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Investing late in the cycle

Investing late in the cycle

The US economic expansion has now become the longest in the country’s history, beating the 120-month bull run of 1990-2000.

The economy has been growing at a steady pace since June 2009, when it began to emerge from the financial crisis, and has been instrumental in the global recovery.

But indicators suggest that we are entering the latter stages of the global macroeconomic cycle.

Highlighted in the chart below, the downward trajectory of global purchasing managers’ indices, gauges of economic activity, is worrying, and follows declining GDP growth rates in developed and emerging markets. In addition, US-China trade tensions could undermine already slowing global economic growth.

As the tide begins to turn, how should credit investors respond?

At this stage of the cycle, it is tempting to retreat into defensive industries. But we see opportunities among cyclical companies – particularly in several high-quality corporates in the basic materials sector, which includes steel, metals and mining, building materials and chemicals.

These companies benefited from fiscal stimulus provided by major central banks in the aftermath of the last crisis, and many have taken creditor-friendly steps to strengthen their balance sheets since the last commodity cycle ended almost five years ago.

They have tended to prioritise debt repayments over shareholder dividends, strengthening their balance sheets.

These dividends, when reinstated, are often subject to satisfactory levels of free cash flow, as well as the company passing leverage tests and meeting debt targets.

Capital expenditure levels have trended lower post-crisis, meaning that post-peak overcapacity levels should not be as high this time around.

This has also freed up capital allocation for debt servicing. Combined, we expect these actions are likely to result in more resilient balance sheets amid a downturn.

In line with our current approach, we have a favourable view of the cement industry, despite softening macroeconomic sentiment.

Global demand has been weakened by the slowdown in China, which consumes more than half of the world’s supply. But there are positive dynamics for cement companies, too. Late-cycle economic stimulus can boost infrastructure activity and support demand for cement.

 

The material has a low value-per-weight, which makes it hard to transport economically and means that production and demand are more localised. Trade war concerns may not immediately affect cement as much as other industries, although they could have an impact on the health of important markets.

There are also some notable cement producers that are strengthening their balance sheets. For example, Cemex, the Mexican building materials company, has achieved this by instigating a creditor-friendly financial policy.

Cemex has improved its credit profile by selling assets – it disposed of $3.6bn (£2.8bn) worth last year. It has also implemented cost-saving programmes to improve its operating performance.

The company generated $5.2bn in free cash flow over the past five years, which it has used to reduce debt. Its net leverage ratio fell from 5.5x in 2013 to 3.8x last year. Its credit rating has also improved, rising from B- in 2012 to BB in 2017.