Financial Times Europe - 09.11.2019 - 10.11.2019

16 ★ FTWeekend 9 November/10 November 2019

Joe Rennison

On Wall Street

I

n the middle of the boom in lever-

aged loans last year, rating gencya

S&P Global forecast a bright future

for 24 Hour Fitness, a California-

basedchainofgyms.

As part of its rationale in rating a new

$850m loan at single B plus, &P said itS

believed anyrise in the company’s lev-

eragefromleasesonnewgymswouldbe

offset y higher revenues. As a result,b

the companycould aintain a debt-to-m

earningsratioofaboutsixtimes.

It is part of a broader trend of rising

“add-backs”, where a short-term knock

to earnings is glossed over on the expec-

tationprofitswillcomegoodovertime.

But profits have not come good. This

week, S&P cut its rating on the com-

pany’s debt to single B minus, saying

revenues generated by the company’s

expansion to more than 450 clubs

across 13 states were less than the

agency expected when the loan was

issued in May 2018. The market price of

thedebtplungedtodistressedlevels.

S&Psaiditsdowngradewasnotdueto

lower than expected earnings for new

gyms but instead driven by falling reve-

nues from existing fitnesscentres at the

timetheloanwassold.

But for some analysts and investors, it

seems to be yet another example of rosy

forecasts from companies — and in

many cases, their private equity owners

— being indulged by rating agencies,

leadingtoinflatedscores.

Other debt-laden issuers have suf-

fered similar fates to 24 Hour Fitness.

Software company4L Technologies’

debt plummeted his year after weakt

earnings guidance, aid people familiars

with the private company’s perform-

ance. The same happened to beauty

companyAnastasiaBeverlyHills.

“If earnings fall, leverage goes up,”

said Matthew Mish, head of credit strat-

egy at UBS in Chicago. “Then the reality

is you are going to start getting solvency

concerns. The rating agencies have not

kept up with the deterioration in the

qualityofdeals.”

Removing add-backs pushes total

leverage on loan deals this year from 5.

times debt to earnings — already a

record — to 6.7 times, according to

researchfromUBS.

Just 9 per cent of new deals this year

carry leverage over 7 times, including

add-backs. But strip them out, and the

numbershootsupto46percent—more

than triple the share of two years ago.

Over the same period, the share of deals

rated single B minus has risen only

slightly,from10percentto14percent.

Rating agencies said hey make theirt

own assessments of whether add-backs

arerealistic.

But massaging earnings through add-

backs is just one area in which loan

standards have deteriorated s demanda

from yield-starved investors has tipped

the balance of power in favour of bor-

rowers. Despite a softening in that

demand this year, the trend towards

weak documentation, through looser

covenants,hasbecome mbedded.e

A lack of protection through cove-

nants — terms within loans that limit

things such as the borrower loading up

on more debt or taking cash out of the

business — could heighten default risks

for investors. Many fund managers feel

that the likes of S&P and Moody’s have

not done enough to penalise aggressive

borrowingthroughlowerratings.

The agencies counter that weaker

lendingstandardstendtocutbothways.

Alackofprotectionscanraisetheriskof

defaultbuttheycanalsogivecompanies

morewriggleroomtoavoidit.

“If a credit rating is the likelihood of

default and the likely recovery, a flexi-

ble credit agreement shouldn’t neces-

sarily affect [a company’s] rating,” said

Christina Padgett, head of leveraged

financeresearchatMoody’s.

It is a delicate matter for the rating

agencies, which were hauled in front

of lawmakers fter the financial crisisa

and criticised for the high scores they

attached to subprime mortgage bonds.

This week, the Securities and Exchange

Commission held a hearing in which a

panel urged the regulator to end the

“issuer pays”model in which compa-

niesthatsellbondsalsopayforratings.

Steve Wilkinson, a senior director at

S&P Global,said he did not believe om-c

placencyhadcreptintoratingsofcorpo-

rate debt.The rise in lower rated debt

suggested the risk of defaultwas

“substantially higher than it was before

thefinancialcrisis”,headded.

But some investors are not taking any

chances. Dan Ivascyn, chief investment

officer atPimco, told the Financial

Times that it remained important for

investorstodotheirowncreditwork.

“I don’t think you can count on the

rating agencies to protect you at the end

ofacycle,”hesaid.

[email protected]

‘Add-backs’ provoke

fears of distorted

credit ratings

Removing add-backs

pushes leverage on loan

deals from 5.4 times debt

to earnings to 6.7 times

3 Global stocks, lifted by positive trade

war signs, stumble as week closes

3 US dollar remains strong, while

sterling stays steady ahead of election

3 Copper rises, but Brent crude held

back by conflicting supply cut signals

After a week in which global stocks rose

for the most part on the back of signs of

trade war progress, they sputtered

yesterday as trade worries resurfaced.

In midday trade in New York, the S&P

500 was flat. Europe’s Stoxx 600 closed

0.4 per cent down. In Asia, Hong Kong’s

Hang Seng fell 0.7 per cent and China’s

CSI 300 lost 0.5 per cent.

The lacklustre results came despite

Wall Street’s three main equity gauges

closing at record highs on Thursday

following reports that the US and China

had agreed in principle to remove some

tariffs imposed during their trade spat.

However, doubts returned yesterday as

investors sought more concrete signs of a

resolution.

“The US-China trade talks are heading

in the right direction, but there are still

several obstacles that will need to be

overcome,” said Stephen Brennock, an

analyst at PVM Oil Associates in London.

Indications of a detente boosted global

equities early in the week after US

commerce secretary Wilbur Ross said

that he was “quite optimistic” that the

remaining hurdles in the first phase of

trade negotiations could be overcome

soon. He also reaffirmed that Chinese and

US leaders still planned to meet this

month.

However, by the middle of the week,

after reports emerged that the meeting

between Donald Trump and Xi Jinping

might be delayed until December,

markets turned sour. European shares

closed virtually flat as did the S&P 500,

and the Dow and Nasdaq slipped. Asia

also fizzled, with China’s CSI 300 losing

half a per cent.

Momentum returned on Thursday after

China’s state media reported that China

and the US had agreed “to remove some

of the additional tariffs in phases”. The

Stoxx 600 gained 0.3 per cent, Germany’s

Dax jumped 0.8 per cent and the Hang

Seng closed 0.6 per cent higher. US

stocks shone brightest, with Wall Street’s

three main equity gauges closing at

record highs. Treasury bonds also sold off

on the day, driving yields higher as

investors became more optimistic a

resolution to the trade deal would revive

global economic growth

Yesterday’s slide in Asia spread to

Europe as trading began. The theme

continued into early trading in New York.

The trade talks also played a leading

role in currencies and commodities

markets throughout the week.

The US dollar was resurgent due to the

largely optimistic tone of the talks. Both

the Norwegian krone andSwedish krona,

however, had a volatile week, giving back

recent gains against the euro. Sterling

remained steady as investors cast the

Brexit saga aside ahead of December’s

general election.

Brent crude prices stayed around $61,

held back by Opec and partners giving

conflicting signals on whether they would

further cut supply. Hopes of a resolution

to the trade war pushed copper higher,

while the prices of precious metals, seen

as havens in times of trouble, fell.

Joe Murtagh

What you need to know

Global stocks track higher on trade war progress

MSCI World Index

Source: Refinitiv











 Nov  

The day in the markets

Markets update

US Eurozone Japan UK China Brazil

Stocks S&P 500 Eurofirst 300 Nikkei 225 FTSE100 Shanghai Comp Bovespa

Level 3085.58 1588.91 23391.87 7359.38 2964.18 108829.

% change on day 0.01 -0.27 0.26 -0.63 -0.49 -0.

Currency $ index (DXY) $ per € Yen per $ $ per £ Rmb per $ Real per $

Level 98.268 1.102 109.145 1.279 6.988 4.

% change on day 0.127 -0.181 -0.174 -0.234 0.006 0.

Govt. bonds 10-year Treasury 10-year Bund 10-year JGB 10-year Gilt 10-year bond 10-year bond

Yield 1.909 -0.263 -0.065 0.701 3.270 6.

Basis point change on day -2.770 -2.700 2.610 -0.500 2.500 0.

World index, CommodsFTSE All-World Oil - Brent Oil - WTI Gold Silver Metals (LMEX)

Level 358.09 62.44 57.31 1484.25 17.53 2872.

% change on day -0.16 0.14 0.40 -0.12 -0.06 0.

Yesterday's close apart from: Currencies = 16:00 GMT; S&P, Bovespa, All World, Oil = 17:00 GMT; Gold, Silver = London pm fix. Bond data supplied by Tullett Prebon.

Main equity markets

S&P 500 index Eurofirst 300 index FTSE 100 index

| ||||||| |||||||| ||||

Sep 2019 Nov

2880

2960

3040

3120

| || |||||||| |||||||||

Sep 2019 Nov

1480

1520

1560

1600

| ||||| |||||||| ||||||

Sep 2019 Nov

7040

7200

7360

7520

Biggest movers

% US Eurozone UK

Ups

Xerox Holdings 4.

Regeneron Pharmaceuticals 4.

Noble Energy 3.

Walt Disney (the) 3.

Monster Beverage 3.

Novo Nordisk 2.

Terna 1.

Enel 1.

Pernod Ricard 1.

Merck 1.

London Stock Exchange 2.

Centrica 2.

Dcc 1.

Hiscox Ltd 1.

Aveva 0.

%

Downs

Gap (the) -6.

Albemarle -5.

H&r Block -5.

Johnson Controls Int -4.

News -3.

Prices taken at 17:00 GMT

Natixis -7.

Commerzbank -3.

Seadrill -2.

Allianz -2.

Inditex -2.

Based on the constituents of the FTSE Eurofirst 300 Eurozone

Ocado -7.

Evraz -3.

Nmc Health -3.

Burberry -3.

Rio Tinto -2.

All data provided by Morningstar unless otherwise noted.

Gap as the S&P 500’s biggest fallerw

after the surprise exit of chief executive

Art Peck raised doubts over whether the

spinout of Old Navy brand planned for

next year will go ahead.

The retailer also warned that same-

store sales last quarter had been weak

across all its brands.

Mr Peck’s “indifference to design and

product as responsible for much of the

current brand erosion” and his support

for the spin-off plan may have been

because “he saw it as a way to extend his

career at Gap” said Wedbush.

Albemarle etreated after ther

chemicals group warned that weak

lithium prices would spread outside China

next year and excess inventories would

take between 12 and 18 months to run

down.

Monster Beverage as in demand onw

better than expected earnings, thanks

largely to a resolution of supply chain

problems delivering 34 per cent growth in

international sales.

Quarterly results liftedWalt Disney,

with operating income topping forecasts

as the company’s studio and media

networks offset a poor performance from

the acquired Fox brands.

Teradata lid on a profit warning ands

the exit of the cloud computing

specialist’s chief executive.Bryce Elder

Wall Street Eurozone London

Natixis umbled as downgrades followedt

the French bank’s results.

The update late on Thursday showed

fund management performance

bolstering earnings but costs and

impairments both disappointed — and

the return on tangible equity continued

to drift away from management’s target.

A “stellar performance” ahead of the

update and a valuation that looks “very

demanding versus peers” suggests some

profit-taking was warranted, said Kepler

Cheuvreux, which cut Natixis to “reduce”.

Weaker than expected half-year results

fromRichemont ut the Cartier ownerp

under pressure.

It largely reflected operating losses at

its Yoox Net-a-Porter online division due

to higher investment, promotion and

shipping costs.

ISS unced following Thursday’sbo

profit warning after Pierre-Francois

Riolacci, finance director at the Danish

office services group, bought shares.

Vestas ained after Deutsche Bankg

added the wind turbine maker to its “buy”

list.

Results this week from Vestas “were

robust on pretty much every level” with a

strong order book and better margins

helping assuage worries about a likely US

downturn post-2020, said Deutsche.

Bryce Elder

Asia-exposed stocks includingBurberry

andPrudential etreated as optimismr

about US-China trade talks switched back

to uncertainty.

G4S aded after RBC Capital Marketsf

turned cautious.

A 25 per cent bounce from recent lows

had priced in the security group’s strong

market positions and defensive nature

but there was no guarantee that the

planned demerger of its cash-handling

division would release value, RBC said.

It favoured a disposal of the cash unit,

saying a demerger would do nothing

beyond giving investors shares in two

small, indebted businesses.

Ocado ed a sell-off among the UKl

market’s more highly valued stocks.

Jefferies repeated “underweight”

advice on Ocado after hosting an investor

roadshow at a delivery depot operated by

US rival Takeoff Technologies.

Takeoff’s smaller facilities were “the

most productive, viable and economic

answer to online fulfilment”, said

Jefferies, which called US retailer Kroger’s

deal with Ocado “a poor and significant

long-term capital allocation mis-step”.

Charles Taylor ained after a bidg

vehicle backed by private equity group

Lovell Minnick Partners sweetened its

offer to buy the insurance services

company.Bryce Elder

MARKETS & INVESTING

NOVEMBER 9 2019 Section:Markets Time: 11/20198/ - 18:48 User:stephen.smith Page Name:MARKETS2, Part,Page,Edition:EUR , 16, 1