High yield pain, long-term gain; CL Buy Altice, LBTY off CL, still Buy
* High yield sell-off deepens; spreads now in the 78th% percentile
Over the past week the sell-off in high-yield bond markets has accelerated.
HY spreads over five-year U.S. Treasuries are now c.660 bp vs. c.500 bp in
June. Historically, spreads have fallen to c.300 bp in a benign macro
environment and spiked to c.900 bp in a ‘typical’ recession. In the context
of a positive macro outlook for DMs, GS credit strategists argue that the HY
market is now oversold. But given the recent sell-off, we believe it is worth
evaluating downside scenarios in case debt markets weaken further.
* Higher cost of debt would weigh on LT FCF, NT multiples
We focus on highly levered Altice (pro-forma 2016E ND/EBITDA 4.7x) and
Liberty Global (5.0x). Near-term re-financing risk is minimal, with longtenured
debt maturities of 7/8 years, respectively, and primarily fixed-rate
debt. However, wider HY spreads imply increased long-term funding costs,
while in the near term both stocks could de-rate pro-rata with the change in
marginal funding costs, as was the case in 2008/09.
* Evaluating risk-reward in a downside scenario
We stress-tested our forecasts for a downside scenario in which the market
extrapolates long-term funding costs of c.9%-10% (vs. 5%-6% today), and
equity FCF yields consequently rise to c.10%-11%. LBTY would see the
greatest implied impact on 2020E FCF/sh (-c.35%) as it has a limited tax
shield, although buybacks at a lower stock price could be an offset. The
impact on Altice FCF would be -20%, given its very rapid de-leveraging.
* Altice (CL Buy): A de-leveraging story with limited LT downside
We see risk-reward as attractive and reiterate our CL Buy post the sell-off
around the recent equity placing. We estimate 6% downside to c.€16/sh in
a recessionary scenario, and 76% upside to c.€30/sh if the current growth
concerns pass and ATC executes on restructuring. We lower our 12m price
target to €30 from €37 to reflect the current higher cost of capital.
* Liberty Global (Buy): Off CL on VOD deal delay; remains attractive
We remove LBTYA from our European Conviction List, but remain Buy
rated, as the termination of talks with Vodafone pushes out M&A catalysts.
We still see attractive longer-term risk-reward, with 18% potential
downside to $36/sh vs. 55% upside to $68/sh. We lower our 12m price
target to $60 (from $70) given a higher WACC and delayed M&A benefits.