Irish ‘junk bond’ devotees get houses in order as market sours

Cardboard box-maker Smurfit Kappa has been one of the darlings of the Irish stock market over the past two years, with its shares rising almost 120 per cent from their March 2020 lows – when Covid-19 sent health systems and the global economy into shock.

The group’s recent full-year results provided justification for believers. Demand for its cardboard jumped 8 per cent last year – a multiple of the typical rate of 2-2.5 per cent over the past decade – as online shopping took off during lockdowns, and the pandemic,, rather than slowing a shift from plastic to more sustainable packaging, turbocharged the trend.

"Very few of our 65,000 customers are not working on, or thinking about, projects that require our innovation to move them away from non-sustainable packaging," Tony Smurfit, chief executive of the group founded by his grandfather, told analysts on a call last week. "The opportunity is truly immense."

Although the company believes that volume growth will moderate to 3-4 per cent this year, it will remain above the long-term trend. And while Smurfit Kappa had to suck up €657 million of extra costs last year for recycled cardboard and energy – with more to come in 20220 as inflation continues to sweep through the global economy – it reckons it will be able to continue to pass it on to customers.

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Cantor Fitzgerald stock analyst Ian Hunter sent a bullish note to clients in recent days highlighting that there may be more to go for the stock, with his €55 price target pointing to about 13 per cent upside.

But another breed of number cruncher has been charmed most by Smurfit Kappa in recent times: analysts at some of the world’s most influential credit ratings agencies.

The group had been happily trading and issuing billions of euro of debt for almost two decades in the speculative so-called “junk” or “high-yield” bonds market before its move in late 2020 to raise €660 million in a share sale to bolster its balance sheet and fund investments prompted a rethink.

Fitch, Moody's and Standard & Poor's have each raised their ratings on Smurfit Kappa since then to the lower echelons of what is perceived as investment grade. Having regained this status for the first time since its predecessor, Jefferson Smurfit Group, was subject to a debt-fuelled $3.5 billion (€3.1bn) takeover in 2002 by US private firm Madison Dearborn, the company is not planning to let go.

Developments

"With a strong business profile and our ability to consistently deliver substantial free cash flow, the group is aiming to maintain investment-grade credit ratings," chief financial officer Ken Bowles assured analysts last week, noting that it plans to keep its borrowings at between 1.5 and 2 times earnings before interest, tax, depreciation and amortisation.

Recent developments in global bond markets suggest he is right. While the market interest rates – or yields – attached to all types of bonds have risen on both sides of the Atlantic in recent months, amid speculation about the pace at which central banks will hike official rates and wind down bond-buying programmes, the speculative high-yield debt market has borne the brunt.

Investors have pulled almost $17 billion (€15bn) of out US junk-bond funds over the past six weeks, the most since early 2020, when financial markets were in panic mode, according to figures from financial markets data firm Refinitiv Lipper.

Highly-indebted companies have also become more concerned about the reception they might get. Only $32 billion of junk bonds have been sold so far this year in the US, far the world's most active high-yield market, down from $73 billion issues by this time in 2021, according to Bloomberg.

A Bank of America index that tracks yields pool of US junk bonds rose to 5.6 per cent this year, from 4.3 per cent at the end of last year.

The effective yield on a similar index for US investment grade bonds is just over 3 per cent. A Bank of America gauge for risky euro area corporate bonds has risen by 1 percentage point so far this year to 3.8 per cent.

Still, bizarrely, yields on these speculative bonds have been below general inflation rates since last year as levels of highly-indebted companies reneging on debt in both markets languish at record lows – thanks, largely, to the trillions of euro that central banks and government have pumped into the global economy during the pandemic.

But how long can that last? The unprecedented level of temporary stimulus has only delayed defaults in many case. The risk is that yields on speculative grade bonds are headed in one direction for the foreseeable future, making it more expensive for companies to refinance.

Players

Fortunately the two biggest Irish players in the junk bonds market in the past two decades – Paul Coulson of glass and metal packaging beast Ardagh Group and Denis O'Brien's Digicel – have been working on easing their debt burdens of late.

Ardagh has used cash raised from the spin-off of its drink cans unit, Ardagh Metal Packaging, on the New York Stock Exchange last year to pay down some of its most expensive debt. A reported plan by Ardagh and a Canadian teachers' fund plan to put their food and speciality metal cans joint venture on the market this year could provide another route to chip away at its debt pile.

Still, with a holding company at the top of the corporate tree sitting on $7.4 billion of net debt at the end of last September, it will remain well entrenched in junk territory.

And while Digicel’s creditworthiness remains deeply challenged as a result of two debt restructuring years – with bondholders forced to write off $1.6 billion of its debt in 2020 to prevent likely liquidation – O’Brien plans to use most of the $1.85 billion being raised in a sale of its Pacific unit to pay down its $5.3 billion of debt.