Is everything still on track?

The announcement of the agreement to merge Siemens and Alstom’s train assets will create a large European champion, which should be better placed to compete with increased competition from China’s CRRC. It marks the end of speculation on a number of outcomes, and on whether the vested interests of both France and Germany could be satisfied.

The framework agreement still has to be approved by regulators and shareholders. However, assuming the approval is forthcoming, the increased scale will make the combined businesses more able to compete with the behemoth of CRRC, which has annual revenues larger than the prospective combined European entity. CRRC has been increasingly looking to compete outside of China, and has already won projects in both the UK and Czech Republic. It is also expected to bid for work from HS2 (a planned high-speed railway in the UK).

Bombardier – a Canadian manufacturer with a large European business – is thought to be the biggest loser from the announcement, since it remains a subscale competitor in Europe. Bombardier’s bonds were already weak due to the headlines about its aerospace division, and this agreement is unlikely to help.

Rail infrastructure offers a variety of opportunities for bondholders to invest in, including the manufacturers of “kit” such as Alstom, Siemens and Bombardier. These opportunities also extend to the national rail companies such as Deutsche Bahn, Network Rail Infrastructure and SNCF Réseau, who pay for the signalling and other technical equipment that the manufacturers provide. The rolling stock companies such as Great Rolling Stock, Angel Trains and Porterbrook acquire trains and carriages and lease them to operators. These train operating companies (such as First Group and Stagecoach) run the trains. All will be affected by any changes to the choice or price of rolling stock and associated infrastructure, or to any further change in competitive dynamics. We are keeping a close eye on these developments, which have both potential positives and negatives for the end passenger and the bond investor in the railway industry.

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Testing times

The recent egg scandal has once more brought the issue of food safety into the public spotlight. Along with the horse meat scandal and baby milk in China, there are strong reasons to suggest that food testing will continue to be required to ensure the quality of the food chain and human health.

One of our recent additions to portfolios is Eurofins Scientific, a global laboratory and advisory service that offers a wide range of testing services across a variety of industries. Eurofins believes it is the world leader in the food and feed testing market where it tests for dioxins and organic contaminants, pesticides, mycotoxins, allergens, authenticity, pathogens and vitamins. Its wider environmental testing services are underpinned by increasing regulations for a clean and healthy environment

The company also offers services to the biopharmaceutical industries and speciality clinical diagnostics where its laboratory services, backed by high R&D spend, support the more accurate diagnosis and treatment of diseases and improve healthcare.

The company has a history of growth through acquisition, but these are largely bolt-on services or geographies such as its recent acquisitions of Japan Analytical Chemistry Consultants (“JACC”) and Ecopro Research (“Ecopro”). JACC is one of the largest independent agro science testing laboratories in Japan and Ecopro is a leading food testing laboratory in Japan. The cost of these purchases remains relatively low and they have a strong track record in managing leverage downwards post deals.

This remains an attractive credit to own.

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Facing a squeeze – new issue premiums

Corporate bond issuance has been strong over the last two months despite a brief slowdown prior to the French presidential elections. Syndicate desks at investment banks continue to aggressively tighten guidance from the Initial Price Talk (IPT). The level of new issuance tightening is usually a strong guide to market appetite and the attitude to risk. It implies there is still a lot of mileage in investment grade credit.

At the moment syndicate desks are squeezing the new issue premium 15-20bps, bringing new deals at or very close to secondary curves. By pricing at levels near to existing bonds or comparable issues, we are seeing new issue premiums squeezed to 2bps. Earlier in the year the revisions to initial guidance were generally 10-15bps.

The continuation of the ECB’s bond buying programme is providing a strong technical push in Europe; it has now purchased about €90bn of bonds or the equivalent of 90% of net new issue (i.e. new bonds less redemptions). The hunt for yield and income is also continuing to attract strong demand in the US. Even large M&A-led issuance such as the recent Cardinal Healthcare multi-tranche issue tightened (in some tranches) by 30bps pre-launch. Normally these types of deals require some concession from the issuer to ensure that the new large supply of bonds finds a stable home.

But as long as books are reasonably well covered, this indiscriminate cutting by 20bps continues and it makes relative and absolute value analysis of individual deals harder to discriminate between the good, the bad and the ugly. With a number of outstanding M&A transactions yet to be financed, supply until the end of the year is likely to remain strong. As long as the market remains robust this supply will be readily bought; however initial guidance and the subsequent revisions are likely to be tested if demand into investment grade credit starts to slow.