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UPS Packages ‘A’-Rated Bond As U.S. Corporates Deliver Yield

By:

Senior Market Analyst at Interactive Brokers

Investment-grade corporate bonds continue to attract investors despite recent market volatility, with a healthy slate of new supply continuing to satiate still-healthy risk appetite.

Bond investors have generally retained their interest in higher-quality corporate debt, while ongoing and escalating trade-related risks between the U.S. and China have spurred a plunge in U.S. Treasury yields.

For the week ended August 7, Thomson Reuters/Lipper U.S. Fund Flows reported a net inflow of roughly US$2.8bn into investment-grade corporate bond funds, while riskier, high yield funds saw net outflows of nearly US$4.1bn.

The yield on the 10-year U.S. Treasury note was bid at about 1.674% intraday Tuesday— a more than 33 basis point-wide inversion from the 3-month bill, which was trading at roughly 2.008%. 

Moreover, high-grade corporate debt continues to lure global investors to the yield offered in the U.S. primary market – especially among those bond buyers who have been priced out of their local markets or have a dearth of available paper.

The yield on the 10-year German Bund, for example, has fallen to a low of around -0.613%, while the Swiss, French, Dutch and Swedish 10-year bond yields are all below zero.

In fact, the entire yield curves of Germany, Switzerland, France, The Netherlands and Sweden have all turned negative.

‘A’-rated, long-dated debt at risk

Meanwhile, analysts at Barclays recently noted that the demand for long-dated U.S. debt “could come under pressure more broadly, with the precipitous decline in yields weighing on insurance/pension flows.”

Barclays observed that industrial 10s30s curves have steepened this year, but while ‘BBB’ curves are steep from a historical standpoint, the ‘A’ curves are not. In fact, they said, “adjusting for the level of yields, ‘A’ 10s30s spread curves appear flat.”

As a result, Barclays added that ‘A’-rated long-dated debt is “most at risk of widening from declining yields.”

UPS’s ‘A’-rated deal

Against this backdrop, Atlanta-based courier United Parcel Service (NYSE: UPS) was set to sell Tuesday around US$1.5bn worth of ‘A’-rated notes in three parts, amid a more upbeat risk-taking tone.

UPS said it intends to use the net proceeds of the sale to make early contributions to certain of its primary domestic pension plans, as well as to repay commercial paper and for general corporate purposes.

The offering was being co-lead managed by BarclaysGoldman Sachs, Morgan Stanley and Wells Fargo Securities. Early indications of price spreads on UPS’s proposed 5-, 10- and 30-year tranches were in the areas of 90bps, 110bps and 150bps more than comparable U.S. Treasuries, respectively.

Credit profile

Moody’s Investors Service assigned an ‘A2’ credit rating on UPS’s deal, with a negative outlook.

Moody’s noted that the company has historically maintained “aggressive governance regarding financial policies, with free cash flows being directed entirely to share repurchases and no cushion for significant discretionary contributions to its underfunded single-employer pension plans.”

Moody’s analyst Jonathan Root said the negative outlook “reflects what Moody’s believes will remain a challenging operating environment and the compounding effect of potentially material requisite pension contributions that will likely have to be debt-funded, even if share repurchases are further tempered.”

The ratings agency continued that UPS’s earnings and cash flows are likely to be adversely affected by ongoing growth in e-commerce that may lead to a greater proportion of lower-yielding e-commerce packages. Heightened competition is also expected to sustain pressure on yields across the company’s service categories, more broadly, and volume reductions stemming from weaker global economic growth are also anticipated.

Root added that trade friction between the U.S. and its various trading partners, and the effects on trade and consumer spending in Europe and the UK should a hard Brexit occur by the October 31 deadline, “will also pressure package demand, potentially for an extended period.”

The logistics giant has also been undergoing C-level management shifts following the release of its second-quarter of 2019 earnings results.

The firm said Monday it had installed Brian Newman, PepsiCo’s EVP of Latin American finance and operations, to replace Richard Peretz as its CFO, effective September 16, 2019.

Peretz said that “UPS grew profits across all business segments,” with performance “driven by the efficiencies created by investments in our network, the success of ongoing initiatives and our ability to execute in an ever-changing environment.”

UPS affirmed it aims to earn between US$7.45 to US$7.75 per share in the full-year 2019, with adjusted free cash flow expected in the range of US$3.5bn and US$4bn.

In Q2’19, the company earned adjusted EPS of US$1.96, with domestic daily volume growth of more than 7% and next-day air volume up over 30%.

Supply-side

UPS was joined Tuesday by several other investment-grade companies with new bond sales, including Exxon Mobil Corp (NYSE: XOM), as well as real estate investment trusts Regency Centers (NASDAQ: REG) and Brixmor Operating Partnership (NYSE: BRX).

To date this week, a total of a little more than US$11bn of fresh, investment-grade corporate bond sales priced, almost half the estimated US$26bn tally expected by most syndicate managers.

Ron Quigley, head of fixed income syndicate at Mischler Financial, also pointed out that among the deals in the pipeline, New York City-based risk manager Assurant (NYSE: AIZ) could bring a ‘BBB’-rated bond sale to market after having mandated J.P. Morgan and Wells Fargo to arrange fixed income investor calls that ended Tuesday.

Also, a ‘BBB’-rated, private placement from the Export-Import Bank of India may be in the works following a series of investor meetings in the U.S., Europe and Asia that began July 30.

In the meantime, select the Event Calendar option in the IBKR Trader Workstation for a full list of U.S. and global corporate events and earnings, dividend schedules, economic data, IPOs and more.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Disclosure: Author Security Holding: No Positions

The author does not hold any positions in the financial instruments referenced in the materials provided.

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