Some European industrial junk credits are now trading above par while others remain in the high 80s and 90s, a disparity that has high-yield pros disagreeing about whether credit issues or technical factors are driving the prices. "It is all technical," argues David Newman, high-yield research analyst for Salomon Smith Barney in London. He points to the fact mutual bond fund inflows into the U.K. market hit $644 million for last week. With few new issues, those flows tend to head toward recognized names. "There are the largest inflows since June, 2000," he adds. Credits such as Alfa Laval, Grohe Holding, Ineos Acrylic and William Hill are trading around 106, while BSN Financing and Isco .are in the low-90s. Frank Ferrantelli, head trader for CIBC World Markets in London, sees the trading opportunities, as does Newman, who believes the reason for the trading disparity is because investors are flocking to familiar names in reaction to the volatile fourth quarter of last year. He points out that the similarly rated Premier Foods' 12 1/4% notes of '09 (B3/B-) is yielding 13.9% while William Hill's 10 5/8% notes of '08 is yielding 9.75%. "Why not sell William Hill and buy Premier, taking out 12 points of money and a downward yield of 430 basis points?"
But in the U.K. investors don't know Alfa Laval or Grohe, says Martin Reeves, portfolio manager at Alliance Capital Management in London. He considers the market "absolutely rational. If the market was so irrational it would all be arbitraged away by now." Ratings are not the way to judge a credit, he adds, "There is a massive difference between the weaker and stronger credits, with about a two-times coverage ratio for William Hill but only a 1.8 times cover for Premier Foods." He adds that Isco is trading down simply because of credit issues: "Its equity price has dropped from $25 to $4 since July - there is obviously a reason for that. The company keeps disappointing recently while others in the industry are beating expectations."
A New York buyside trader believes the market disparity is a function of "The higher quality names just catching the bid first, and the second tier is only now catching up." Investors will start selling the top tier names as they become too rich, and start buying the bottom names, providing an eventual equilibrium. "People are going to start selling the more expensive names soon," adds the trader, and the situation now is reminiscent of a few years back, "when names like Jazztel were trading around $180-their warrants alone getting between $60-80. But back then it was a function of the strong equity market, and now is a similar situation, just without the big stock market boost."
Another bulge bracket trader in London says the reason for the rally on certain names is because they issued paper with high coupons because the market was unhealthy, and now that the market is looking better, the paper has rallied. He points to paper such as Grohe and Alfa Laval, that have coupons around 12%, versus Isco or BSN, whose bonds have a coupon of 10 5/8% and 101/4% respectively. "This is just a duration play." Newman doesn't buy into this argument, "Look at overall yield, not coupons. Grohe is trading around 108, so its yielding significantly less than BSN."
