Bullish credit analysts back cyclicals

Cyclical credits offer good value for those bond investors confident about the state of the economy.

Construction offers value for credit investors, according to Barclays Capital

Credit market specialists confident the economic recovery remains on course believe cyclical sectors currently pricing in a double-dip recession offer good value.

“We are constructive on cyclicals, based on the macro view that there will be a slow but steady healing of the economy,” says Vasant Mehta, a London-based credit analyst at fixed income asset management firm Payden & Rygel.

More specifically, analysts such as Mehta are enthusiastic about cyclical credits with exposure to regions where growth is expected to be stronger or in sectors that benefit from government support. Mehta is positive on the building materials sector, for instance, because many of the large players have exposure to the US, which he says will continue to benefit from the government’s stimulus measures.

In addition, the large building materials firms may also have exposure to comparatively thriving emerging economies. “There is still a decent amount of growth in the building sector in emerging markets, and in Asia particularly, although we are keeping an eye on China to see what happens there,” says Mehta.

Similarly, Sven Kreitmair, Munich-based joint head of corporate credit research at UniCredit, is overweight on companies in the auto sector who are profiting from Chinese growth, such as BMW, Daimler and Volkswagen. He says: “Multinationals that have huge Asia or China exposure can mitigate low European growth.”

In its first-half report, Renault predicted the global automotive market will grow by approximately 8% in 2010, even though the French carmaker estimates a 7–9% drop in the European market.

Andrew Sheets, London-based head of European credit strategy at Morgan Stanley, is constructive on cyclical sectors deriving a greater share of revenues from outside Europe. “That is where we have the most confidence in the durability of the economic recovery,” he says. Like Kreitmair, Sheets is positive on autos, but is also keen on the mining sector, which he says benefits from the same non-European exposure.

Alternatively, Sheets says chemicals offer good value, but only in the high yield space. He highlights French company Rhodia, which is rated B1 by Moody’s and BB- by Standard & Poor’s, as an example. Rhodia’s euro-denominated 7% 05/18 callable issue is currently yielding 6.376%, having traded at 6.676% on April 30.

In an August 2, 2010 report called Rhodia – Upgrade Ahead?, Alex Andersen, a corporate bond analyst at Jyske Bank, recommends buying Rhodia’s 2018 bond. He says improvements in the firm’s credit profile have increased the probability of a rating upgrade. In addition, Rhodia is well-diversified geographically, with strong positions in Europe, North America, Latin America, and especially the growing Asian markets.

Investors wishing to purchase underperforming cyclical credits may need to act quickly, however. In a July 1 report called US Credit Alpha: Halfway to Where?, Barclays Capital credit research analysts Jeffrey Meli, Shobhit Gupta and Alex Gennis wrote that the US property building sector is an “attractive candidate to buy on weakness”, after disappointing new house sales in May of only 300,000 caused credit spreads to widen.

The analysts wrote: “We view the recent underperformance as overdone, and believe the sector may offer an opportunity to buy on weakness,” adding that BarCap’s homebuilder analyst, Vincent Foley, had marketweight recommendations on Beazer Homes, KB Home and Pulte Homes, and overweight recommendations on some DR Horton bonds.

However, spreads were quick to tighten again, with KB Home’s 6.25% 06/15 issue tightening from a peak of 9.054% on June 29, to 7.756% by August 9. Similarly, the 6.25% 03/15 issue by Meritage tightened from a peak of 8.302% on May 25 to 6.708% on August 9.

Sheets also views the retail sector as being rich at current levels.

Investors more sceptical of a global recovery may prefer to stick with non-cyclicals. “We are still seeing quite a bit of unwinding of leverage in the system,” says Paul Hatfield, chief investment officer of Alcentra, BNY Mellon Asset Management’s specialist high yield unit. “There are still sovereign debt concerns, and the jury is out on how realistic it is for countries to get a grip on them. It will be a tough couple of years with all the cutbacks for anything that faces discretionary or consumer expenditure.”