Only three weeks ago we looked at Non-Investment Grade stocks (NIGs) with the obvious view that they would not fare well (FROM NIG TO VIRUSED ZOMBIES?). It is actually quite an ugly picture which has developed. The original NIG list (77) has worsened its case, i.e. has fallen more quickly than the Stoxx600. But above all the 77 have become 105 and rising…
Let us start with the underperformance vs. the Stoxx600. The green line shows the acceleration of the relative fall, except for the last few days when markets tried to see a buoy in Central Banks’ agitation.
We can only repeat the point that we have made many times since negative rates showed up on the screens (late 2015). Zero rates manufacture zombie companies: they can service zero interest bills but can never generate the FCF to pay back the principal. In essence: no growth, no debt payback, and so once a zombie, always a zombie.
It may be that the extraordinary means thrown at economic agents so that they keep on going while the world stalls under the weight of a virus will inject free oxygen into such businesses but, again, the odds that genuine GDP growth will follow this crisis are pretty low.
Then there is the issue of supply of NIG companies. At AlphaValue, whose definition of NIG is based on annual financials and qualitative metrics, the number of NIGs for 2020 has jumped to 105 from 77 in a matter of three weeks.
This is more than a 33% increase and reflects fast-deteriorating business conditions (2020 EPS at AlphaValue trimmed from +6.5% by early March to -30% now and falling). This is also close to 26% of the coverage universe of non-Financials. The issue is that 8 of those 105 stocks are now foreseen to have rights issues which have been allowed for in the modelling but that happen to be not enough to keep an investment grade rating.
We knew by early February that COVID-19 had a Minsky moment potential and that risk debt would be the starting point of a market crisis. However, the current breakdown in markets primarily recognises the urge to find an exit for geared investors. It has yet to recognise that there is a substantial gap between what they think they own and the sad reset in progress.
To make the point, we double-checked how many of the 105 universe is still regarded as investment grade by traditional credit rating agencies: 39. It is also fair to say that 50 of the NIGs isolated by AlphaValue are not rated (i.e. will not pay for a rating). That leaves room for ample disappointments in credit markets and in equity ones as these will offer the liquidity to short that cannot be found with credit market makers ducking under the table.
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Founded in 2007, AlphaValue is the world’s leading provider of Independent European Equity and Credit Research. We provide comprehensive, unconflicted research-only (no execution, no corporate finance) coverage of c. 480 European mid and large cap stocks. We have an average of 46% of negative recommendations at any one time. Learn more at www.alphavalue.com