Each quarter, we select a specific sector from our coverage and dive into the numbers to demonstrate how Cognitive Credit can be used to inform high-level analysis of a sector, quickly and easily. In our latest Sector in Focus piece we look at the Consumer Services space, according to the MSCI GICS system.
We start by examining the balance sheet positioning of Consumer Services as a whole, globally. Looking across the aggregate of US and European IG and HY, out of all 24 GICS (L2) sectors, Consumer Services has the third highest Adjusted Net Leverage at 3.9x, and the second lowest Interest Coverage ratio at 4.1x. This would seem to indicate that reactive to other sectors in the investment landscape, balance sheets in Consumer Services are more challenging and could be particularly vulnerable if operating metrics were to decline materially.
This trend appears in both the US and European credit universes individually – the combined US IG & HY market is shown below for illustration.
With this backdrop in mind, next we hone in on revenue trends for some of the more discretionary portions of US HY Consumer Services. As a proxy for this, we examine the aggregate of two L4 Sub-Industries: Casinos & Gaming and Hotels, Resorts & Cruise Lines. Of the 18 resultant companies, we take the top 10 (by revenue) for each metric.
Below charts a time series of year over year revenue change for this discretionary cohort within Consumer Services. This analysis shows that revenues have continued to grow positively since covid, but that the rate of growth has moderated substantially over the last 8 quarters, and has generally been declining towards zero as year over year comps get more difficult. Penn Gaming, Frittata, and Marriott Resorts recently saw LTM revenue growth tick into negative territory.
10 largest companies by revenue:
Next, we zoom in on gross margin trends for the same group. For most of the constituents, margins took a substantial hit during the pandemic, indicating potential vulnerability should the economic picture weaken for the consumer. Margins largely retook post-covid levels 6-8 quarters ago. From this recovered point, some names have shown early signs of weakness over the last several quarters, including Ballys, Boyd Gaming, Fertitta Entertainment, Penn Entertainment, MGM Resorts, and Hilton Domestic. That being said, gross margins for the space are mostly steady and yet to “crack” post Covid. Could those that showed a significant Covid trough be appropriate short candidates for investors with a negative view on consumer spending over the next 12-24 months?
Cross-market analysis like the above is easy with Cognitive Credit. Our Comparables feature offers a top-down view of all our fundamental data across our four coverage universes (European & US High Yield, and European & US Investment Grade), allowing you to find relative value opportunities across your markets, sectors and companies quickly and conveniently.
Putting aside likely corporate events at Caesars and MGM Resorts, this analysis reveals total net debt ticking up at Hilton Domestic, Marriott Resorts, Hilton Grand Vacations, and Penn Entertainment.
Finally, we attempt to contextualize the debt growth above against company operations by plotting LTM Free Cash Flow / Total Net Debt for each member of the cohort. This analysis highlights relative weakness at Penn Entertainment, Marriott Resorts, Fertitta Entertainment, and Caesars Entertainment.
Contextualizing this further by examining it against Adjusted Net Leverage, Penn Entertainment and Marriott Resorts continue to stand out as companies with higher potential credit vulnerability relative to others in the sector.
Next, we examine the tradable investment landscape for these names. A Market Screen is performed for fixed rate bond instruments within US HY, (L2) Consumer Services, (L4) Casinos & Gaming and Hotels, Restaurants & Leisure, with at least $400 million outstanding and maturity due within 4 to 8 years.
Ranking the resultant bonds by Z Spread, the analysis reveals Bally and Frtita have priced in the most significant level of credit stress, with Z spreads of approximately 800bps. Interestingly, Penn and Churchill Downs remain towards the middle of the pack.
Putting together the various criteria analyzed above, Penn Gaming stood out from several angles. It was one of the only companies with declining revenue, while also suffering from deteriorating gross margins, increased total net debt, and negative Free Cash Flow. All the while, it was priced near the middle of the pack on Z Spread. On the other hand, Boyd Gaming demonstrated still positive revenue growth, leverage more than a turn lower than Penn, some of the strongest interest coverage in the peer group, and positive Free Cash Flow amounting to about 20% of net debt. Despite this, the difference in yield on the comparable ~5 year bonds between these 2 credits has converged in recent months from ~130bp to ~70bp. Perhaps this pair trade is worth further investigation.
In what ways might analysts look out for signs of potential stress in quarters ahead? A close eye on Working Capital trends may provide some insight.
Interestingly, most of the cohort analyzed showed a meaningful usage of Working Capital in the LTM period. Could Accounts Receivable continue to tick higher or collections from customers grow more difficult in the quarters ahead? This could be interesting to watch in the coming months as a potential leading indicator of consumer health.
Cross-market analysis like the above is easy with Cognitive Credit. Our Comparables feature offers a top-down view of all our fundamental data across our four coverage universes (European & US High Yield, and European & US Investment Grade), allowing you to find relative value opportunities across your markets, sectors and companies quickly and conveniently.