An anomaly that can be exploited

"Many readers might not be aware on the extent to which corporate bond yields have collapsed over the past 6 months, particularly in Europe. Below is a chart of Single A European Corporate Bond Yields. Given the turmoil one has witnessed in Europe, it might be surprising to some that bond yields for these companies (or the cost of raising money in the bond markets) have halved from their recent peaks in December of last year. Indeed, the deleveraging process and flight to safety in certain European markets have benefited the stronger companies in those markets.

 


It is therefore no wonder that European corporates are rushing to take advantage of this opportunity to raise money at often the lowest rates on record. One such example this week was European oil major, Royal Dutch Shell, a stock we own in our PSG Global Equity Fund, which announced its first bond sale since 2010. According to Aviate, the $2.5bn raising included its first ever 30 year note, yielding just 82bp over 30 year treasuries, and also 5 year bonds yielding just 1.125%. The weighted average cost of existing corporate debt is 2.5% (which we expect to fall further) and an earnings yield (the inverse of the Price Earnings ratio) of 11.8% (see figure 2).

Indeed, as per World Bank and BP numbers, China makes up 20% of the world’s population though consumes around 10% of global oil production on an annual basis. Over the long term, that consumption ratio will probably rise, providing an underpin to the oil price and hence Shell’s earnings.

We believe that the concept of de-equitisation, that is retiring equity (by buying shares) using debt will continue to be popular with smart management teams across the US and Europe.

we find it difficult to get bearish on European equities whilst this arbitrage opportunity exists, balance sheets are strong and valuations in many instances are at very attractive levels. "

REF :

GREG HOPKINS
PSG Asset Management

"The PSG Angle is an electronic newsletter of  PSG Asset Management. "