Level 3 Communications Levels Up To Investment Grade
Summary
- Moody’s Ba3 credit rating on Level 3 Communications overstates the company’s credit risk. We rate the company four notches higher, as a lower medium investment grade credit.
- LVLT’s credit risk should be lower, given their strong cash profile and robust recovery rate.
- Credit risk is also overstated by cash bond markets with a cash bond YTW of 3.267% relative to our Intrinsic YTW of 2.357%, while CDS markets are slightly overstating credit.
Cash Flow Profile
Moody’s is materially overstating the credit risk of Level 3 Communications (NYSE:LVLT) with its Ba3 rating. Our fundamental analysis highlights a much safer credit profile for LVLT: the company’s strong cash flows easily cover all their operating obligations. Moreover, in years when cash flows fall short of debt maturities, the combination of their cash flows and sizable cash on hand should allow them to service all obligations including debt maturities. Furthermore, strong PP&E recovery relative to debt levels drives a robust recovery rate of 132% on unsecured debt. The firm should therefore have access to credit markets if they choose to refinance their debt. We therefore rate LVLT four notches higher at an IG4 credit rating, or a Baa2 equivalent using Moody’s ratings scale.
In addition, cash bond markets are overstating LVLT’s credit risk with a cash bond YTW of 3.267% relative to an Intrinsic YTW of 2.357%, while CDS markets are slightly overstating credit risk with a CDS of 178bps relative to an Intrinsic CDS of 108bps.
The chart provides a far more comprehensive view of credit fundamentals than traditional ratio-based analyses. It shows the cash flow generation and cash obligations related to the credit of the firm, adjusted for non-cash financial statement reporting distortions from GAAP. The blue line indicates the gross cash earnings (Valens’ scrubbed cash flow number) expected to be generated based on consensus analyst estimates and Valens Credit’s own in-house research team. The blue dots above that line include the cash available at that time while the blue triangles indicate that same amount plus any existing, available lines of credit.
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