When the economic cycle reaches the point where corporate earnings are plunging, hundreds of companies will come under closer scrutiny and often become distressed. Investors who get in around the low point will realize huge gains. The trick, of course, is figuring out which pose the risk of bankruptcy and which do not.
Distress currently stands at a low level in the bond market, meaning there are few opportunities in low-grade corporate bonds today. The “good” news – for distressed bond investors, that is – is that financial distress is on the rise.
In this issue, we are recommending the bonds of a company that is bringing speed-of-light internet connections to much of America. If it does nothing more than avoid default, the bond will return 12% per year for the next six years.
Bank loans are becoming harder to obtain. Meanwhile, credit ratings on corporate bond issuers are improving. The freight train represented by credit tightening is hurtling down the track, but it hasn’t arrived at the station yet.
As escalating default and bankruptcy rates make bond investors increasingly risk-averse, we can expect to see a growing number of basically sound companies’ bonds trading at depressed prices. And that means opportunities for distressed debt investors will increase materially over the next year.
Most investors believe the Fed is done or nearly done with its inflation-fighting interest rate hikes – and so far, no recession is in sight. That means perceived risk will remain subdued in the high yield bond sector… for now.
The bond we’ll introduce today is trading at a 16% discount to par. The parent company was extremely profitable until the pandemic derailed its business. Now, three years removed from the pandemic, the company is turning a corner and on its way to becoming extremely profitable once again.
Corporate bankruptcies are running at their highest rate since 2010, the year after the Great Recession. As defaults rise, investors will likely become more cautious about taking credit risk and it should become easier to find attractive values in lower-quality bonds.
The company we’ll introduce today is deeply distressed… a formerly solid business on the ropes through no fault of its own. The risks are high, but the profits will likely be higher.
In our view, the distress ratio is likely to double or triple from its current level by late 2023 or early 2024. And that means a crop of new distressed opportunities will soon arise.