TheChek News Flow

Yesterday Unhedged complained that, given the economic backdrop, stocks looked a little expensive. So what is one to own instead? It is hard to recommend fixed income, given the high volatility — mostly upward volatility — of interest rates. For the first time in a long time, even decent-quality bonds are as scary, or scarier, than stocks.

Another leg up in rates, and leg down in bond prices, cannot be ruled out when no one knows for sure where the Federal Reserve will stop. Flows into bond funds have been deeply and persistently negative all year, except for the brief period this summer when the market saw the mirage of a Fed pivot.

Still, there is a case to be made for buying bonds, and specifically corporate bonds. Here is that case, put very crudely, in a single chart:

That is the yield on bonds from the highest tier of junk-rated bonds, compared to the earnings yield on the S&P 500 (that is, the reciprocal of the price/earnings ratio). Right now, BB bonds yield more. This does not happen very often. The yield differential is about what is was in the acutely frightening early days of the coronavirus pandemic. Are things as bad now as they looked then? There are assorted perfectly technical quibbles that could be raised with this comparison, but it gets to the heart of the argument. Bonds look cheapish, relatively.

Why cheapish, not plain old cheap? A lot of what makes corporates look cheap compared to stocks is higher Treasury yields — a higher risk-free rate. The additional compensation investors are getting for taking on BB default risk, about 330 basis points, is only middling by historical standards. Here is a long-term chart of the spread:

In addition, the compensation for trading down from the lowest rung of investment grade (BBB) to the highest rung of junk (BB) is not all that special. The difference between the BBB and the BB spreads (the spread spread, if you will) stands at 1.4 per cent, just a bit above its 10-year average.

On some measures, high-yield bonds are not cheap at all. Marty Fridson, of Lehmann Livian Fridson, uses a model that shows a fair value spread for the entire high-yield index (BBs and everything junkier) at about 7.2 per cent, well ahead of the 4.8 per cent spread the index currently offers. The main reason is that his model demands more yield when the availability of credit is constrained — as it is now, according to the Fed’s loan officer survey, for example.

During the past few years, most companies pushed their debt maturities years into the future. According to Scott DiMaggio, co-head of fixed income at AllianceBernstein, only about 20 per cent of the bonds in the US market mature in the next three years, “a very manageable number”. But there is more to credit risk than refinancing, as Unhedged recently discussed.

That said, many BB rated bonds are issued by companies that seem very unlikely to default outside of a very severe recession: the index includes Sprint, Ford, Occidental, Yum Brands, T-Mobile and so on.

Interest rate volatility, and the accompanying direction risk, hang over the whole discussion. Investors will remember the brutal 17 per cent fall in the JNK — the largest of the junk-bond exchange traded funds — over the past year. Remember, though, that for most investors duration risk must be weighed against the riskiness of equities and the vulnerability of cash to inflation.

The bonds in the JNK have average maturity of between five and six years. The five-year Treasury has risen almost 2 per cent in the past 12 months. If rates rise another two percentage points, take a moment to think about what that implies about inflation, and what it will do to your stock portfolio.

Finally, the flat yield curve presents an opportunity. Quite good yields are available in bonds with maturities of just a year or two. The yield to worst on Ford’s BB+ bonds maturing in September of 2025 is 6.5 per cent, for example. Sprint’s bonds due June 2024 pay 5.5 per cent.

The corporate bond market is by all accounts very illiquid right now. It is not easy to buy bonds. But I think there is a case to be made for doing so, at the short end, and in the higher reaches of the junk spectrum.

Berlin moves to secure the future of three of the country’s refineries owned by Russian oil company

The German government has taken control of three refineries owned by Russian oil company Rosneft, the latest in a flurry of measures to deal with the energy crisis triggered by the invasion of Ukraine.

The move secures the future of PCK, a refinery owned by Rosneft in the north-eastern German town of Schwedt, whose future was threatened by a looming EU embargo on imports of Russian oil.

PCK sits atop the “Druzhba” pipeline, which carries crude about 4,000km from central Russia directly to Schwedt. Authorities’ efforts to secure alternative supplies of oil for the refinery had been complicated by the fact that Rosneft is its majority owner, controlling 54 per cent of its shares.

A statement issued by the German economy ministry on Friday morning said the government was placing Rosneft Deutschland GmbH and RN Refining & Marketing GmbH under the trusteeship of the Bundesnetzagentur (BNA), the country’s federal energy regulator.

That puts Rosneft’s stakes in three German refineries — PCK in Schwedt, MiRo in Karlsruhe and Bayernoil in the Bavarian town of Vohburg — under the BNA’s control. Rosneft accounts for about 12 per cent of Germany’s oil refining capacity, making it one of the largest oil processing companies in the country, the ministry said.

The decision to seize control of Rosneft’s assets mirrored a move in April, when the government placed the German assets of Kremlin-controlled gas exporter Gazprom under the trusteeship of the BNA.

The assets, which include Germany’s largest gas storage facility, Rehden, were owned by Gazprom Germania, which has since been renamed SEFE.

The move on Rosneft is the latest in a string of measures by the German government to deal with the chaos caused by Russia’s war in Ukraine, which has driven European gas and electricity prices to record levels.

Germany has accused the Kremlin of “weaponising” its energy exports to Europe by throttling the flow of gas through the Nord Stream 1 pipeline between Russia and Germany.

As gas supplies dwindled, the government in Berlin moved to bail out Uniper, the country’s largest importer of Russian gas, which has been pushed to the brink of insolvency. Uniper said this week that the government could increase its stake in the company to more than 50 per cent.

The economy ministry said that by placing Rosneft’s German assets under trusteeship, “we are countering the threat to the security of [Germany’s] energy supply and setting an essential foundation stone for the preservation and future of the Schwedt site.”

PCK is one of the main suppliers of petrol, diesel, jet kerosene and fuel oil to Berlin and the surrounding region, Brandenburg, and is seen as an essential element of east Germany’s energy infrastructure.

Many Schwedt residents began to fear for the future of the refinery after Germany signed up to the EU’s oil embargo, with some wondering why it had not followed the example of Hungary, the Czech Republic and Slovakia, which are also linked to the Druzhba pipeline but negotiated temporary exemptions, citing their lack of alternatives to Russian oil.

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Truce reached with activist investor over sports network has left media group’s chief weighing up his options

In a letter addressed to Disney chief executive Bob Chapek in mid-August, activist hedge fund manager Dan Loeb said a “strong case can be made” for the ESPN sports network to be spun off from the company.

Loeb, known for waging bruising battles against the likes of Sony and Sotheby’s, outlined his argument along with a host of other recommendations to improve performance at Disney, including a board “refresh”, taking full control of the Hulu streaming network and cost-cutting measures.

Less than a month later, however, the aggressive manager of hedge fund Third Point reversed his position on spinning off Disney’s sports network after Chapek told the Financial Times that he had a plan to “restore ESPN to its growth trajectory”. In a tweet, Loeb said he had come to a “better understanding of ESPN’s potential as a standalone business”.

Loeb’s message came as a relief to Disney and ESPN employees, but the episode has shone a light on the deeper problems facing the sports network — and left investors wondering about the details of Chapek’s plan to fix them.

“[Chapek] has got to explain to Wall Street how ESPN can be a good business,” said Rich Greenfield, an analyst at LightShed Partners. “Cable networks are just a challenged business. The problem is less and less people are subscribing to [traditional] TV, and the sports costs keep coming up.”

Neither Disney nor Third Point would comment on the matter, but both emphasised there has been cordial dialogue between Loeb and Chapek.

Once Disney’s profit engine thanks to its commanding share of cable subscribers, a steady stream of affiliate fees and advertising revenue, ESPN has suffered in the streaming age.

Its subscriber base has fallen from a peak of 99.4mn in 2011 to a projected 73.6mn by the end of this year — a drop of more than 25 per cent — according to estimates by S&P Global Market Intelligence.

Worse, its famous cash-spinning ability is expected to shrink dramatically over the next three years, said Scott Robson, senior research analyst at S&P Global. He estimates cash flow will drop from about $2.5bn in 2021 to $1bn in 2025.

“Everybody knows that the . . . cable bundle is deteriorating over time,” Chapek told a Goldman Sachs conference this week. “It’s still a significant business, very appreciative from a cash flow standpoint for us. But at some point, we see the writing on the wall where this is going, and we’re preparing for that.”

Besides cord-cutting, ESPN is facing escalating costs of rights to broadcast sports — driven in part by streaming services run by deep-pocketed Apple and Amazon. Disney expects to pay $10.3bn in contractual commitments for sports programming this year, and an additional $60bn in future commitments.

“These sports rights are getting more and more expensive,” Robson said. “It’s really going to start negatively impacting the bottom line at ESPN.”

But Chapek told the FT he believes ESPN can return to its growth. Crucial to this will be more aggressive marketing of ESPN Plus, its sports streaming network, as part of a bundle with its other streaming platforms, Disney Plus and Hulu. ESPN Plus has about 22.8mn subscribers, or nearly 10 per cent of Disney’s 221mn streaming subscribers.

Chapek noted the enduring power of sports to attract large audiences, even in an age of audience fragmentation. He also believes ESPN can become a force in the rapidly expanding US sports-betting industry — a step that earlier generations of Disney leaders would have thought too racy for the family-friendly company.

Disney acquired a 5 per cent stake in DraftKings, a fantasy sports and betting group, in 2019 when it bought 21st Century Fox. It also has a deal with Caesars Entertainment that gives it the exclusive right to provide sports betting odds to ESPN. Chapek has even floated the idea of launching an ESPN-branded sports betting app, though the company has not started work on this, insiders say.

In his letter, Loeb said it would be easier for ESPN to pursue sports betting outside of Disney. He also said a spin-off would help reduce Disney’s debt, which stood at $46bn at the end of the most recent quarter.

But Loeb’s proposal to spin off ESPN divided Wall Street analysts. Greenfield at LightShed Partners supports the idea, but analysts at MoffettNathanson wrote last month that it would be “financially dangerous to divest ESPN”. Not only are Disney’s revenues reliant on ESPN’s cash, they wrote, but investors aren’t keen on a leveraged asset whose primary business is cable television in the era of cord cutting.

Moreover, recent sports rights deals show the ever-appreciating value of live events. Disney rival Paramount last month more than doubled the price it will pay Uefa for US rights to broadcast the Champions League, now worth $1.5bn over six years.

Apple has reached multibillion-dollar agreements to air Major League Soccer and Major League Baseball, while Amazon last year joined the most expensive package of live sports rights ever sold: the National Football League’s $110bn broadcast terms over 11 years.

Inside ESPN, executives argue that the network is better served with the marketing might of the rest of the Disney company, which includes the ABC broadcast network. They point to the seven-year deal ESPN signed last year with the National Hockey League allowing it to show games on the ESPN cable network, ESPN Plus, the Hulu streaming service and ABC. A similar 12-year plan was signed recently for the rights to the Wimbledon tennis championships.

Even with the headwinds facing its core cable television business, Chapek said Disney had been “deluged” with interest from companies seeking to buy ESPN or join in a spin-off after reports that the company was weighing a sale earlier this year. “If everyone wants to come in and buy it . . . I think that says something about its potential,” Chapek said.

He added: “When the rest of the world knows what our plans are, they will be as confident about that proposition as we are.”

Loeb appears satisfied to wait for Chapek’s plan — at least for now.