Asset Class Weekly - M*A*S*H: A Report About High-Yield Bonds

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Includes: ABX, AKS, AMD, APA, AR, ATI, AVP, BBEPQ, BDRBF, BTUUQ, CC, CGG, CHK, CLF, CLMT, CLR, CNQ, CNX, COP, CRC, CRK, CRZO, CVE, DNR, DPM, DVN, DYN, ECA, EPD, ESV, ETE, ETP, EXXIQ, FCX, FGP, GEL, GNW, HELIQ, HES, HK, HOV, I, IHRT, KMI, LINEQ, LPI, MEMP, MON, MPC, MPLX, MPO, MRO, MT, MU, NAV, NBL, NEM, NFX, NGL, NM, OAS, OKE, PACD, PDS, QEP, RIG, RRC, S, SD, SGMS, SJB, SM, SN, SSE, STX, SWN, SXL, TCK, TLN, TROX, UPLMQ, VIA, WIN, WLL, WMB, WPX, WPZ, X, XCO
by: Eric Parnell, CFA

Summary

We return to the war zone that is the high yield bond market.

Any signs of promise are more than offset by continued deterioration.

The energy sector remains at the heart of the battle, but others are at risk of being drawn into the conflict.

"We act insane, because if we didn't, we would most surely become insane." -- Hawkeye Pierce, MASH: A Novel About Three Army Doctors, 1968

It has been another month since my last report in January from the war zone that is the high yield bond market. At the heart of the conflict was and remains the embattled energy sector, which has seen its share of the high yield bond market shrink from over 13% to below 9% due to the heavy casualties inflicted on the sector by the precipitous decline in oil prices. But with oil prices having stabilized at least for the moment and now trading a few dollars higher in the low $30 per barrel range, it is worthwhile to survey the battlefront and check on the wounded to see if we can identify any signs of improvement or if the situation is continuing to deteriorate.

As we have before, we will begin by checking on the wounded that are most at risk in the high yield bond space. What companies have since passed our last walk through, and who is still hanging on.

The Wounded

In January, we had 12 publicly traded companies that were trading at a more than 75% discount to par following the bankruptcy of Arch Coal and the delisting of Penn Virginia. Since that time, we saw paper company Verso enter into bankruptcy, reducing the list of names from the previous group by one. Given the developments over the past month, it is now worthwhile to divide this remaining group of at risk credits into two separate units.

The first is the intensive care unit that includes those publicly traded companies that are now trading at a more than 90% discount to par. For these five companies, it is simply a matter of time at this point.

  • Energy XXI (NASDAQ:EXXI)
  • Linn Energy (NASDAQ:LINE)
  • Peabody Energy (NYSE:BTU)
  • Seventy Seven Energy (NYSE:SSE)
  • Ultra Petroleum (NYSE:UPL)

It should be noted that this seemingly terminal group is not without its notable names. Ultra Petroleum until recently ranked among the larger producers in its peer universe and is a name whose stock I had owned for a brief period a few years back. And Linn Energy was until recently a Seeking Alpha favorite prior to its descent.

What of the remaining wounded whose credits are trading between a 75% to 90% discount to par and are in dire circumstances in their own right? The following is the latest list of names working to hold on in the recovery ward. The latest wave of wounded arriving from the front line of highly stressed credits that were previously trading between a 50% to 75% discount to par are shown in bold.

  • Breitburn Energy Partners (NASDAQ:BBEP)
  • California Resources (NYSE:CRC)
  • Cliff Natural Resources (NYSE:CLF)
  • Denbury Resources (NYSE:DNR)
  • Exco Resources (NYSE:XCO)
  • Genworth Financial (NYSE:GNW)
  • Halcon Resources (NYSE:HK)
  • Memorial Production Partners (NASDAQ:MEMP)
  • Pacific Drilling (NYSE:PACD)
  • Sandridge Energy (NYSE:SD)

With the arrival of four new wounded names from the front lines, we now have ten names struggling for survival in addition to the five that are in intensive care for a total of 15 companies.

Let us now leave the high yield bond M*A*S*H unit and travel out to the front lines where the battle to overcome what has become chronically low oil prices rages on.

The Front Line

In January we had 19 publicly traded names on the front lines as defined by trading at a highly stressed 50% to 75% discount to their par value. As indicated above, three of these names have since been taken down and shipped to the high yield M*A*S*H unit. For those that remain, a number are likely to follow on a similar path. And the new arrivals including those that have now fallen from the second wave of trading at a 25% to 50% discount to par and have now joined the battle on the front line are shown below in bold.

  • AK Steel (NYSE:AKS)
  • CGG (NYSE:CGG)
  • CHC Group (NYSE:HELI)
  • Chesapeake Energy (NYSE:CHK) - Returned from M*A*S*H following debt restructuring
  • Comstock Resources (NYSE:CRK)
  • iHeart Media (OTCPK:IHRT)
  • Intelsat (NYSE:I)
  • Midstates Petroleum (NYSE:MPO)
  • Navios Maritime (NYSE:NM)
  • Oasis Petroleum (NYSE:OAS)
  • Sanchez Energy (NYSE:SN)
  • SM Energy (NYSE:SM)
  • Transocean (NYSE:RIG)
  • U.S. Steel (NYSE:X)
  • Whiting Petroleum (NYSE:WLL)
  • WPX Energy (NYSE:WPX)

It is worth noting that one name from the previous list managed to move back to the second wave following the recent completion of asset sales by PPL spin-off Talen Energy (NYSE:TLN).

The Second Wave - High Yield Bonds

As in the past, the second wave focuses on those companies whose debt is trading at a 25% to 50% discount to par. This first list focused on high yield bonds increased from 25 names in December to 32 in January. Two names as indicated above have gone off to the front lines, while one has returned. The following is the list of names getting ready for potential battle in trading between a 25% and 50% discount to par.

  • Advanced Micro Devices (NASDAQ:AMD)
  • Allegheny Technologies (NYSE:ATI)
  • Avon Products (NYSE:AVP)
  • Bombardier (OTCQX:BDRBF)
  • Calumet Specialty Products (NASDAQ:CLMT)
  • Carrizo Oil & Gas (NASDAQ:CRZO)
  • Chemours (NYSE:CC)
  • CONSOL Energy (NYSE:CNX)
  • DCP Midstream Partners (NYSE:DPM)
  • Energy Transfer Equity (NYSE:ETE)
  • Ferrellgas Partners (NYSE:FGP)
  • Genesis Energy (NYSE:GEL)
  • Navistar International (NYSE:NAV)
  • NGL Energy Partners (NYSE:NGL)
  • Laredo Petroleum (NYSE:LPI)
  • Oneok (NYSE:OKE)
  • Precision Drilling (NYSE:PDS)
  • QEP Resources (NYSE:QEP)
  • Scientific Games (NASDAQ:SGMS)
  • Sprint (NYSE:S)
  • Talen Energy
  • Targa Resource Partners
  • Teck Resources (NYSE:TCK)
  • Tronox (NYSE:TROX)
  • Windstream (NASDAQ:WIN)

Here we find some incremental signs of promise, as the number of names on this list has fallen back to 25, in large part for good reasons. Eight of the names that had been included in the second wave including Antero Resources (NYSE:AR), ArcelorMittal (NYSE:MT), Dynegy (NYSE:DYN), Hovnanian Enterprises (NYSE:HOV), Marathon Petroleum (NYSE:MPLX), Micron Technology (NASDAQ:MU) Newfield Exploration (NYSE:NFX), Range Resources (NYSE:RRC) have moved back off of this list. Granted, each are still trading anywhere between a 15% to 25% to their par value, but the fact that these names have not deteriorated further is a good sign. Moreover, no new names were added to this list in the past month.

The Second Wave - Investment Grade Corporate Bonds

In arguably the most worrisome development following last month's visit was the deterioration seen among investment grade bonds, as the number of companies on the second wave ballooned from 13 to 23.

First, it should be noted that Freeport McMoRan (NYSE:FCX) has departed from this list having since been downgraded to high yield status. The following that remain are those companies whose debt is trading at a 25% to 50% discount to par. New additions to the list below are shown in bold.

  • Apache (NYSE:APA)
  • Canadian Natural Resources (NYSE:CNQ)
  • Cenovus Energy (NYSE:CVE)
  • Continental Resources (NYSE:CLR)
  • Devon Energy (NYSE:DVN)
  • Encana (NYSE:ECA)
  • Ensco (NYSE:ESV)
  • Energy Transfer Partners (NYSE:ETP)
  • Hess (NYSE:HES)
  • Kinder Morgan (NYSE:KMI)
  • Marathon Oil (NYSE:MRO)
  • Marathon Petroleum (NYSE:MPC)
  • Monsanto (NYSE:MON)
  • Noble Energy (NYSE:NBL)
  • Seagate Technology (NASDAQ:STX)
  • Southwestern Energy (NYSE:SWN)
  • Sunoco Logistics (NYSE:SXL)
  • Viacom (NASDAQ:VIA)
  • Williams Companies (NYSE:WMB)
  • Williams Partners (NYSE:WPZ)

Unlike the high yield bond second wave that saw marginal improvement, the status of the investment grade second wave remains largely even over the past month. Four names moved off of the second wave in Barrick Gold (NYSE:ABX), ConocoPhillips (NYSE:COP), Enterprise Products Partners (NYSE:EPD) and Newmont Mining (NYSE:NEM), but all four are still trading at a 20% to 25% discount to par. Thus, they are off the list, but only barely. Moreover, two of the four that saw improvement over the past month were gold miners, which is good for these companies but not necessarily the areas where one would like to see improvement as a signal for broader economic confidence.

Bottom Line

Overall, conditions in the at risk high yield bond space continued to deteriorate further over the past month since mid January. While we did see pockets of marginal improvement among the middle of the road high yield credits found in the second wave, this was more than offset by the notable deterioration of conditions on the front line and in the M*A*S*H unit. Perhaps just as importantly, while conditions did not get worse among investment grade bonds that were recently showing signs of stress, they did not necessarily improve either.

With all of this in mind, investors remain well served to continue avoiding the high yield bond space for now outside of those that are inclined to undertake tactical inverse positions against the asset class through instruments such as the ProShares Short High Yield (NYSEARCA:SJB). Any such allocations to the SJB are not necessarily for more conservative investors and should be undertaken with great care and close attention to detail.

Overall, it appears that the high yield bond space continues to edge closer to a wave of bankruptcies that will begin the true cleansing process across the category. How far and wide this cleansing process spreads if and when it finally arrives remains to be seen. To date, it has largely been confined to the energy sector, but has been showing signs of spreading to other sectors in recent months. In addition, banks and other financial institutions are likely to take a hit depending on the severity of any such bankruptcy wave once it finally hits. But in the end, any such washout will ultimately be healthy for the sector and economy in general. Failure is part of the market system. And while it is painful to endure along the way, the process will leave those companies that survive in a stronger competitive position to compete and thrive into the future.

Disclaimer: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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