As interest rates continue to rise, there is increasing anxiety in financial markets about the possibility of some kind of credit event.
The Financial Times has assembled a list of more than 200 companies that it calls “debt monsters in the downturn”, whose debt is trading more than 10 percentage points or 1,000 basis points above government bonds.
That means the market may be concerned about the possibility of some of these companies defaulting on their debt.
FT’s list features seven Canadian companies.
by Naimul Karim and Denise Paglinawan, Financial Post
Seven Canadian businesses have made a list of global companies that debt markets appear to be concerned about as central banks raise interest rates to tackle inflation.
Compiled by the U.K.-based Financial Times and dubbed the “debt monsters in the downturn,” the report lists just over 200 companies and includes Canadian miners Iamgold Corp., New Gold Inc. and Taseko Mines as well as other Canadian firms such as Telesat Corp., Gran Tierra Energy Inc., Ensign Energy Services Inc. and Husky III.
To assemble the list, the FT screened Ice’s Global High Yield index for companies with debt trading more than 10 percentage points or 1,000 basis points (bps) above government bonds, as of Sept. 9.
A wider yield spread can indicate that the market perceives a greater risk of default associated with a bond issue.
“Scores of debt-laden companies suddenly face the uncomfortable prospect of trying to service higher interest bills with crimped cashflows,” the FT report said, though it cautioned that making the list, which did not account directly for the volume of debt each company carried, was by no means a death sentence.
“Consider this as a tour of businesses that debt markets are fretting over, rather than a collection of condemned companies,” the report said.
The majority of the Canadian companies on the list were in the resources and energy space and on the lower end of the spread spectrum.
A number of these companies have had to spend more on operations due to rising prices and posted weaker-than-expected results in the second quarter.
Recently, the Bank of Canada raised its policy interest rate by 75 basis points to 3.25 per cent and signalled that more rate hikes could follow in an ongoing effort to stamp out decades-high inflation.
Broadly speaking, as interest rates have climbed, companies have missed out on growth opportunities, suspended expansion plans, faced supply-chain disruptions and are encountering challenges in refinancing their debt at reasonable rates, said Peter Adu, vice-president and senior credit officer in the corporate finance group at ratings service Moody’s.
“How an issuer can handle rising interest rates depends on the industry it operates in and resulting contagion risk, and the issuer’s rating (i.e. investment grade or speculative grade),” Adu said
He added that bond prices have fallen due to the inverse relationship with interest rates and that the issuance of bonds in general has declined due to lower borrowing interest.
Eric Beauchemin of DBRS Morningstar, who declined to address the companies on the list directly, said that while rising rates can pose problems, it’s not typical for the whole debt burden of an issuer to come all at once.
“This means it’s going to take a while before higher rates are fully reflected in the debt structure of most issuers,” he said, adding that inflation in itself is a bigger risk at squeezing margins in many sectors, which can have a faster impact on credits than rising rates.
Beauchemin said that the rating agency has been keeping an eye on things amid rising rates but doesn’t anticipate a wide range of negative rating actions at the moment.
Adu, who covers telecom and satellite companies including Telesat, believes that the sectors are “relatively stable” despite the “slowing macroeconomic environment,” as they don’t have any liquidity issues and generate good cash flow.
“My telecom companies have mostly fixed-rate debt so the impact of rising interest rates is not immediate.
They will be exposed when they have to refinance maturing debt but they should absorb the impact well because they have excellent liquidity,” he said.
In response to the report, Toronto-based New Gold, which traded at 1,066 bps above government bonds according to the list, said that it maintained “a very healthy balance sheet with no debt due until 2027” and that it expects a “meaningful increase in gold production” during that time.
Iamgold, at 1,852 bps, which has operations in Suriname, Burkina Faso, Mali and Canada refused to comment on the report.
In August, the company said that it would need more funding to complete its Cote Gold project in Sudbury and also reported higher capital and operational costs for the project than some analysts’ expectations.
Taseko Mines, at 1,036 bps, wasn’t immediately available for comment.
The Vancouver-based miner reported what one analyst described as “significantly weaker” results than analysts had been expectating in the second quarter in August as it mined lower-than-expected copper grade from its Gibraltar mine in British Columbia and missed analysts’ production and financial targets.
According to Bank of Nova Scotia analyst Orest Wowkodaw, the miner exited its second quarter with a higher net debt position of $356 million as opposed to $308 million in the first quarter of this year.
Calgary-based Gran Tierra, at 1,099 bps, said it isn’t concerned about its current debt level as the oil and gas exploration company benefits from strong commodity price environments.
The company said it’s taking advantage of current strong oil prices and is following through on its plan to allocate free cash flow towards debt.
“Gran Tierra’s net debt to EBITDA is under 1X, which is well below the historical average for the industry, we have no near-term maturities and are very comfortable with our cash flow profile,” it said in an email.
Ensign Energy, at 1126 bps, which did not respond in time for comment, reported having almost $1.4-billion in long-term debt, net of cash, during its second quarter earnings report in August.
The oilfield services provider has said it anticipates to incur a final loss this year, before generating positive profits in 2023.
Telesat, at 1,791 bps, also was not available for a comment. The company’s operating expenses increased in the second quarter, which it said was partly due to its reversal of a bad debt provision in the first quarter of 2021.
The Ottawa-based satellite communications company reported about $3.7-billion in long-term indebtedness in the most recent quarter.
Husky III, at 1,200 bps, which controls Husky Injection Molding Systems Ltd., also failed to provide a comment.
The company is no longer publicly traded.
Numerous Chinese real estate companies such as China SCE Group and Greenland Global Inv. and two Ukrainian companies topped the FT’s list, with extreme spreads over government debt.
Other recognizable names on the list included U.S. meme stocks Bed Bath & Beyond at 5,464 bps and AMC Entertainment at 1,339 bps; work-sharing outfit Wework at 2,036 bps; Macau-based gambling giant Wynn Macau at 1,087 bps and the U.K.’s Pizza Express at 1,004 bps.
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Image: Corporate Finance Institute