Small Companies: Pay More Attention to its Convertibles
| For Cecilia Prieto | 0 Comentarios
U.S. equities were mostly higher for the month of January, with the S&P 500 hitting a fresh all-time high for the first time since early 2022. Stocks seamlessly extended their positive momentum from Q4 into the New Year, sustained by the stellar performance of several “Magnificent 7” names, including Nvidia (NVDA), Netflix (NFLX), and Meta (META). Despite caution prompted by overbought conditions lingering from year-end, the market continues to exhibit its resilience.
On January 31, the Federal Reserve maintained interest rates at their current levels while indicating a reluctance to initiate rate cuts as soon as March. During the press conference, Fed Chair Jerome Powell stated that the Fed needs to see more evidence that falling inflation is sustainable and that there is a ‘ways to go’ before declaring that a soft landing has been achieved. Investors have been encouraged by leading indicators such as the PMI, corporate results, and commentary, suggesting that an economic deceleration is already well underway. The next FOMC meeting is March 19-20.
Small-cap stocks began the month trailing behind large-cap stocks, which is unusual considering small-caps have historically performed well in January. The lackluster performance of small-caps can be largely attributed to their significant surge in December. However, we anticipate a favorable environment for smaller companies in 2024 as post-peak rates and necessary consolidation in certain industries like media, energy and banking should lead to a more robust year. M&A activity began the year strong, setting the stage for catalysts to emerge within our portfolio of companies.
Merger Arbitrage investors were crimped by widening spreads following the termination of Avangrid’s acquisition of PNM Resources and the overhang from two deals blocked by regulators – JetBlue’s $7.5 billion acquisition of Spirit Airlines and Amazon’s $1.4 billion acquisition of iRobot. Spreads widened in sympathy on deals subject to extended antitrust reviews, including Albertsons, Capri, Hess/Chevron, Pioneer/Exxon. Our belief is that these deals will be completed allowing investors to earn greater returns going forward.
In the case of PNM Resources, after the companies received all other required approvals, the companies appealed New Mexico’s utility regulator’s rejection to the state’s Supreme Court. Avangrid then elected to let the merger agreement expire in January instead of waiting for a decision from the Supreme Court. While the outcome was disappointing, the downside in PNM was judged limited, and we sized the position appropriately. Furthermore, PNM provided updated guidance in February that positions it as one of the fastest growing utilities in the US and deserving of a premium valuation. We expect to work out of PNM in the coming months as shares narrow the valuation discount.
While equity market performance in January was driven by a few mega-cap tech companies, the convertible market has many small and mid-cap issuers, with opportunities for asymmetrical returns over the longer term. We continue to see a large number of maturities that will need to be addressed this year, which we expect to benefit convertible issuance. With interest rates remaining higher, convertible’s relatively low interest rates should make them a compelling option as companies look to refinance without a significant increase in interest expense. Recent issuance has come at attractive levels for investors while still offering companies an attractive cost of capital. Many of the new issues over the past 6 months have performed well out of the gate, and remain compelling portfolio holdings as they generally have lower premiums than many existing issues.
Opinion article by Michael Gabelli, managing director at Gabelli & Partners
