of 6.5% senior notes due 2022 as debt reduction remains its top near-term priority. Based on the strength of first quarter results and recovering demand, XPO significantly raised its 2021 adjusted EBITDA guidance to $1.825-1.875 billion from $1.725-1.8 billion previously. This new guidance represents an adjusted EBITDA increase of 31-35%, consisting of 30-34% for Transportation and 28-32% for Logistics. Expected free cash flow was raised to $650-725 million from $600-700 million. Based on our updated model, we expect XPO’s 2021 net leverage to decrease to 2.4x (pre-spin off). We will continue to follow the company’s spin-off process and decide on continuing coverage of XPO RemainCo and GXO once post spin-off capital structures are finalized. The senior notes due 2024 yield a scant 0.6% while the senior subordinate notes due 2034 yield 4.6%. Remain outperform with limited upside.

AB InBev: May 07

…After a disappointing 2020, attributable primarily to the impact of the coronavirus, AB InBev posted a good start to 2021 with a revenue increase of 12% in the first quarter. Organic net revenue soared 17.2%. Management claimed that it gained market share in the majority of its key markets. Volume increased 13.3%, while revenue per hectoliter rose 3.7%. Not surprisingly, Asia Pacific was the primary driver, delivering organic growth of 62%. Recall that this region felt the effect of COVID-19 much sooner than other countries, resulting in a 52% decline in revenue in the first quarter of last year. Middle Americas organic revenue rose 16%. Revenue in Europe/Middle East/Africa fell slightly, reflecting the lockdowns that have been implemented in several countries in that region. In addition, there was a 1-month alcohol sales ban in South Africa mandated by the government. We estimate that both reported and organic revenue will rise roughly 11% in 2021. Despite the impressive revenue growth, gross margins dropped 110 basis points. The company did spend less on SG&A relative to sales, but nevertheless EBITDA margins were down more than 200 basis points. This follows a huge decrease in margins last year. Margins were buffeted by unfavorable channel and packaging mix, commodity cost increases, the foreign exchange effect, and higher variable compensation accruals. These factors more than offset the positive brand mix and ongoing cost discipline. Management expects margins to decline over the remainder of the year mostly because of the increasing cost of raw materials, with most of the pressure in the second half of the year. The company will raise prices as necessary, but there may be a lag. Management hopes to boost margins in the longer term via volume growth. We project free cash flow of roughly $3 billion in 2021. Capital expenditures are likely to be substantially higher than last year because of increased investments in innovation and other consumer-centric initiatives. We assume that a decent portion of the free cash flow will be used to reduce debt. AB InBev slashed debt considerably last year, mainly by using proceeds from the sale of its Australian operations. However, since EBITDA dropped dramatically, leverage actually rose to 5.6x from 5.2x. The better EBITDA we are estimating this year should push leverage back down to 5.2x. If all of its free cash flow is used to cut debt, leverage would fall further to 5.1x. AB InBev is sitting on cash of roughly $16 billion. If some of that cash was employed to lower debt, leverage could drop to 5x or even lower. The cut in the dividend last year enhanced free cash flow. However, we presume the company will seek to restore the dividend once the pandemic eases, thereby constraining free cash flow again. The prospect of increasing sales after a rough patch is encouraging. Yet margins continue to erode. Leverage is likely to decline, but it still remains high. We maintain our underperform recommendation, with the 2030 notes trading at a spread of +68.

Outfront Media, Inc.: May 07

The company has significantly reduced costs due to lower transit franchise expense, lower billboard property lease expense and lower maintenance. Nevertheless, the decline in revenue drove a dramatic decrease in adjusted EBITDA to just $11 million, down almost 70% from the prior year quarter when it posted $76 million. Net cash from operating activities was negative, a use of $11 million versus positive $15 million in last year’s quarter. Outfront has also been cutting capex significantly -it was down by 50% from the prior year period. We calculate LTM adjusted EBITDA near $170 million that leads to net leverage and interest coverage of 12.2x and 1.2x, respectively. Our 2021 projections include a fairly rapid recovery in the second half of the year for both billboard and transit advertising. The swing factor is how much a return to the office affects ridership on public rail systems. Outfront has partially preserved margin through a shift in transit payments to revenue sharing versus minimum annual guarantees but we expect leverage to remain elevated at near 7x. However, liquidity is strong at near $1.1 billion of cash and availability, and the next big maturity is not until 2024. Outfront’s leading position in the out-of-home advertising market showed more resiliency in the recession 10 years ago than it has in the pandemic. Its heavy reliance on larger metropolitan markets and transit advertising revenue plus its customer concentration has left it in a more difficult position than some of its competition like Lamar. Even so, traditional print and offline media will continue their decline presenting opportunity for share gains for OOH. And with a decent post-pandemic recovery, Outfront’s digital growth should return as well. We last viewed the 2025 bonds as having limited upside at a y.t.w. of 3.8%. At their current y.t.w. of 4.3%, we maintain the rating.


Turk Telekom AS, Turkcell Iletisim Hizmetleri AS: May 07

When looking at their balance sheets, both companies have strong credit measures with industry-low leverage ratios. Turkcell had a net leverage of 0.9x (4Q20: 0.8x) and we expect this ratio to remain close to 1x this year while the company will pay TRY 2.6 billion of dividends this year. Turkcell had a cash balance equivalent to $1.65 billion and with a net long FX position of $183 million (vs $132 million in 4Q20). This compares well with only $0.5 million of debt due for repayment in 2021. Turk Telekom’s net leverage stood at 1.3x and the company reported a net long FX position of $100 million. Yet, Turk Telekom has a bigger amount of rolling short-term debt due this year, which we negatively view compared to the better coverage of short-term debt at Turkcell. For FY21, we also expect Turk Telekom’s net leverage to be around 1x. Since we last wrote on Turkish corporates in our country report dated March 24, 2021 the bond spread of Turkcell and Turk Telekom tightened by approximately 120bps. Their spread initially widened in March after Recep Tayyip Erdogan’s shock dismissal of Turkey’s central bank chief, but those bonds have now pared almost all the losses seen in March. TURKTI 6.875% 2025 bonds now trade at 110.5, a z-spread of 326bps and offer a yield-to-worst of 3.9%. Turkcell’s TCELLT 5.75% bonds maturing in 2025 trade at 108, a z-spread of 302bps and a yield-to-worst of 3.8%. These bonds are valued by the market at a premium to state-issued debt as Turkeys government bonds maturing in 2025 trade at a z-spread of 454bps. The gap compared to underlying sovereigns was historically tighter but, unlike corporate bonds from Turkcell and Turk Telekom, Turkey’s government bonds have not yet fully recovered the pressure seen in March. While we have a positive fundamental opinion in the two companies, we now see less value in their bonds at current trading levels. We therefore change our rating from “outperform” to “underperform” on the two issuers.

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