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.
Though credit markets are overstating risk, equity markets are expecting a slight profitability improvement going forward based on current valuations. LVLT is trading at a moderate 1.3x V/A’, with market expectations for ROA’ to marginally expand from 6% levels in 2015 to 9% levels, with 5% Asset’ growth going forward. Analysts expect ROA’ to marginally improve, to 6% in the near future. This implies that even if the firm is able to further leverage their asset base, equity is fairly valued unless they greatly improve profitability.
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