Day of reckoning for Europe’s zombie companies will offer distressed opportunities
A leading London-based alternative asset manager says the COVID-19 crisis has created major opportunities in European credit as it strangles economic activity and triggers a powerful public policy response.
“Not all market segments have been distorted equally,” Stuart Fiertz, the President and Director of Research at Cheyne Capital, told Investment Magazine’s Fiduciary Investors Digital Symposium. “There is a particularly compelling risk/reward available in European credit. Opportunities where investors can lock in high visible IRR, yet still retain significant upside potential.”
“We are still at the sweet spot of generous support, decreasing the probability or likelihood of default, yet still leaving enough yield for investors.”
Fiertz said that significant uncertainty remains, including what path the recovery will take and what will be the permanent shifts in consumer behaviour.
“To properly take account of that uncertainty, we recommend that you invest in senior debt,” he said. “That way you will have the cushion against downside uncertainty; while liquidity-driven dislocation will help drive returns going forward.”
Despite the generous central bank support, the market is discounting a 7 per cent cumulative default rate for European investment-grade credit. “This looks generous,” Fiertz added.
That compares favourably with the worst-ever five-year realised rate of 5.4 per cent which includes the Great Depression; the worst five-year cohort since 1970 which is 2.3%; and the 50-year average of just 90 basis points.
But generous support for investment-grade credit and for the so-called fallen angels has meant the public markets are open with investment-grade issuance averaging around a 12-year maturity since the crisis began, and that has reduced financing risk and default risk.
Fiertz said that segments of the market not supported by public largesse are “even more interesting”, including private equity-owned firms that are excluded from central bank support.
There are opportunities to provide super senior rescue financing generally at just 1.0 x EBITDA or even less, he said, either through bilateral loan facilities or new bond issuance. Locked in yields can reach 15 per cent with further upside the likes of upfront fees and prepayment penalties.
Support programs also don’t extend to real-estate backed bonds, which are still trading at March lows. Fiertz said investors there should look at senior debt and use sober recovery expectations. “It’s possible to lock in a high visible IRR and be positioned for further upside if this market segment tightens back anywhere towards pre-crisis levels,” he said.
Fiertz added that leading into the crisis, there had been 10 years of limited speculative building in commercial property which led to low vacancies. When combined with stalled or cancelled projects during the crisis, “the supply/demand balance is going to remain in decent shape”.
The fund manager is concerned about the retail side, however, where retailers have asked for reduced rent, which Fiertz estimates could be as high as 50 per cent, in exchange for a share of operating profits or revenues. “We’re concerned that creates an asset that’s neither fish nor fowl,” he said. “It’s no longer a real estate asset and it’s not an operating retailer. Where does it fit in an investor’s portfolio?”
Elsewhere, Fiertz said blocks of student housing in the UK would still be filled and the dynamic would remain in good shape. And in continental Europe, where student housing was still emerging, there is an undersupply.
Fiertz said that there will be a day of reckoning for Europe’s zombie companies, which are being propped up by government support, over the next two to three years. “You’re going to see tremendous opportunities on the distressed and stressed side of the market,” he said.