High Yield: What the fundamental data tells us

Bernard McGrath, CFA, CAIA, Senior Investment Specialist Union Bancaire Privée, UBP SA

Key takeaways:

Fundamental high yield data are more constructive than market sentiment may indicate
Leverage is lower than average, interest coverage ratios higher and margins are expanding which all point to a relatively low default environment
UBAM - Global High Yield Solution offers investors a yield of 11.3%

In this note, we aim to look past the prevailing sentiment to analyse the fundamental data as regards the high yield market. We hope to show that high yield companies are in strong shape, with leverage low, interest coverage ratios high and margins strong, all arguing in favour of the asset class wherein UBAM - Global High Yield Solution today offers a yield above 11%.

Leverage is a key indicator for the healthiness of a high yield company’s balance sheet. More debt implies more risk, particularly as debt financing costs rise. However as illustrated below, Net Leverage remains contained and below the long-term average level

1 ubp high yield net leverage

Source: UBP, Morgan Stanley Research, as of 31.03.2022. Net Leverage is calculated as Net Debt / LTM EBITDA.

A second ratio closely followed by fundamental analysts is the Interest Coverage Ratio, calculated as Earnings divided by Interest Expense. In effect, it is the ability for the company to pay the cost of their debt based upon the earnings they are making. Interest Coverage Ratios today are very favourable for high yield companies and are towards the highest they’ve been since 1997, despite 5 year US Treasuries increasing 150bp in the past twelve months to 31.03.2022.

1 ubp high yield interest coverage ratio 2

Source: UBP, Morgan Stanley Research, as of 31.03.2022. Interest Coverage Ratio is calculated as LTM EBITDA / LTM Interest Expense.

In addition to high yield companies being able to service their debt, Earnings Margins are also very healthy. Looking at the long-term trend, high yield companies have continued to grow their Earnings Margins over the past decade. Interestingly, although inflation effects clearly impact margins, only two sectors recently recorded a drop in sequential quarterly Earnings Margin; Energy given the consolidation in commodity prices following the extremely strong rally, and Tech whose decline was modest.

1 ubp high yield earnings margin 3

Source: UBP, Morgan Stanley Research, as of 31.03.2022. Earnings Margin is calculated as LTM EBITDA / LTM Sales.

What this implies is that default levels in the high yield space are expected to remain relatively low, at c.2% in 2023. Despite the constructive fundamental data, due to the number of obvious risks to financial markets such as tightening monetary policy, Covid lockdowns, and the ongoing Russia/Ukraine crisis, high yield spreads have widened significantly. Today, for instance, UBAM - Global High Yield Solution, offers investors an 11.3% yield, the highest level since the fund’s inception in 2010.

1 ubp yield in usd since inception 4

Source: UBP, Bloomberg Finance L.P., as of 16.05.2022. Past performance is not a guide to current or future returns.