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Friday Fixed Income

Five companies with toxic debt situations.

music selection:  “Solsbury Hill” — Peter Gabriel

Every Friday, I share something I’ve learned from research the fixed income space.  That is often a list of attractive Closed End Funds, or individual discounted bonds I think have a good risk to reward profile.  Other times, I share long or short equity ideas that my research has turned up.  Today, I’m looking to add short exposure to five companies that I think could find themselves in dire straights with a liquidity crisis preventing them from refinancing debt at attractive rates.

The first is Tenet Healthcare (THC).  This is a healthcare company with a market cap of about three billion dollars.  Amazingly, the company carries almost 15 billion in debt that is due in the next twelve months.  In the most recent full year, the company had Free Cash Flow (FCF) of 403 million.  At the same time, interest expense was 1.028 billion.  The most recent quarter looks pretty ugly too.  FCF was 223 million while interest expense was 254 million.  This is a company that cannot afford to both pay its bills and maintain its facilities.  If they can get replacement financing at all, the interest rate will likely be punitive.  Look for the company to sell assets or dilute shareholders in the coming  year.  Their finances are that desperate.  I have purchased the 20 strike long put with 17JAN2020 expiry for 2.15 a share to gain exposure to a collapse in share price.

The next is General Motors Company (GM).  The big three automaker didn’t learn its lesson about excessive debt from its 2008 disaster.  The company continues to hampered by crushing legacy pension obligations.  Most importantly, sales are largely driven by sales to sub-prime credit.  Subprime credit expansion is going be the theme of this these and the next three as well.
Nearly 40% of the $1.1 trillion in auto loans outstanding is to less-than-prime borrowers. Of that, more than $200 billion is subprime.  Experian reports new subprime loans are down 2% in the last year and deep subprime is down a massive 6%.  Credit is tightening and GM is going to lose its source of critical revenue.  Look for things to get really bad for subprime lenders (and industries that rely on subprime borrowers for sales) when the yield curve inverts.  The spread between the two and ten year treasury is already down to a mere 24 basis point putting an enormous amount of pressure on subprime lenders.  When the dominoes start to fall, look for GM to be looking for another government bailout.  I have positioned myself to profit from another collapse in GM share price by buying the 35 strike long put with 17JAN2020 expiry for 3.65 a share.  My puts are already in the money.

A similar story is brewing with Ford Motor Company (F).  I won’t rehash the subprime story except to say F is also heavily dependent on subprime lending for sales.  When credit liquidity dries up like it always does in a crisis, Ford will be deeply unprofitable and facing payments on over 150 billion in long term debt.  Margins have already been falling for some time and the company has already thrown in the towel on passenger cars in North America.  They won’t build them anymore as they have found they simply can’t turn a profit on those models.  My play has been to buy the 7.87 strike (the odd strike price is the result of Ford paying a special dividend) long put with 17JAN2020 expiry for 47 cents a share.  My puts are a mere 17% out of the money and I think F could fall much further by then.

Turning to banking, I am going short Capital One Financial Corporation (COF).  COF has the most exposure to subprime credit card debt of all the big banks.  Of its roughly 250 billion loan book, about 40% is credit card debt.  More than a third of the borrowers are sub-prime.  When the economy gets tight, credit card repayment rates fall like a rock.  Capital One should know this better than anyone.  They got hammered in the 2008 financial crisis when credit card losses led the stock to fall from around 83 dollars to 8 by 2009.  Rising interest rates are putting the breaks on the economy while squeezing the company’s margins.  Any economic turbulence will see them experiencing massive losses.  I intend to take advantage of their precarious position and have purchased the 70 strike 17JAN2020 expiry puts for 2.15 a share.  My puts are currently 29% out of the money but could move deeply in the money quickly.

Finally, I am in the market to add short exposure to Santander Consumer USA Holdings Inc. (SC).  Santandar is holding the opposite side of the deal from GM and Ford.  They are a huge subprime and even deep subprime auto lender.  At first blush SC has a great business.  They borrow under 4% and lend at an average rate of over 16%.  But recently, cost of funds has been rising while net interest margin has been declining.  It is a troubling trend.  The company is sitting in the crosshairs of the Federal Reserve.  We are in a rising interest rate environment and this is going to pinch margins.  There is another big problem.  Santandar has a partnership with Fiat Chrysler and finances 28% of the automaker’s US sales.  But Fiat wants to exit the partnership and do its finance in house.  This is the catalyst that can send Santandar into a tailspin.  I have a 2.75 limit order in place for the 20 strike long put with 17JAN2020 expiry.  The contract has recently been trading over 3 dollars after seeing some recent interest.  I expect it will come down in a few weeks.

Devour your prey raptors!

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