The Earnings Call Delinquents

When companies host quarterly earnings calls, almost every analyst on the line covers stocks. Bond investors rarely get on, because bonds rarely come up. Most companies only want to talk about earnings with credit analysts and investors when they are facing financial trouble.

But that should change, according to unpublished research from asset manager Invesco, particularly as the bond markets get closer to the end of the current credit cycle than the beginning. Low interest rates have prodded public companies to issue debt at record levels. 

Rahim Shad, a senior high-yield analyst on Invesco’s fixed income team, told Institutional Investor that quarterly earnings have long been integrated into the firm’s credit research. “Do bond investors care about earnings? We do, and more bond investors now are getting involved,” Shad said. “It’s late cycle. People are starting to pay attention,” he added.

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Historically, bond investors haven’t joined in earnings calls as the discussions gear toward equity investors focused on growth. In addition, the size of the investment grade bond market dwarfs that for non-investment grade paper. But credit risk matters substantially more for investors in high-yield and other securities.

For many years, Wall Street firms  employed rafts of equity-focused analysts but far fewer, sometimes none, for credit. Bond investors relied on credit ratings agencies, such as Moody’s Investors Service, for opinions, as well as other third parties. But after their ratings proved useless — or worse — during the financial crisis, investment organizations have built up capabilities and rely much more on proprietary research.

Stock investors are interested in measures such as earnings per share. But anybody transacting in bonds wants to know about risk. It’s why bond guys are natural pessimists. “Everything, I mean everything, we do is anchored in risk,” said Shad. Early warnings abound in earnings calls. For example, company executives may talk about using free cash flow to reduce debt. “And two quarters later they make an acquisition they never talked about. That’s a surprise I don’t like,” he noted. While firms are free to change their strategies to reflect the market, Shad and his team want some kind of warning. 

During earnings calls, Invesco analysts look for clues of changing risk profiles that can’t be deduced from leverage ratios alone. Indicators can include companies’ equity cushions, margin trends, and the operating environment. 

The reality is that companies are far better at communicating information to stock investors than bond investors. Shareholders get surprised occasionally, but they also have access to reams of relevant public data that creditors do not. Many companies fail to detail their balance sheet strategies or capital allocation plans, for example, which affect the debt they’ve issued. Bond investors need to be creative and read between the lines of public announcements — or listen closely to earnings calls, according to Invesco.

Shad wishes companies would step up their creditor communication game, but opacity has its benefits. The equity markets are awash in data, and as such offer few opportunities to unearth undervalued companies by coming across little-known nuggets of information. The bond data vacuum rewards those willing to do the messy work of uncovering information themselves, he said.