Convertibles outperform in latest rout; SunEdison weakens in active trade; Chesapeake down

Rebecca Melvin

New York, Aug. 26 – SunEdison Inc.’s multiple convertible issues weakened again in active trade on Wednesday as the name continues to vex the convertibles market. But equities snapped a six-day losing streak, with the rally accelerating into the market close, helping buoy the overall convertibles market.

The SunEdison paper was “in about 1 point on swap, on average,” a Connecticut-based trader said.

The move represented the continuation of a trend that has been in place for about a month among the company’s six outstanding convertible issues.

“It’s a sizable part of the convert market, so it will have an impact,” a New York-based analyst said regarding SunEdison. “Those with exposure in their portfolio will be impacted.”

Another name that has been a drag on the convertible market is Chesapeake Energy Corp. The energy company, which is another serial issuer in the space, has seen its stock slide 68% since the beginning of the year to almost $6.00 and down from a 52-week high of $27.00.

Likewise the Chesapeake convertibles have tumbled, with the longer-dated Chesapeake paper suffering by a greater magnitude than the shorter-dated issues.

Cobalt International Energy Inc. has also been irksome for the convertibles market, but this week it improved after news of an agreement to sell assets in Angola for $1.75 billion.

Convertibles outperform

So far, the convertibles market has held up better through the latest market rout that it did during the correction of 2011 or in 2013 when the so-called taper tantrum occurred, a New York-based convertibles analyst told Prospect News.

In addition the convertibles market has outperformed other asset classes such as high yield during the last downturn.

Most likely its resilience is related to the fact that the selling has hit only pockets of the convertibles market, including energy and China-related issues, and the rest of the market has done OK, the analyst said.

As of late Monday, the convertibles market overall was down about 0.5 point to 0.75 point.

The reason that convertibles outdid high yield is that energy accounts for only about 5% of the convertibles market, whereas it accounts for about 15% of the high-yield market, the analyst said.

Balanced paper fair value

On Wednesday, equities staged another turnaround, with indices bouncing in early trade, helped by a positive durable goods number for July, which rose 2.2% and was better than the expected 0.1% rise.

Also helping markets was a change in the expectation that the Federal Reserve will start to lift interest rates next month. New York Federal Reserve president William Dudley said early Wednesday that a September rate hike by the U.S. central bank looks less compelling now than it did a few weeks ago, and that was enough to convince many market players that there will be no rate increase when the Fed meets for a regularly scheduled policy meeting in the middle of the month.

Also on Wednesday, the Chinese stock markets remained lower, but the rate of selling slowed. The Shanghai composite stock index closed down 1.3% on Wednesday, following a 7.6% drop on Tuesday and an 8.5% slide on Monday.

“Converts are doing what they are supposed to do,” the analyst said regarding using convertibles as a hedge against market downturns. There has been some valuation contraction because of credit issues, but the decline has been small compared to other downturns.

Valuations have come in, but not drastically, the analyst said. “If you look at the balanced segment of the market, it was about 1.5% rich a few months ago and it has come down to fair value,” the analyst said.

Other than energy and China, the rest of the market has behaved reasonably, he said.

Stocks have declined and spreads are wider, but not violently wider, he said.

“Spreads are wider and rates have come in, and that has helped,” he said.

But while cheapness is confined to certain buckets, how convertibles continue to perform will depend on where the broader markets go from here.

Names like SunEdison, Chesapeake and Cobalt “can definitely go lower in a less confident environment,” he said.

But if the market recovers, those names will come back up slowly although maybe not back to where they were before, he said.

SunEdison slide continues

There are a number of reasons why SunEdison has gone down so sharply and for so long. As a solar company, it does well when fossil fuels are at a higher price and when the production breakeven price is higher, so the plunge in energy prices has been detrimental. Another contributing factor has been the risk-off sentiment related to the plunge in China stocks, an analyst said.

In addition, the SunEdison equity has been a favorite among hedge funds. “They like the story and have been a huge holder of the stock, so there has also been a technical aspect to why the stock has been hammered.”

But not only has the stock move been feeding into the convertibles, the credit has also sold off because the company is not cash flow positive, the analyst said.

SunEdison’s new 6.75% perpetual convertible preferred shares traded down to 77.75 bid, 78 offered on Wednesday from about 84 previously.

SunEdison’s newer 2.625% convertibles due 2023 and 3.375% convertibles due 2025, which are referred to as the E and F tranches, traded down to a 57 handle, which was down from about 59 late Tuesday.

SunEdison’s 0.25% convertibles due 2020 and also the SunEdison 2.375% convertibles due 2022 were both trading at the 64 context, according to Trace data.

Meanwhile, the shorter-dated SunEdison 2% convertibles due 2018 were at 84.4.

SunEdison common shares were fluctuating but ended up 4.8% at $9.22, after plunging 18% on Tuesday.

Mentioned in this article:

Chesapeake Energy Corp. NYSE: CHK

Cobalt International Energy Inc. NYSE: CIE

SunEdison Inc. Nasdaq: SUNE

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