Alcoa Corporation: January 25

For the first quarter, the company anticipates adjusted EBITDA will be in line with the fourth quarter based on current metal prices. For 2022, AA’s shipment guidance looks for 48-49 million dry metric tons of bauxite, in line with 2021, 14.2-14.4 million metric tons of alumina, an increase of 2-4% reflecting the resolution of the San Ciprián strike and recovery from a bauxite unloader outage at Alumar, and a decrease in aluminum to 2.5-2.6 million metric tons from 3.0 million metric tons due to the divestiture of the Warrick Rolling Mill and changes in the smelting portfolio. Benefits from current metal index price should mostly offset higher raw material and energy costs and improvements from portfolio actions and sales contract pricing will mitigate other headwinds. Based on our revised projections, we look for the company to end 2022 and 2023 with leverage at a modest 0.5-0.6x and zero net debt. AA ended 2021 with adjusted proportional net debt of $1.1 billion (net debt plus pension and OPEB liabilities), down $2.3 billion year over year and with its remaining U.S. pension plans fully funded. With proportional adjusted net debt within its target range, cash exceeding the minimum desired level of $1 billion, and a dividend initiated, the company’s capital allocation will be returning cash to shareholders, transforming the smelter portfolio, and raising capital spending to support mid-sized growth projects. The 6.125% senior notes due 2028 yield 2.8%. We remain outperform with limited upside.

UnitedHealth Group: January 25

One transaction which did not close in 2021 was the acquisition of Change Healthcare, a health care technology company. Last January, UNH agreed to acquire CHNG for $9.0 billion in cash plus the payoff of $4.7 billion of debt: a $3.4 billion term loan facility and $1.3 billion in senior notes. The plan is to merge CHNG into OptumInsight (data, analytics, research, consulting, and other services.) CHNG shareholders approved the deal last year. However, the companies received a second request from the antitrust division of the Department of Justice in March 2021; the department is still conducting its review. As we previously discussed (see GC report on UNH dated 9/1/21), the merger proxy disclosed that CHNG was concerned during the negotiation period about antitrust risks. UNH sweetened its offer, but the agreement does not include an anti-trust related termination fee. In December, CHNG exercised its option to extend the outside date for the closing until April 5, 2022. When the transaction was announced a year ago, UNH said it planned to fund the purchase largely by issuing commercial paper and senior unsecured notes. If the deal is completed, we would expect to see a short-term bump up in leverage but expect that ratios would soon revert to the long-term target of around 40%, as was the case following the addition of Catamaran (pharmacy benefits management), which was purchased for $14 billion (including assumed debt) in 2015. UNH issued $7 billion of debt last year in a five-part transaction, with maturities ranging from 2024 to 2051. The debt/capital ratio was 38% as of 12/31/21, down year-over-year from 38.9%. UnitedHealth’s ability to maintain consistent leverage ratios is supported by its strong cash flow trends. In 2021, cash flow from operations was $22.3 billion, or 1.3x net income. For 2022, the company says it expects operating cash flow will increase to nearly $24 billion (1.2x expected net income). Last year, cash flow was used to fund capital expenditures, $2.5 billion; cash payments for acquisitions, $4.8 billion; dividends, $5.3 billion; and share buybacks, $5.0 billion. On its fourth quarter earnings call, UNH said it expects repurchase activity in the range of $5 billion to $6 billion this year. Our credit score is stable as we expect UNH will continue to benefit from its strong market position and diversified business mix, even as it spends aggressively on acquisitions and capital distributions. The 2.3% notes due 5/15/31 are seen at T+78. Opinion: buy.

Turkiye Petrol Rafinerileri A.S.: January 25

Against this backdrop, Tupras is a defensive play in Turkey because of the country’s dependence to the company for its supply of refined fuels. The company’s revenue and most operating expenses are USD-denominated, which provides some hedge against the volatility of the Turkish lira. The company reported some good results for 3Q21 and raised its guidance of net refinery margins to $4.5-$5.0 per barrel (from $2.5-$3.5) on the back of solid demand levels and supply constraints experienced at the end of last year. Now that the fears about the spread of the omicron strain ease, the consumption outlook for gasoline, diesel and even jet fuel should gradually improve in 2022. in our view. Tupras had a net leverage of 1.5x in 3Q21 and we believe that this ratio stood close to 2x in 4Q21 despite the sharp decline in the Turkish lira seen in late 2021. In November 2021, Tupras announced strategic initiatives to reduce its carbon emissions by 27% in 2030 and 35% by 2035 compared to 2017 levels, before becoming carbon neutral in 2050. As part of this plan, the company will mostly develop new energy resources such as sustainable aviation fuels, green hydrogen, and zero-carbon electricity. These new projects should add 30% to the company’s EBITDA compared to last 5-year average. To achieve that, Tupras plans to invest $5 billion by 2035 and $10 billion in total by 2050. This corresponds to an annual average investment of $350 million. This strategic move will enhance the sustainable development of the company going forward. Our most recent view on TUPRST 4.5% Oct. 2024 bonds was “outperform” at a price of 98 and a z-spread of 442bps (on December 1st, 2021). These bonds now trade at a price of 98.75, a z-spread of 386bps and offer a yield-to-worst of 5%. We expect Turkey’s largest industrial company to keep adequate credit measures in the short term. While the capital upside potential of these bonds is limited, we still believe that they offer a good carry for tenor of approximately 2.5 years. We keep our “outperform” rating on TUPRST 4.5% 2024 bonds.

Exelon: January 24

 …As for Exelon, its business risk will miraculously improve by leaps and bounds. It will be a “pure play” transmission and distribution utility with no generation assets, the largest in the country. Its service territory spans seven states, giving it excellent geographic and regulatory diversification, with generally supportive regulation. The lingering hangover at Commonwealth Edison arising from its decade long scandalous behavior has an end in sight (barring additional revelations), as it is about halfway through its three-year deferred prosecution agreement (DPA) period with good behavior so far, after which charges will be dropped. Exelon can deliver E.P.S. growth even assuming the new equity issuance as its capital investment plan of $29 billion over the next four years will result in rate base growth of 8.1%. Even with some $14 billion in incremental borrowing requirements over this time and the cash distribution to Constellation, management is forecasting funds from operations/debt to average 13%-14%. Our pro forma forecast for 2022 is within this range, although we are projecting leverage to weaken to debt/EBITDA of about 5.5x. This is what happens when you spin off a unit with estimated EBITDA of $2.5 billion, hand it nearly $2 billion in cash, and spin it off with leverage of only 1.5x. Bear in mind that Exelon, thanks to hefty cash distributions from Exelon Generation, typically posted FFO/debt in the mid twenty percentage range. Exelon’s credit metrics will be materially weaker after the spinoff, but this will be offset by materially lower business risk. The cash and the EBITDA from Constellation will be missed, but the volatility and business risk will not. The investment thesis for an Exelon bondholder is a strong one. It is rare to find a 100% regulated utility with no generation assets, supportive regulation, considerable scope and scale, and a commitment to strong investment grade ratings even should it require equity issuance. With the spinoff a certainty, we are moving to an “outperform” (2030 notes at T+99).

Shimao Property Holdings Ltd: January 24

The main risk remains the access to liquidity, and the latest news is not encouraging. In October, Shimao had to publish a public statement after rumors spread that it was in talks to extend a repayment to a trust. It is in compliance with the “three red lines” that the Chinese government had introduced to limit leverage in the sector and has repaid its CNY1.9 billion domestic onshore bond that matured on 15th January. The creditors of one of its onshore asset-backed securities have accepted the extension of payments to the end of 2022. The company has also announced the sale of a development project it owns to a state-owned entity, for $167 million. It is also putting up for sale two floors of an expensive office tower in Hong Kong, hoping to raise $205 million, but this will take time and buyers will know that the seller is under pressure to raise cash. These sales also remain small, in the context of Shimao’s overall debt of $26 billion, as of June 2020. The Chinese government is relaxing the rules on the use of down-payments, which will provide some relief: Shimao recorded $3.5 billion as of June. Whether this will be sufficient to give a lifeline to the business will be seen, as new home sales continue to plummet. The whole property sector is under stress, with major defaults among the largest companies. The SHIMAO 6.125% 02/2024 bonds have fallen off the cliff: from a cash price of $80 in early December, they have now fallen to the mid $40s, on renewed worries of an outright default. For a company that last offered bonds to the market in September, this is a very bad outcome. We continue to see some downside, given the weak state of the market. UNDERPERFORM.

Netflix Inc.: January 24

…Operating margins in the fourth quarter were only 8.2%, dramatically lower than in previous periods, but actually better than management had forecasted. However, the company issued guidance for margins of 19% to 20% for 2022, which would be 140 basis points below 2021 at the midpoint. The margin weakness is attributable primarily to the foreign exchange effect, since Netflix does not hedge, as well as the hefty content spending needed to attract subs. Free cash flow was negative by nearly $600 million in the fourth quarter but was only modestly negative for the full year. Management expects free cash flow to be positive this year, although the weaker subscriber growth could imperil this goal. Given the substantially better EBITDA this year along with slightly lower debt, leverage at year-end dropped to 2.4x. The weaker margins anticipated this year suggest EBITDA will not be much higher. But Netflix intends to pay off the $700 million of debt maturing in the first quarter. Therefore, leverage could drift even lower this year unless subscriber growth and margins fade. While free cash flow is set to turn positive, it may be constrained by weaker subscriber growth, eroding margins, and substantial content spending as Netflix fends off stiff competition. Although spreads have widened considerably of late, we foresee additional weakness. Therefore, we maintain our underperform recommendation, with the 2030 notes trading at a spread of +124.

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