The high-yield retail subsector has staged a remarkable turnaround over the last year, making it a clear winner amid the COVID-19 pandemic. Prior to the onset of the coronavirus, this sector was the poster child for zombie credit, with numerous overleveraged and secularly challenged businesses that appeared to have remote prospects for sustained success.
However, COVID-19 ushered in dramatic changes in personal behavior and changed the way many of these businesses operated. Previously, high-yield retail was an unattractive sector, full of one-off illiquid credit stories, numerous bankruptcies with limited recoveries, poor competitive positioning and tired brands. These factors made the group a difficult place to invest with any conviction. Mall-based retailers were in the most difficult position, seemingly headed for extinction. To their credit, many management teams have done a great job of becoming relevant again to both consumers and investors, and the group is now viewed in an entirely different light.
Notwithstanding recent equity volatility and a handful of earnings misses, the credit story across the group remains largely intact. As this week’s chart shows, credit spreads before 2020 were elevated, trading about 200 basis points above the overall high-yield index. During 2021, spreads have compressed to the overall index, reflecting the tremendous improvement in credit quality across the space, higher-quality composition of the subsector as a result of downgrading from investment grade and stronger new issuer profiles, as well as renewed confidence in the sustainability of results.
Before 2020, the narrative was of the death of the mall, while Amazon and other more nimble online startups eroded profitability of brick-and-mortar stores, and intense competition from Walmart, Target and other world-class retailers ready to quickly pounce and dominate any attractive category. While none of these threats have gone away, investors have chosen to focus more on the changes management teams have made to stay competitive and resume growth, along with better balance sheets and free-cash-flow strength.
The high-yield sector includes many different types of companies ranging from apparel to footwear, auto dealers and aftermarket, crafts, pet services, food, specialty, etc. Each company has different sourcing and distribution models and online strategies. It is a sector that I tended to avoid previously, but I have to give credit where it’s due and acknowledge the improvements that have been made. This represents a good example of why it is important to stay flexible in opinion and keep an open mind when looking at credits and industries that have gone through important changes, rather than being too jaded by prior mistakes and unpleasant memories.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
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High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
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