The Oil Gusher #448 Hybrids: Cheap equity or expensive debt?

Key takeaways 

 

•         Credit rating pressure has seen record >$20bn hybrids issued by Big Oils last year.

•         While reducing 'net debt' by around 15%, we estimate hybrid bonds cost Big Oils >$1bn p.a. at an average coupon of 3%.

•         We see Big Oil filling more of its >$80bn remaining hybrid bond capacity given recent yield differential compression.

 

 

Europe's Big Oils have issued $23bn of hybrids since 2020

Hybrid bonds served as a major relief factor for European Big Oils during the COVID-19 down-cycle. Close to 60% of all hybrid bonds outstanding by Europe's Big Oils were issued since 2020 - worth $23bn with (pre-tax) coupons below dividend yields. 

 

Hybrids account for up to 20% of market cap

Of those Big Oils that have issued hybrid bonds, they now make up close to 20% of gross debt on average (Incl. hybrids and IFRS16 leases). Hybrid bonds have reduced net debt even more materially (by up to 35% at e.g. Repsol and OMV). Hybrids today account for 10-20% of market cap at OMV, Repsol, BP and TotalEnergies. At the same time, we calculate hybrids (pre-tax) interest adds outflows worth 4-22% of 2021 dividend payments (while on average reducing 2021 net income by ~5%).

 

Credit rating thresholds in sight

BP topped its peer group with hybrid bond issuance last year worth $12bn and a corresponding reduction in debt (given BP's accounts treat 100% of its hybrid bonds as minority equity interest) - resulting in a 9pp reduction in gearing as defined by BP. Across Europe's Big Oils, we estimate average FFO / net debt has improved by 7pp if treating hybrid bonds as 50% equity. FFO / net debt is a core threshold metric used by S&P; and we note BP - despite S&P treating 50% of its hybrids as equity - is likely to nevertheless fall short of the 30% threshold required for BP's A- credit rating.

 

Recent compression of yield differential vs. senior bonds

Over the past three months, we have seen a steady decline in the hybrid-senior spread differential, which now trades at the 10th percentile of its 20-year historic range. This compression means it is getting cheaper to raise more hybrid debt (we calculate Europe's Big Oils still carry $81bn capacity before reaching maximum hybrid thresholds). 

 

Credit Research preference for hybrids

Our Credit Research colleagues have Overweight recommendations on all BP (NC 26s/NC29s) and Total hybrids apart from a Marketweight on Total at the short end (NC-22s).