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February 08, 2012 at 10:44 AM EST
Narrowing CDS Spreads Reflect Earnings Momentum In The Industrials Sector
Noting the stronger than expected earnings performance of US industrial companies, S&P’s Global Markets Intelligence group sees potential upside in companies such as Southwest Airlines. We think there are a number of intriguing trading possibilities among industrials CDS. For example, Southwest Airlines Co.’s CDS tightened 37% to 118 bps over the past month, though [...]

Noting the stronger than expected earnings performance of US industrial companies, S&P’s Global Markets Intelligence group sees potential upside in companies such as Southwest Airlines.

We think there are a number of intriguing trading possibilities among industrials CDS. For example, Southwest Airlines Co.’s CDS tightened 37% to 118 bps over the past month, though it is 4 bps wider than a year ago.

As the fourth-quarter earnings season winds down, the percentage of industrials companies beating the S&P Capital IQ consensus estimate was the largest (67.44%) of any of the 10 sectors through Feb. 6. Highlights included results from Caterpillar Inc., which reported $2.25 per share against the estimate of $1.77, and Textron Inc., whose $0.49 per share topped the forecast of $0.35.

A majority of companies within the sector expressed optimism about 2012, with Caterpillar saying, “The 2011 increase in sales and revenues was the largest percentage increase in any year since 1947, and much of it was driven by demand for Caterpillar products and services outside of the United States…We’re expecting 2012 to be another year of good growth.” On a forward 12-month basis, the consensus expects the industrials sector to report the most significant earnings growth of all 10 sectors, at 11.1%.

The GMI research team wanted to see if five-year credit default swap (CDS) spreads for U.S. industrials reflected this bullish outlook. We found that the average spread for corporates in this sector tightened by 11% over the past month, according to CMA DataVision. However, it wasn’t enough to lift the average spread out of speculative-grade territory.

But the average spread for the industrials group does not tell the whole story. Transportation spreads tightened by 30% over the past month and are averaging 70 bps. Capital goods spreads narrowed 31% to 196 bps, and commercial and professional services spreads tightened only 1% to 569 bps.

Excerpted from Credit Market Commentary: Market Derived Signal: CDS Spreads Reflect Earnings Momentum In The Industrials Sector

Technorati Tags: Caterpillar, CDS, Earnings, industrials, Southwest Airlines, Textron

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