In the annals of investment reporting this comes along as one of those no stercore* Sherlock moments. The bonds didn’t fall as far as the stock, recovered faster and ended up less down after the SEC announcement and writedowns last week. Well, yes, this is how debt and equity will respond to corporate announcements. The same happens on the upside too. On the really very simple basis that this is what debt and equity do, respond differently to corporate news.
Kraft Heinz (ticker: KHC) has become one of the rare cases in which a company’s bondholders are more optimistic than its shareholders. The company’s shares dropped 27% on Friday after the packaged-foods giant released a fourth-quarter earnings report that was rife with bad news: Disappointing earnings guidance, a regulator subpoena, a 36% dividend cut, and a $15 billion write-down on the value of brands such as Oscar Mayer and Kraft. But its creditors don’t seem as worried, and the company’s bonds recovered half of their morning losses by midday. And Kraft Heinz bonds are still trading like investment-grade securities, investors say.
Think through it all just for a moment. Before the bond holders lose the stockholders have to lose everything – creditors only get stiffed after equity holders are already wiped out. So, is the stock still above zero? Anyone thinking that it’s about to go to zero?
No, what’s been lost is the value of a certain amount of optimism about the future. So, there’s still that substantial cushion of the equity reserves of the company before the bondholders risk losing a cent.
There’s also that thought that cutting the dividend increases internal cash reserves, something that preserves the bondholders at the expense of the stockholders pocket books.
We can go further too – what’s the value in liquidation to the stockholders? Well, if anyone gets to that point then we’re there because there’s no equity left. So, stockholders tend to get nowt. Bondholders? Depends, obviously, upon seniority and all that but absolutely no recovery at all is pretty rare for corporate bonds. There’s usually some payout. So, the total downside is lower for the bonds than the stock.
And finally, what happens the other way? The company announces lovely profits and what happens? Stock soars, bonds hardly change in price. Because, that’s right, stock is leveraged to the performance of profits and bonds are not. So, leverage works both ways. We expect bonds to react less than stock prices to corporate news.
That is, in what world would we expect bond prices to move more than stock? Well, quite.