Fundamental Analysis

Study Notes:

Now that we’ve reviewed the dangers of default risk, the focus of this lesson will center on the complexities of conducting fundamental analysis.

Corporate bond investors may analyze a myriad of factors about an issuer before engaging in a transaction.

For illustration purposes, let’s analyze a proposed bond to be issued by a major U.S.-based hotel in the wake of the Covid-19 pandemic:

Marriott International offers $1.5 billion worth of low-tier, investment-grade notes due to mature in five years.

You understand from reports in the market that the company intends to use the net proceeds from the sale for general corporate purposes, which may include working capital, capital expenditures, acquisitions or repayment of outstanding commercial paper or other borrowings.

Over the course of pricing, the yield on the issuance has fallen by 150 basis points to 5.75%, and the amount of the deal has risen to $1.6 billion, which are signs that bond investors have shown a lot of interest in the sale.

In your research, you find that both Moody’s and S&P had recently downgraded the firm’s credit rating to a low ‘BBB’, however you also understand that the Federal Reserve recently implemented measures to help support the investment-grade corporate bond market in the near-term, as well as corporate debt that, under certain conditions, slip from investment-grade into high yield – also known as ‘fallen angels’.

Since Marriott’s bond matures in five years and the Fed’s program ends in a few months from the time the debt is issued, you decide to dig further.

Further analysis uncovers that the ratings agencies that downgraded Marriott have also placed the issuer on watchlists for further cuts, which could render its debt as high yield or ‘junk’, which would make it more costly for Marriott to sell bonds in the future.

You also wonder how much the pandemic has affected its operations and liquidity and discover that practically the entire U.S. hospitality industry has been battered by government-implemented travel bans and a related drop in tourism.

Against this backdrop, while Marriott has suffered material declines in revenue per available room (RevPAR), it has also taken several steps to shore-up liquidity.

However, as long as the virus outbreak persists and containment measures are in place, you think the company will likely have a significant negative cash flow and ultra-low occupancy rates, putting its existing debt service obligations in jeopardy.

You also check the stock market and see that Marriott’s equity value has fallen by more than 46% since the start of the year.

Based on the above factors, would you invest in the bond?

Investors of corporate bonds may commit a tremendous amount of time to fundamental analysis to inform their investment decisions – conducting analyses on credit, market, liquidity, operational, and political risks, among countless others – when considering the potential for default.