Azul S.A.: September 14

The credit ratios remain under stress. Total debt has fallen somewhat against 1Q20, with a 6% drop in total debt, including a 23% fall in short-term liabilities. Operating and financial leases, which constitute the largest share of the total liabilities, are down -10% and -13.5%, respectively. Management has indicated that operating leases will continue to fall in BRL in 2Q20, despite the depreciation of the currency (as they are denominated in US Dollars). The published adjusted net leverage ratio stands at 4.8x, unchanged relative to 1Q20, but up from 2.7x a year ago. The fight for survival remains acute. The airline is losing money at a rate of BRL3 million a day in 2H20, on average: this means that the losses are much larger in 3Q20, compared to 4Q20, as the capacity is ramping up gradually. As of the end of June, its cash and investments stood at BRL1.6 billion, plus another BRL3.6 billion of unencumbered assets and deposits, against short-term liabilities of BRL1.2 billion. To protect its cash position, it has been drawing on working capital and renegotiating operating leases, deferring aircraft deliveries from Embraer and Airbus to 2024 and beyond, cutting its lease liability by 21% between March 2020 and December 2020. The next few quarters are relatively safe, with an agreement in place with Azul’s financial partners to roll over the amortization falling due in 3Q20 and 4Q20 beyond 2021. The debt due until 2H21 is mostly in local currency. The capital expenditures are down to a bare minimum, having fallen by -75% in 2Q20. We gave a “buy” in June, as the AZULBZ 5.875% 10/26/24s were priced at $53. They are now trading at a price of $72, yielding 15.3% (z-spread: 1,503bps), compared to $69 (yield: 17%) for for GOLLBZ 7% 01/31/25s, against $64 in June. Although we continue to expect some improvement by year-end, we reduce our recommendation to OUTPERFORM.

Aon plc: September 14

…While the impact of the pandemic has not been as severe as initially feared, Aon says it will continue to manage its balance sheet and liquidity cautiously. Cash (including short-term investments) totaled $1.4 billion at the end of June, up from $928 million at 12/31/19. During the first quarter of 2020, Aon completed $463 million in share buybacks. It spent $368 million in the first half on six acquisitions. The buyback program ($1.6 billion in remaining authorizations) is currently suspended. Aon said on its second quarter earnings call that it might resume buybacks in the latter half of the year, but that it will likely maintain higher than normal levels of cash over the near term given the uncertain economic environment. Common dividend payments will continue (around $400 million annual run rate), and other cash items, including restructuring, pension costs and capital expenditures total around $400 million. Aon says it will manage its leverage conservatively, given the current environment, and that it is committed to an investment grade rating. In May, it priced $1 billion in 10-year senior notes, at a spread of T+212.5. The impact on leverage ratios was not meaningful, because it prepaid a $600 million maturity, which was scheduled to come due this month. There is also a $400 million term date maturity in the first quarter of next year. While shareholder approval has been received, Aon still awaits regulatory approvals, including antitrust clearance. The company does not expect that it will have to divest businesses in order to complete the deal, but this is not yet assured. Some revenue attrition remains possible, since overlapping customers may not want to place all their business with one firm. Our credit score is stable given Aon’s prudent balance sheet management, but the new 2.8% notes due 2030 have tightened 100 basis points to T+112 since the issuance date. At current levels, considering merger integration risk, our opinion is underperform.

The Michaels Companies (MIK): September 14

…MIK ended the second fiscal quarter with $1.25 billion of liquidity (including $651 million of cash), up $100 million year to date. First half free cash flow (cash flow from operations less capital spending) swung $313 million to $253 million on reduced working capital usage and capital spending. This FCF plus cash on hand were used to repay the remaining $300 million of the fiscal first quarter’s $600 million revolver draw, ending the fiscal second quarter with full revolver availability of $602 million and no bond maturities until 2027. The company is still not providing financial guidance but noted that the fiscal third quarter sales trend remained strong through early September. While SG&A expenses will face headwinds in the second half related to performance-based compensation and the fact all stores are expected to be open for the period, tariff pressures should abate. Based on our updated projections, we look for fiscal 2020 leverage to be 3.2x (5.0x rent adjusted) with $440 million of free cash flow. With an acknowledgement from the company that “leverage is not optimal” we would expect the near-term priority for excess cash flow to be debt reduction, although the company expects to lay out its capital allocation strategy at its September 24th Investor Day.  To continue growing in store and e-commerce sales, MIK is enhancing its curbside pickup offering, launched MichaelsPro (making bulk buying easier for Makers), revamped the Michaels Rewards loyalty program, and recently remodeled two existing stores in Texas to test a new store design, hubs in the fine art, kids, seasonal, and custom framing departments, and more efficient check out options. The 8.0% senior notes due 2027 have tightened considerably to yield 6.8%. With near-term results likely to be solid, we change to outperform with limited upside as we await the new capital allocation strategy to be announced within the next two weeks.

Intel: September 11

…What spurred the stock weakness earlier in the quarter was the company’s announcement that the launch of its 7-nanometer technology would be delayed by as much as six months due to a defect mode that resulted in yield degradation. This is not the first time Intel has been forced to push out the introduction of new technology. We admit that it is frustrating to witness internal struggles in the face of a tremendous market opportunity. Nevertheless, consider that Intel still carries dominant market shares. Revenue soared 20% in the second quarter, after surging 23% in the first quarter. Admittedly, that growth will slow significantly in the second half, with much of the slowdown reflecting the waning of the Windows 10 refresh. The weakness is also partly attributable to the strong performance last year. In addition, Data Center Group growth of 42% or more, as experienced in the first half, is just not sustainable. Nor is the torrid growth of nearly 60% in Memory Solutions sustainable. We estimate that total revenue will increase about 4.5% this year, after expanding just under 2% last year. That figure could rise if the pandemic continues to spread, resulting in even more working and schooling from home. Margins rose sharply in the first half of the year, but are likely to retreat in the second half because of costs associated with the ramp of 10-nanometer production and the lower revenue. Consequently, we expect margins to fall modestly in 2020. Management indicated that it would consider using chips from an external source if needed. That would be a startling change for a company that has prided itself on its technological leadership. But it could boost free cash flow, similar to the impact at Advanced Micro Devices, while stemming the loss of market share. Moreover, that technological leadership is in question at this point. Despite the implementation of a massive share repurchase program, Intel has an abundance of liquidity and the outstanding free cash flow to fund the initiative. Meanwhile, leverage is very low. Revenue growth will likely slow in the near term, but we expect robust growth in the future as Intel continues to expand beyond the PC market. Advanced Micro Devices and Nvidia will probably capture more market share. Yet, Intel still has commanding market positions of more than 90% in data center servers and PCs. We reiterate our outperform recommendation, with the 2030 notes trading at a spread of +93.

Suzano Papel e Celulose: September 11

…The short-term outlook for pulp is slightly positive with several companies indicating that prices may pick up in late 2020. In our model, we still assume that prices will remain stable this year compared to levels reached in 2Q as the decrease in global pulp demand from the Printing and Writing segment is offset by resilient demand levels from Tissue production. Yet, assuming that demand form Printing and Writing will rise in 2021 (as more people return to offices), we expect pulp prices to rise next year. In the meantime, Suzano is set to benefit strongly from the weaker Brazilian real (every 10c weakening of the BRL leads to an extra BRL 0.5 billion of EBITDA generation). We have therefore revised upward our EBITDA forecast for this year and 2021 thanks to the persistently weaker Brazilian real. We now expect a decrease in net leverage ratios towards 4.7x in FY20 and 3.4x in FY21. Our most recent view on SUZANO 6% 2029 bonds was “outperform” at a price of 108.75 and a z-spread of 424bps (on July 22, 2020). These bonds now trade at 114.8 with a z-spread of 332bps and offer a yield-to-worst of 3.85%. Their spread over underlying sovereigns tightened to 75bps, slightly above pre-pandemic levels of around 50-80bps. With the weak real and a gradual improvement in pulp prices expected in the near term, Suzano is on track to deleverage its capital structure. We keep our “outperform” stance on Suzano curve although we now prefer bonds maturing in 2029, 2030 and the new sustainability-linked bonds maturing in 2031 over the longer-dated 2047 bonds.

Chevron: September 11

…Chevron has taken heroic steps to preserve cash amid the oil price environment and the drop in global demand related to the coronavirus pandemic. It has cut its organic capital spending plans by 40%, suspended share repurchases, and announced a transformation plan expected to save $1 billion in operating expenses. Oil prices remain highly volatile, and recently have fallen after recovering somewhat in the summer. Chevron took over $6 billion in impairment and other pretax charges in the second quarter related to its revised energy price outlook, restructuring costs, and the uncertainty surrounding its Venezuelan assets. Apart from the severance expenses, most of the charges are noncash. Even adjusted for these charges, it lost $3.4 billion, largely attributable to realized liquids prices plunging by more than 60% per barrel. Cash flow was also weak, just barely positive, and free cash flow was negative $4.4 billion. This was somewhat offset by $1.5 billion in asset sale proceeds, sending net debt up by $3.3 billion. In the context of Chevron’s total debt, this is immaterial, and despite lower EBITDA, debt/EBITDA remained less than 1x. We are projecting leverage including Noble’s assumed debt to rise slightly to 1.4x this year and breakeven free cash flow. It remains one of the healthiest balance sheets in the industry, highly valued by management. A somewhat worrisome amount of debt due within a year ($13.5 billion) has been addressed by recent bond issuance at extremely attractive rates (for the company). We reiterate our “outperform” (2030 notes at T+81).

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