QVML - Healthy Credit Picture Ahead Of Potential Weakening
2023-03-29 03:27:00 ET
Summary
- We believe credit fundamentals should weaken in the unfolding environment, but to a manageable extent, given their strong starting point.
- Recent results show companies meeting lowered expectations with a slowing macro environment weighing on forward guidance.
- The dust of the banking upheaval should ultimately settle, and the cumulative effects of the Federal Reserve’s tightening cycle should become clear in time.
By Christopher M. Oshewolo
We believe credit fundamentals should weaken in the unfolding environment, but to a manageable extent given their strong starting point.
As management teams continue to work through the implications of banking stress in the late innings of a central bank tightening cycle, credit fundamentals remain a key anchor for investment grade companies. Based on our analysis of trailing 12 months’ data of S&P 500 companies excluding financials, corporate fundamentals continue to be characterized by healthy balance sheets with industrial credit metrics much improved beyond pre-COVID levels.
Recent results show companies meeting lowered expectations with a slowing macro environment weighing on forward guidance. Topline growth and margins have been moderating from historic highs but remain healthy. Notably, results in the retail sector show consumers trading down and seeking value in the face of still-elevated inflation, tighter financing conditions, and a cautious economic outlook. More broadly, a softening demand environment has reduced the pricing power of companies and constrained their ability to continue to pass through higher input costs to offset inflationary trends. As recent announcements of headcount reductions demonstrate, management teams are increasingly looking inward for opportunities to improve efficiencies and reduce costs in defense of margins.
In aggregate, the ability of management teams to revert to conservative financial policies in the face of challenging operating conditions is a well-practiced art, and we are already seeing signs of the playbook at work - share buybacks are beginning to decline as moderating demand and inflationary pressures weigh on cash flow generation. While we expect management’s conservatism to mitigate the impact of a downshift in demand on credit metrics, we do not expect it to be sufficient in preventing leverage from rising in an economic downturn. However, we note that a potential uptrend in leverage should be manageable given the strong starting point for corporate fundamentals. Prevailing volatility in the current environment and a weakening growth outlook should keep the pace of merger and acquisition activity modest and limit related incremental risk to credit fundamentals. Away from the aggregate picture, we anticipate some divergence in the evolution of credit metrics in the unfolding environment and will remain vigilant in surveilling idiosyncratic risks.
The dust of the banking upheaval should ultimately settle, and the cumulative effects of the Federal Reserve’s tightening cycle should become clear in time. While much remains uncertain, the implications for investment grade credit fundamentals should be manageable, as the payoff of a strong starting point.
This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice. This material is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Investment decisions and the appropriateness of this material should be made based on an investor's individual objectives and circumstances and in consultation with his or her advisors. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. The firm, its employees and advisory accounts may hold positions of any companies discussed. Any views or opinions expressed may not reflect those of the firm as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.
Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.
This material is being issued on a limited basis through various global subsidiaries and affiliates of Neuberger Berman Group LLC. Please visit www.nb.com/disclosure-global-communications for the specific entities and jurisdictional limitations and restrictions.
The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.
© 2009-2023 Neuberger Berman Group LLC. All rights reserved.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
For further details see:
Healthy Credit Picture Ahead Of Potential Weakening