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By Anoushka Sharma
Despite rising inflation and macroeconomic volatility, most sectors in non-investment grade credit concluded last year with solid credit fundamentals.
2021 was a year of improving financial performance for many sectors in non-investment grade credit. Despite rising inflation and macroeconomic volatility, most concluded the year with solid credit fundamentals, while their fourth quarter earnings outpaced our median estimates by low single-digits percentages across high yield and leveraged loan issuers.
Across this universe, companies saw healthy demand and were generally able to pass through rising input costs to customers. We believe the strength of the U.S. consumer supported this pricing dynamic, with pandemic savings approximating $2 trillion.
We saw further signs of improving demand in reopening sectors such as Airlines, Hotels and Leisure. Companies in these areas posted meaningfully higher earnings than the prior year, indicating a strong recovery from 2020 shocks. Management teams provided guidance implying that demand and forward bookings have nearly recovered or exceeded pre-COVID levels.
The Real Estate and Homebuilding sector benefited from record backlogs, with median revenue and EBITDA up nearly 15% year-over-year, exceeding our estimates. Homebuilders are navigating supply-chain bottlenecks and rising input costs by passing through higher pricing, which has had minimal impact on consumer demand to-date. That said, the higher interest rate environment and its impact on home affordability will be demand factors to watch from here.
Technology and Electronics reported solid results in the fourth quarter, with approximately 8% and 12% median EBITDA growth across high yield and loan sectors, respectively. This is due to continued demand for software, in which the recurring-revenue nature of the business and highly secular demand for information technology resources provide a degree of insulation from macroeconomic volatility and supply-chain challenges affecting other sectors.
Underperforming sectors included Cable TV and Telecom, which remained relatively flat year-over-year from a revenue perspective due to competitive factors and the pull-forward of demand in 2020 (as work- and school-from-home became prevalent), creating relative weakness in 2021. Nonetheless, the sectors both remain defensive and relatively non-cyclical.
The non-investment grade market saw margin headwinds in sectors such as Industrials and Food and Beverage where companies had challenges in passing on higher input costs.
Overall, fourth quarter earnings trends demonstrated that non-investment grade credit entered the current period of volatility on stable footing. We expect underlying credit fundamentals to remain strong, with default outlooks well below historical averages in 2022 and 2023.
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