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Credit quality of Swiss issuers remains solid
Credit Suisse study: Swiss Credit Handbook 2014The ‘Swiss Credit Handbook 2014’ published today contains the credit profiles of the most important Swiss issuers and participants in the Swiss franc capital market. Assessments of the creditworthiness of the different entities covered by Credit Suisse credit analysts – comprising Swiss corporates, utilities firms, cantons and cities – are provided in the Handbook. It thus encompasses a wide range of borrowers that are not covered by major international credit rating agencies and also examines the outlook for selected issuer industries.
The global economy expanded by 3.0% in 2013, driven by good growth in emerging markets and steady growth in more mature economies. Although the rate of growth was stronger in emerging markets, these regions also experienced high levels of inflation and exchange rate volatility that had a significant effect on the earnings of a large number of global corporates.
Many Swiss corporates have a natural hedge against foreign exchange volatility due to the geographical diversification of their business. However, this volatility has a negative impact on earnings and, to some extent, on key credit metrics since the companies in question tend to hold their debt in major currencies. Overall, Swiss companies continued to report slightly positive revenue trends due to moderate global GDP growth, which remained slightly ahead of the global inflation rate. Companies achieved top-line growth through a combination of higher sales volumes and better sales prices, although revenues were adversely affected by negative foreign exchange impacts. Analysts in Credit Suisse’s Swiss Institutional Research team believe that this trend is set to continue.
The profit margins being reported by companies covered by Credit Suisse credit analysts in 2014 come close to the levels seen in the economic boom period before the financial crisis. The credit analysts have also identified cost factors – rather than revenues – as the main driver of these strong margins. Across all sectors, Swiss companies have focused in the past few years on implementing efficiency and cost measures in response to the slower pace of global economic growth. For the full year 2014, analysts expect to see another slight improvement in margins that is likely to be driven mainly by cost measures and not solely by growth. They also expect the efficiency measures and cost optimization programs already launched by companies in 2012 and 2013 to have an impact in the course of this year.
The current macroeconomic environment should further underpin revenue growth as Europe’s economy continues to recover. According to the analysts, North America should achieve growth that comes close to 2013 levels and emerging markets should continue to act as the main driver of growth among Swiss companies.
Ratings still under pressure in the utilities sector
The Swiss Credit Handbook now covers more than 100 issuers for the first time following the inclusion of five new corporates (CFT, Emmi, Mobimo, OC Oerlikon and Regionalspital Emmental) and four new public issuers (the cities of Geneva, Lausanne, Lugano and Winterthur) in the universe covered by Credit Suisse credit analysts. Since the last Credit Handbook was published in September 2013, there have been four rating downgrades and five rating upgrades. Apart from Aryzta, where debt-financed acquisitions pushed the company further into the lower-rated investment grade universe, all downgrades related to the utilities sector. BKW and Repower were downgraded due to industry challenges resulting from persistently low electricity prices. As a result of the BKW downgrade, Kraftwerke Oberhasli's rating was lowered. In contrast, Galenica and Georg Fischer were upgraded following a consistent improvement in their key credit metrics. In the public sector, the Cantons of Vaud, Thurgau and Uri now have higher ratings thanks to their renewed solid financial performance.
The outlook for Nobel Biocare and Bobst improved to stable from negative as their businesses stabilized. The outlook for the Canton of Basel-City has changed to stable from positive since its financial results for the full year 2013, as well as its budget for 2014 and its medium-term financial plans, have not indicated any further improvement in its financials. The rating outlook for AFG is now negative as the restructuring and repositioning of the company – combined with various management changes – are proving more difficult than previously expected. If the company is unable to achieve a swift turnaround and to successfully reposition itself in the current market environment, it will stand to lose its investment-grade rating. The outlook for Holcim's rating is now negative in view of the proposed merger with Lafarge. Although beneficial for the profile of the business, this merger could negatively affect Holcim’s financials due to Lafarge's weaker credit metrics, as reflected by its sub-investment grade rating prior to the announcement of the merger with Holcim. The merger will be a complex and lengthy process, and there is still some uncertainty regarding the level of proceeds that will be generated by the transaction and their intended use. In the public sector, the outlook for the Canton of Appenzell-Ausserrhoden is negative after another year of financial pressures and expected budgetary challenges. In contrast, the outlook for Roche's rating has changed to positive from stable in view of the continued strong generation of cash flows and its increasingly healthy balance sheet.
Strengthening M&A trend
While central banks are keeping interest rates low and investors are searching for yields, a revival in mergers and acquisitions (M&A) activity may soon be on the horizon. As a result of several very large deals in the pharma, telecoms and media sectors, M&A volumes for the current year have reached a high level although the actual number of transactions remains on a par with recent years. The proposed merger of Holcim and Lafarge is one of the largest deals in the Swiss corporate sector over the past 12 months in terms of market capitalization. Novartis has also announced a multiple transaction with GSK under which it is planning to acquire the latter's oncology business and to sell its own vaccines business to GSK and its Animal Health division to Eli Lilly. Other larger-scale transactions include the acquisitions of Sulzer Metco by Oerlikon, Russell Stover Candies by Lindt and National Suisse by Helvetia Insurance. In addition to these major transactions, several companies have engaged in bolt-on acquisitions to improve their market position and to thus expand their existing product portfolios or access new regions. Various divestments were made as part of the repositioning of companies, while others were intended to deleverage company balance sheets in order to improve credit metrics. The largest transaction of this kind was the USD 7 billion sale of Las Bambas by Glencore, followed by various smaller deals such as the sale of PowerBar by Nestlé and various disposals by firms including AFG, Valora and Clariant. Holcim will also have to divest part of its business due to regulatory restrictions following the proposed merger with Lafarge. As companies are sitting on large cash reserves and interest rates remain at record-low levels, Credit Suisse credit analysts believe that M&A activities are most likely increase over the next one to two years.
Stable trend in credit quality expected
The companies covered by Credit Suisse analysts are likely to continue focusing on their previously launched efficiency and cost optimization programs in the absence of strong growth. Profitability margins should thus improve slightly – also moderately benefiting cash flow generation. Since capital spending by companies will probably remain at the same level as in 2013, the analysts expect to see an improvement in key credit metrics and anticipate that companies will therefore pursue their plans to seize acquisition opportunities or to increase their focus on shareholders by paying out higher dividends and/or launching share buyback programs. According to the Credit Suisse study, it is to be expected that most of the companies will remain within their current rating categories, as indicated by the 91 stable outlooks out of a total of 102 ratings. There are nine negative outlooks (four utilities firms, three corporates and two public issuers) and two positive outlooks (one corporate and one public issuer).
Credit spreads as tight as it gets
Credit spreads in Switzerland have tightened further and valuations are almost back to the levels seen before the financial crisis. While macroeconomic uncertainties have impacted on spreads for some issuers in the CHF foreign segment recently, the CHF domestic segment has remained very solid. Although Credit Suisse analysts do not see potential for a further tightening of credit spreads, they continue to take a positive view with regard to valuations. The recommendation to stay invested in lower-rated corporates remains in place but the analysts highlight the clear need for a detailed credit assessment of these issuers, since not every lower-rated corporate automatically offers an attractive yield. The sentiment on subordinated debt for Swiss insurers and banks is still positive, thus implying some outperformance potential compared to senior bonds. Credit Suisse analysts also recommend investing in corporate hybrid bonds from Swiss issuers that are rated as at least investment grade on a senior level. Swiss utilities continue to offer the widest spreads among corporates. Although spreads have tightened in line with expectations, some individual investment opportunities may still be found despite increased pressure on credit quality in the energy sector.
About the Swiss Credit Handbook
The Credit Suisse Swiss Credit Handbook has provided an overview of the credit quality of key Swiss issuers in the Swiss franc capital market for the past 12 years, thus making an important contribution to investment decision-making processes in the Swiss economy. The aim of the Swiss Credit Handbook is to cast light on the credit standing of Swiss issuers in the Swiss franc capital market. The study examines the creditworthiness of the largest Swiss bond issuers and main participants in the capital market based on a structured assessment. The Credit Handbook includes all of the entities covered by Credit Suisse credit analysts (53 corporates, 17 partner plants, 26 cantons and 6 cities) and thus encompasses a wide range of borrowers that are not reviewed by international credit rating agencies. Using various rating methodologies, the analysts assess the credit profile of and the outlook for each issuer and subsequently assign them a credit rating. The Swiss Credit Handbook also contains general facts and figures relating to the Swiss bond market and is thus targeted at all investors and financial market participants seeking detailed information about the current development and creditworthiness of Swiss capital market borrowers.
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