Energy Credit (w/ Dan Rasmussen & Greg Obenshain)
DAN RASMUSSEN: So, Greg, I think one of the issues, and you mentioned earlier, energy-- where is high yield ex-energy, which is a question we get a lot. And I know you began your career as an energy analyst. What's your view on US energy and US energy credit? You've been fairly bullish today on BBB or BB credit. Would you be a buyer of BBB or BB energy or US shale credit right now? Where do you see that ending? GREG OBENSHAIN: Yeah, so moving from just overall the valuation levels and then starting to think about individual companies and how I think about individual companies and what I look at, one of the parts of my process is to obviously go through the actual financials of the company. And as you said, I'm a former energy analyst, so I've spent many, many years looking at energy financial statements. And there's been a fundamental problem in the US and in the shale plays, which has been highlighted by a lot of people, that they actually just don't generate cash. So, on the metrics that we look for in credit, which is free cash flow to debt-- real free cash flow to debt after Capex-- and measures of return on assets and other return measures, energy has never scored that well. And the fundamental problem is that they consume more capital than they produce. And this was true in the much higher oil price environment. So, much of the debt that is in high yield and energy is actually not towards global multinationals. It's towards these US shale plays, which really haven't proven to be profitable. So, there was a bigger fundamental issue that was happening within US shale plays before all this happened. The fact that you've had a massive oil sell-off at the same time that you're having a bit of a credit crunch just seems like a onetwo punch for them. But there were more fundamental problems in energy before. So, I wouldn't say I look at the world and say, buy all of high yield, buy energy because it's cheap. That's certainly not the argument at all. In fact, when we go and do our research on what to buy in a crisis in debt, it's really obvious things that actually come to the top. It's buy big companies with high free cash flow to debt with high returns on capital. Buying public companies really helps too, because those were private companies, and actually public companies do better-- obviously, because they have more access to capital. But when you start to go look at what works, the energy companies really don't meet the return on investment and free cash flow metrics that are in that. So, they actually, even quantitatively, would not pass the screen. DAN RASMUSSEN: So, I think that's a nice segue to talking a little bit about what your research has led to, Greg. I think it's a bit of a different way of thinking about high yield and corporate credit than a lot of people are used to, coming from the factor research into US equities-- the factors that Fama and French have identified, which are profitability, investment, size, and value. So, you're looking essentially for small companies that are really cheap, that are not investing, and thus generating free cash flow, and have pretty high profitability basically return on assets metrics.