Net corporate debt to rise by USD550bn as companies deploy record USD5.2tn cash reserves
The world’s companies took on record new debts totalling USD1.3 trillion in 2020, as global profits plunged by a third, according to the annual Janus Henderson Corporate Debt Index.
Total debt (which takes no account of cash holdings) jumped 10.2 per cent to an all-time high of USD13.5 trillion for the financial year 2020, as companies raised cash to ensure they could weather the global recession and any potential restrictions of access to financial markets. However, companies have spent almost none of this new debt and have issued almost no additional debt in 2021 to date. Janus Henderson’s analysis of the world’s corporate bond markets shows that total borrowing has only risen 1 per cent further in the first six months of 2021.
Such thrift has meant that global corporate net debt (total debt minus cash) only increased by USD151 billion, ending the year at USD8.30 trillion (up from USD8.15 trillion a year ago). Adjusted for exchange rate movements, the increase was just USD36 billion. For 2021, Janus Henderson expects total debts to remain broadly flat, but net debt will climb quickly as companies begin to spend some of their cash mountain. Net debts are set to rise by USD500-600 billion this year to USD8.8-USD8.9 trillion. Janus Henderson sees significant opportunities for bond investors, as the combination of improving credit fundamentals and central bank activity in response to the pandemic provides a favourable environment for both the supply of and demand for high yield bonds.
The hard work to reduce outgoings has meant that most of the new borrowing is still sitting on company balance sheets as cash or securities. Cash holdings soared by USD1.1 trillion to a record USD5.2 trillion in 2020, increasing almost twice as much in one year as in the previous five years combined. Rather than spend new borrowings, companies have instead taken steps to strengthen their balance sheets. Companies in Janus Henderson’s Corporate Debt Index cut dividends to the tune of USD130 billion, slashed capex, raised hundreds of billions of dollars from shareholders and from asset sales, and cut share buybacks. However, as the recovery continues, Janus Henderson predicts a boom in capex, dividend payments and share buybacks through H2 2021 and beyond.
Investment opportunities for bond holders in redeemed fallen angles in the high yield sector
For bond investors, there are some interesting opportunities as credit quality improves, especially in the high yield segment. Janus Henderson sees significant scope to identify rising stars in the year ahead, including the rehabilitation of some of last year’s fallen angels. The portfolio managers favour food and beverage (such as Kraft), selected auto manufacturers (such as Ford) as well as opportunities in the energy and consumer sectors.
Tom Ross and Seth Meyer, fixed income portfolio managers at Janus Henderson explain: “Companies around the world have weathered the last 16 months with impressive skill. An investment boom is highly likely after the Covid-19 freeze. This will account for a large portion of the reduction in cash balances this year but share buybacks and higher dividends will be part of the story too.
For bond investors, there are some really interesting opportunities right now. The prospect of higher economic growth and rising inflation is usually considered negative for fixed income, but it also means improving credit fundamentals – better cash flow, improved leverage ratios. Crucially the corporate bond markets are not a single, uniform asset class. Although overall borrowing costs are low, companies still want to move up the rankings because it gets cheaper still. The additional borrowing costs for a BB issuer are 100bp more expensive than for a BBB issuer, just one notch above.
Crucially, the high yield market is in a constant state of flux. At one end, there are bonds journeying back and forth between investment grade and high yield. At the other end, bonds are on the brink of default. All the while, there are hundreds of different issuers jostling for position along the credit spectrum. As these positions change, bond prices move, creating investment opportunities.
Strong economic growth can ignite permanently higher inflation, but it is important to not let fear of higher interest rates dragging on returns prevent investors from capitalising on the potential opportunities. We believe central banks will maintain support for economic recovery by keeping interest rates low and engaging in asset purchases (quantitative easing). This ought to provide a favourable environment for both the supply and demand for high yield bonds, creating opportunities for good credit selection.”
On default risk, Ross and Meyer add: “Default rates have been very low in the pandemic thanks to government support, but we think they are going to stay low, perhaps less than 1 per cent this year and only slightly higher next. Certainly, debt has risen, but cash has soared, markets are wide open, and free cash flow is accelerating, so companies have a fair wind in their sails. Pockets of risk remain – airlines, for example, remain vulnerable to unpredictable policy decisions on international travel. The wider leisure and hospitality sector suffers a lot of this uncertainty too.”