How do you financially analyze an investment grade corporate bond?
These companies rarely ever default so how would you analyze them?
Given that you're not in operational control of the company, how do you forecast the three statements with the effect of the debt on it? If it's to refinance debt, I imagine it is simple, but what if it is to invest in CapEx and R&D - how would you reflect that on future earnings?
What tools do you commonly use? Which metrics and ratios? Which free cash flow are you interested in? Do you care to do a debt waterfall, even though you are senior secured?
Comments ( 9 )
How would you analyze any company? Not sure what / if anything IG has to do with it.
I think its more so about analyzing relevant financial metrics to be able to come up with a comp set, then compare the YTM figures for the comparable companies with said company's YTM. Not too sure, though.
If you're talking about a company's subordinated debt you typically look at how the capital structure affects the default risk of the bond as well as other factors such as market conditions, fcf , and fixed charge coverage.
For example, one would check the interest rate of the bond and if the company can pay that interest. Senior debt from the bank is paid off first, which typically means that a company might have a harder time raising subordinated debt due to the their fcf just barely paying off the other debt.
For these types of debt and convertibles you want to see if the bond will be junk, meaning that the company in default will not be able to make the principle payment at the end, since most of these bonds will do bullet payments or PIKs. To find this the creditworthiness of the company you take into consideration things like assets in liquidation scenarios, catalyst that might have a negative impact on the company fcf , etc.
You value the debt based off the riskiness and the irr . For example, if premusk Twitter issues a convertible note, the company does not have a high chance of default due to having so much cash on the balance sheet that can pay towards the debt interest, as well as the principle in liquidation.
Market comps all day. Your intuition is correct IG bonds are a somewhat homogenous asset class its all about where you trade relative to close peers, new issue concessions, etc. If you're approaching this from the side of an equity investor or I-banker I suppose you would consider how the issuance impacts leverage, interest expense , etc. but from the perspective of the company or a capital markets guy its mostly just about the market.
In terms of fundamentals, analysts will generally consider the same metrics that equity analysts will track: revenue growth, margin profile, cash flow conversion , capital allocation (is the company allocating cash to M&A, dividends, share repurchases, debt reduction, etc.). Things like interest coverage and liquidity are less relevant for IG companies (generally companies will be downgraded to high yield prior to coverage/liquidity issues), so leverage ( debt to EBITDA ) is the main balance sheet consideration.
Even if IG companies don't have much default risk, investors still need to be compensated for credit risk they are taking. IG bonds usually trade off a spread to Treasuries: 10yr General Motors (GM) bonds yield about 5.2% right now, which is composed of the 10yr Treasury yield (3.1%) and the credit spread (2.1%) for taking GM-specific default risk . Bond prices will move up and down based on changes in those two factors, so a potential thesis for an IG bond could be that I think these GM bonds should trade at a credit spread of 1.5% (150 basis points ), which would imply 0.6% (60 basis points) of credit spread tightening. This might be because I think: (1) fundamentals will improve as I expect earnings expectations for GM to improve in the coming months, and (2) relative value is attractive with 10yr bonds for BMW and Daimler (owns Mercedes) trading at a 1.5% (150 basis points) spread. I think the market will recognize this improvement in GM's credit profile and bring its credit spreads in line with those of automotive peers BMW and Daimler. This 10yr GM bonds has 8 years of duration (duration = sensitivity to changes in interest rates / credit spreads), which means that 0.6% (60 basis points) of spread tightening = ~$5 price upside for these bonds (8 duration * 0.6% tightening = price impact of $4.8), in addition to the coupon you are getting paid to hold it.
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Learn moreHi, quick question.
Doesn't duration measure price change in percentage? So, if GM 10s tighten by 60bps, doesn't it mean the price will increase by 4.8%, not by absolute dollar amount unless it' s trading at par ?
Yup you are right
It's more just macro - there is really no risk of default so no deep analysis really necessary.
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