Alt data firm uses ESG to sort ‘angels’ from ‘zombies’ as junk bond market surges


Analysing a company’s ESG profile may be the key when it comes to sorting the ‘angels’ from the ‘zombies’ among the expanding class of recently-downgraded junk bonds, says Truvalue Labs in a new report examining this year’s cohort of ‘Fallen Angels’. 

The AI-driven data company analysed a representative cohort of companies globally whose debt has recently been downgraded from investment grade to junk, and ranked them according to an algorithmic ESG Insight Score that reflects their exposure to ESG risks.

Transport firms featured heavily among the 19 companies which Truvalue named as  “requiring further risk and scenario analysis” by potential investors, including Delta Airlines, British Airways, Royal Caribbean, and Autostrada per l’Italia. 

Andre Shepley, Truvalue’s director of ESG Research, explains: “Downgrades in the transport sector seem intuitive, due to the fact that the pandemic has put a halt to people travelling. But there is also an existential threat toward the business of moving things (or people) around, since the transport industry is one of the bigger contributors to global emissions.”

Across all industries, downgrades from investment grade to junk have surged in 2019, as businesses face severe jolts from the pandemic, with the pool sitting at USD120 billion year to date. 

Truvalue’s research found that those companies whose debt was downgraded tended to have lower ESG ratings, and less ESG momentum, when compared with the S&P 500. 

Shepley says: “For investors, the important thing is to figure out: is the spread in yield between the fallen angels and investment grade bonds enough to also compensate for the excess sustainability risk? These four categories (GHG emissions, labour practices, product design and lifecycle management, and product quality and safety) are driving that delta, and are where investors need to do a closer analysis."

Truvalue encourages investors to weigh up the risk against the potential returns of high yield bonds. It highlighted four key areas of scrutiny for investors, which may impact a company’s ability to pay back debts: greenhouse gas missions, product design and lifecycle management, product quality and safety, and labour practices. 

When it comes to greenhouse gas emissions, Truvalue notes that a “carbon premium” is already emerging, which can be seen in the shifting relative valuations of two automotive firms, Ford and Tesla. In the last decade, Ford’s market capitalisation was 15x that of Tesla’s, but has now devalued to below 15 per cent of Tesla. Truvalue says markets are pricing-in Ford’s underinvestment in electrification.

Truvalue also calculates each firm’s projected annual carbon costs if different levels of tax were applied to emissions, with some of the worst hit including mining firm ArcelorMittal (USD45 billion at the highest carbon cost), along with airlines Alaska Air (USD3 billion) and Delta Airlines (USD13 billion).

Shepley says: “Theoretically, if you put carbon prices on, you get a sense of the potential magnitude of future liability. We use prices to test future scenarios, as investors are always valuing companies on their ability to generate cashflow indefinitely.”

The number of downgrades is expected to keep growing, reaching between USD300 and USD500 billion by the end of 2020. Shepley warns: “There are going to be more fallen angels as we move through this recession. In recent years, debt loads have been increasing, issuance in the lowest tier of investment grade has been more prominent than that in the higher tier – so even the asset class of investment grade bonds has become generally riskier than in the past.”