European high yield: refinancing risks looking more manageable
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European high yield: refinancing risks looking more manageable

Key takeaways:

  • We continue to forecast moderate earnings growth for FY24 and see an overall healthy cash flow picture
  • The average cost of debt is expected to increase by 100bps, but a recent market rally in underlying yields is helping keep levels manageable in aggregate
  • Sector breakdowns show TMT, gaming, and travel and leisure holding up well, but real estate and parts of basic industry continue to struggle. Healthcare’s growth trajectory is expected to return in the latter part of 2024 but from earlier lowered growth expectations.

Moving out of FY2023 and into 2024 we expect European High Yield (EHY) market revenues and EBITDA (earnings before interest, taxes, depreciation and amortisation) growth to improve. In aggregate, we forecast EBITDA growth of 2.6% in FY23 and 6.7% for FY24. Net leveraging is expected to be stable for the remainder of FY23 with deleveraging returning in FY24.

Free cash flow (FCF) and interest coverage are expected to remain healthy through the year, although we expect interest coverage to decline due to higher funding costs. Overall, we forecast the average cost of debt across our coverage universe to increase to 4.9% in FY24, versus 3.8% in FY22, reflecting refinancing activity at significantly higher rates.

While we expect refinancing activity to continue to put upward pressure on financing costs, the recent rally in core yields has helped mitigate this risk to a level that looks manageable in aggregate.

Applying a circa 100bps increase to 2024 cost-of-debt as a proxy for prevailing BB/B yields, this would still leave relatively healthy mid-single-digit FCF/net debt levels.

Sector commentary

Basic industry The demand picture across a number of key construction and consumer end-markets continued to deteriorate over the course of 2023, resulting in an extended destocking cycle and significantly reduced operating rates for the Chemicals and Building Products sectors. This has driven reduced FY23 forecasts versus our mid-2023 view and we now expect earnings to remain depressed through to mid-2024.

 

Automotive 2023 was a solid year for the auto sector as Covid and supply-chain constraints eased and raw material cost inflation abated, supported by continued strong demand. The order backlog and level of consumer demand should ease in 2024 and this is reflected in lower but still positive growth versus 2023. Cost restructuring plans and recoveries, declining raw materials and production normalisation should support auto supplier EBITDA in 2024, which in turn should support marginal deleveraging. Uncertainty remains over consumer discretionary spending and the cost of automotive financing and forecasts may be too constructive if rates remain elevated in 2024. The dominance of high-quality BB names, strong liquidity and significant refinancing completed before 2023 has capped financing costs.

 

Healthcare Overall, we have lowered our growth expectations for the sector driven by reduced demand in the testing and labs segments. We expect a return to double-digit growth for the sector in FY24.

 

TMT The sector is still expected to have a relatively stable earnings development, reflecting our view that cost inflation can ultimately be passed through via relatively modest price increases, which are by and large now being implemented across the sector. As a result we expect to see margin recovery in 2024 and related EBITDA growth. With capital expenditure pretty much at peak, it should help drive some deleveraging across the sector in 2024.

 

Gaming The sector has shown strong resilience to any concerns over a consumer downturn, and growth – albeit slowing – should continue into 2024. M&A continues to be accretive to financials with generally strong FCF supporting deleveraging, which remains a focus for gaming management teams. Bond maturities tend to be longer dated but a recent issue saw strong demand, mitigating a substantial step up in financing costs.

 

Travel and leisure Gyms have experienced a marked recovery post-pandemic and have been investing cash into network expansions. Thanks to this, membership levels have continued to grow while inflation pass through has increased per member yield. In recent months, the sub sector has outperformed expectations with no sign of deterioration into 2024. In travel, the pent-up demand continues to further boost revenue and profits into 2024. Names with the longest booking cycle, such as cruises, are trending even better than we saw for 2023.

 

Retail Food retail continued to deliver fairly robust sales growth in 2023, driven by high inflation and offset by softer volumes. For 2024 we expect growth to moderate towards the lower single digits, while EBITDA margins are expected to modestly improve (typically by around +20bps). For the rest of retail, sales growth for 2023 is now expected to be better than our previous forecast as the consumer has remained resilient despite inflationary headwinds. This has been particularly true for issuers focused on travel retail and beauty/cosmetics. The one weaker than expected area has been luxury furniture (International Design Group) which has seen sales growth turn negative and margins come under pressure. We expect a continuation of these trends in 2024.

 

Real estate While much of the real estate sector has benefitted from the more constructive interest rate outlook, we remain cautious on highly leveraged high yield issuers. Net leverage remains very high (in the mid-20s for some companies) – albeit forecast to decline. Similarly, interest coverage remains very low, forecast at 1.9x in both 2023 and 2024. Companies are still generally benefitting from largely fixed rate capital structures which are yet to reflect the impact of higher rates. For the most part, these structures would be unsustainable if they had to refinance today. More positively, underlying operations are generally expected to remain solid across the coverage universe with low vacancy rates and continued like-for-like rent increases.

 

 

23 January 2024
Tom Southon
Tom Southon
Senior Analyst, High Yield
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European high yield: refinancing risks looking more manageable

Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.
In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.
In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香 港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.
In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.
In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.
In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.
In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market
Supervisory Authority (FINMA).
In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.
In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.
In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香 港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.
In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.
In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.
In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.
In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market
Supervisory Authority (FINMA).
In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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