Watch out for issuers with cash, says Morgan Stanley

High yield companies are hoarding increasing amounts of cash, notes Morgan Stanley analyst Jocelyn Chu, in the bank’s latest Leveraged Finance Insights report. She calculates that US high yield companies have increased their cash balances by almost 30% in the past year to $141 billion, as they strive to rebuild balance sheets and worry about liquidity.

But management teams are not paid to sit on cash, she notes, and holding cash that earns near zero in interest is not an efficient use of corporate balance sheets. Therefore, expect high yield companies to start spending it soon, on a mixture of resumed capital expenditure, debt repayment and payments to equity investors. 

The most likely companies to use cash to reduce debt are those with higher than average leverage that have maintained their capital expenditure. Many chemicals and energy companies fall into this category.

A second group of companies are those which, like the first group, have maintained capex but which are less leveraged. These companies are the ones most likely to increase equity distributions or buy back shares. Several metals, mining and utilities credits are in this group, as well as a company such as NRG Energy, which has lower leverage than its peers at 3.4 times. The management of this company, whose credit default swap trades at 535 basis points, has sent strong signals that it favours equity-friendly uses for its cash.

Companies that have underinvested in capex are the ones most likely to increase it again, and those with relatively low leverage are seen as most likely to engage in M&A activity. Candidates for increased capex and/or M&A spending can be found especially in the paper/packaging, telecoms and technology industries, according to the report.

Those companies that are highly leveraged but which have not maintained their capex face tougher choices than most. An example is chemicals name Huntsman, which is eight times levered. Managers of the company, which trades at 550bp in the CDS market, have indicated that they may use their now $1.5 billion of cash to pay down debt. But Morgan Stanley believes that with recovering customers now starting to rebuild inventories, Huntsman’s cash is more likely to be diverted away from debt reduction in favour of capital spending.