Penn National Gaming: October 25

Penn’s second quarter results were very strong and significantly greater than the prior year and even well exceeded those from 2019. Revenue increased 17% or $223 million to $1.55 billion. Adjusted EBITDAR was up 38% over 2019 to $587 million while second quarter adjusted EBITDA was $470 million (versus $326 million in 2019). Significant margin expansion of close to 700% versus 2019 second quarter reflected the cost reductions Penn made at the onset of the health crisis. All geographic segments saw EBITDAR improvement, especially the South that reported an adjusted EBITDAR increase of near 90% to $177 million. The Midwest and Northeast also outperformed with adjusted EBITDAR increases of 44% and 25%, respectively. We calculate LTM adjusted EBITDAR of near $1.8 billion leading to rent-adjusted leverage of 4x. Post quarter end Penn closed on a $400 million eight-year notes priced at 4.125%. Pro forma this transaction, Penn’s liquidity is strong at near $3.4 billion, a big improvement from 2019. Operating results in the June-July period were positive and management said adjusted EBITDAR in the two-month period was projected to exceed the same period in 2019 by 40% due to higher revenue trends and additional margin improvement. We are adjusting our 2021 EBITDAR projection to $1.9 billion to reflect the second quarter results and what is likely to be a record third quarter with a yearend projection of stable leverage in the low 4x range. Although strong operating trends could decrease later in the year, Penn Interactive seems poised to achieve breakeven EBITDA and start to add to results soon. The 2027 bonds we rated outperform have moved up and now trade at a y.t.w. of just 2.3%. Underperform with limited downside.

Suzano Papel e Celulose, Klabin: October 25

Both Klabin and Suzano reported some good results in 2Q21. The increase in Suzano’s EBITDA led to a hefty free cash flow generation and another sequential reduction in leverage ratios. Its net leverage was at 3.4x vs. 4.3x in 1Q21. Klabin benefitted from strong pricing levels in pulp, paper and packaging products. This enabled the company to cut its net leverage ratio to 3.5x (down from 4.4x in 1Q21), levels not seen since mid-2019. The two companies launched new investment projects earlier this year (Cerrado pulp mill for Suzano and Puma II project’s phase 2 for Klabin). They will therefore keep elevated capital expenditure levels until 2023. Suzano and Klabin bonds have been under pressure since we last wrote on the two companies in August. While we do not expect any improvement in Brazil’s weak fiscal balance in the short-term, we have a positive fundamental opinion on Klabin and Suzano. Yet, we still believe that Suzano bonds are less attractive than Klabin ones as Klabin 2029 bond’s spread is 50bps wider than Suzano’s 2029s. Hence, we reiterate our “outperform” rating on Klabin curve (with the company’s 2029 bonds trading at a price of 109.2, a z-spread of 280bps and a yield-to-worst of 4.25%) and our “underperform” stance on Suzano bonds (with the company’s 2029 bonds trading at a price of 114.5, a z-spread of 230bps and a yield-to-worst of 3.6%).

: October 25

…As for the third quarter, JNJ’s organic sales growth was 10.6% and adjusted earnings rose by 19%. (All sales comparisons are organic.) Pharmaceutical segment sales rose above the market at 13.8%, while Medical Devices have recovered to exceed the same period in 2019, growing 7.6% over 2020, although surgical procedures waxed and waned during the quarter, especially elective surgeries. Consumer Health sales were up 5.7% (up 8% from 2019) led by OTC products, benefiting from comparisons with last year’s historically weak cough, cold, and flu season and demand for digestive health products. The Medical Devices segment saw a strong margin recovery with sales leverage, which was offset by lower pretax margins in Consumer Health and Pharmaceutical, for a consolidated pretax margin about flat at 34.5%. The sales mix and the absence of COVID-19 related costs in the prior year period lifted gross margin by 120 basis points, while the SG&A expense rate was about flat, and a higher R&D expense rate (mostly in Pharmaceutical) offset the higher gross margin. Special items were abundant, primarily for litigation costs, intangible amortization, and R&D, totaling $4.2 billion pretax. JNJ has not yet issued a cash flow statement or a balance sheet, but based on limited information, we estimate on a trailing twelve months basis debt/EBITDA improved to 1.0x and free cash flow exceeded $11 billion, up 40%. Cash and marketable securities totaled $31 billion, nearly equal to total debt. JNJ possesses tremendous financial flexibility to meet its litigation payouts as they arise. We reiterate our “outperform” (2030 notes at T+23).

Steel Dynamics: October 22

Third quarter sales jumped 118% year over year to $5.1 billion (up 14% sequentially). Sales for Steel more than doubled to $3.7 billion on a 211% increase in the average price and a modest 2% gain in external shipments while this segment’s operating income swung to $1.4 billion from $144 million in the year ago period on higher prices, volume, and margins. Sales for Fabrication also doubled to $494 million on a substantial increase in average price and higher shipments while segment operating income improved by $50 million to $89 million on margin expansion. Metals Recycling sales and operating income rose 215% and 304% to $587 million and $47 million, respectively, on higher scrap prices and shipments as well as increased margins. On a consolidated basis, third quarter adjusted EBITDA surged 490% to $1.4 billion (rose 36% sequentially). LTM adjusted EBITDA of $3.5 billion (an increase of $2.3 billion for the nine months) covered interest 53x and leverage was 0.9x, significant improvement from 12x and 2.6x, respectively, in 2020. STLD ended the third quarter with steady liquidity of $2.3 billion. For the nine months, free cash flow (cash flow from operations less capital spending) after dividends improved $680 million to $518 million as higher earnings more than offset increased working capital usage related to surging metal prices. This FCF, along with cash, were used to repurchase $731 million shares ($338 million in the third quarter), leaving total debt unchanged at $3.1 billion. With the $400 million of 5% senior notes due 2026 callable this mid-December, we believe the most likely outcome is a refinancing of this debt over the near term. Current North American steel market fundamentals are in place to support strong demand and high selling prices through the fourth quarter and into 2022. This bodes especially well for both the Steel and Fabrication segments over the near term, while the new Sinton mill and the planned four new value-added coating lines should support growth over the medium term. We look for leverage to decrease this year to 0.7x, down from our previous forecast of 0.9x. The 3.45% senior notes due 2030 yield 2.5%. Remain outperform with limited upside.

KWG Property Holding Ltd: October 22

The Chinese authorities have played a dangerous game in trying to contain the so-called “speculative” home buying spree. Regulators have reportedly started to ease restrictions on home loans for first-time buyers and relax a cap put on banks’ exposure to the real estate sector. In an economy like China, where the central government holds a lot of power, the authorities can order banks to boost lending, which will support the approval of new mortgages in 4Q21. We initially thought that Evergrande would be considered a systemic risk and that its default would be avoided by the Chinese government. In choosing to go for a more market-driven resolution, a path of high uncertainty has been preferred. We are now seeing the consequences of such a choice. The second half is going to be very challenging for KWG, after weak first and second quarters. Revenues have increased by +0.3% over the first half, including a -2% drop from the sales of properties. Profits for the first half fell by -27%, due to higher marketing expenses, rising administrative costs and lower gains from other sources. While total debt has remained flat against the end of 2020, the net leverage has increased by half a turn to 4.3x. We expect the slump in the second half to cause leverage to deteriorate further. The liquidity risk remains manageable for the remainder of 2021, but in 2022 and 2023, the maturities coming due will need to be met. With a weighted debt average life of only 2.27 years, KWG is exposed to the risk of funding sources drying up in the face of a falling market. Our long-held “underperform” view on KWG is reinforced by the current gloom over the Chinese real estate sector. KWGPRO 5.875% 11/2024s are currently yielding 9.3% (z-spread: 834bps), against 5.0% (z-spread: 460bps) in June. By comparison, CIFI Holdings’ bonds 6% 07/2025s offer a yield of 6% (z-spread: 494bps), or 150bps wider than in June. Keep at UNDERPERFORM.

The Travelers Companies: October 22

…While business insurance had strong earnings in the third quarter, personal insurance (auto and homeowners) swung to a loss of $2 million, down from earnings of $392 million a year ago. A year ago, personal insurance benefited from 12.8 points of favorable prior year reserve development, because of $322 million in recoveries from PG&E related to the 2017/2018 California wildfires. There was also a reversal of the low losses seen in personal auto insurance in 2020, as the frequency of losses reverted to pre-pandemic levels. Even though customers are still making fewer commuting trips, travel for other reasons, such as shopping or leisure, has increased. The severity of losses is being affected by higher labor and material costs (a trend also affecting homeowners’ policies). The underlying combined ratio for personal auto rose to 97% in the third quarter, up from a low of 81.5% a year ago. Last year, The Travelers gave its customers “stay-at-home credits” and even filed in some cases to reduce its pricing, but now it is planning to file for rate increases in 40 states over the next three quarters. Given the need for regulatory approvals, higher prices won’t happen immediately, but the company said on the earnings call that some of the increases will go into effect beginning in the fourth quarter. Despite the higher losses in the auto business, operating cash flows for the third quarter reached a record level of $2.5 billion. Holding company liquidity was $2.0 billion at 9/30/21, up from $1.7 billion at the end of last year. The liquidity target is equal to estimated annual interest expense plus common dividends (current run-rate of around $1.2 billion). There is a $1.0 billion line of credit facility that extends until 2023. There are no senior and/or junior subordinated debenture maturities until April 2026 (when there is a $200 million maturity). Debt/capital levels remain prudent (22% at 9/30/21). The Travelers suspended share buyback activity in the second and third quarters of 2020 but resumed repurchases in the fourth quarter. For the first three quarters of 2021, the company completed $1.4 billion in buybacks and paid $655 million in dividends to shareholders. Our credit score is stable; we expect The Travelers will continue to manage its risk profile prudently and that it will maintain a strong balance sheet. The 3.05% notes due 6/08/51 are seen at T+77. Opinion: buy.

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