Attention Sydney Airport holders, with the 2030s selling at a premium, it may be time to switch to the 2020 inflation linked bond for great relative value. You don't have to hold bonds to maturity, investors prepared to trade can earn higher returns. This note tells the story
As published in The Australian on 27 February 2018.
Sydney Airport has long been a share market darling, for good reason. It operates the busiest airport in Australia with a long term lease over monopoly infrastructure assets, coupled with consistent growth over many years.
Few realise that the airport has issued two Australian dollar denominated bonds that provide a different, protective function that is well worth investigating. In recent months, the trading between the two bonds gives great insight into the psyche of bond investors.
Back in 2004 and 2006 Sydney Airport issued inflation linked bonds that mature in 2020 and 2030 respectively. The 2020 bond was issued at a yield of Consumer Price Index (CPI) + 3.76 per cent per annum and the 2030 bond at CPI + 3.12 per cent per annum.
As much of the airport’s income is tied to inflation, think car parking and retail leases, the company issued debt linked to inflation, to minimise the differences between future income and expenses.
The bond issues also provided the company with long term funding certainty of 16 and 24 years – it’s hard to get that sort of commitment from a bank!
For investors, inflation linked bonds are the only direct hedge against inflation and for that reason a key, ongoing recommended holding.
Over the years, the majority of our clients have owned one or the other and sometimes both bonds, depending on their inflation expectations, the price and resultant yield between the two bonds and also other similar risk bonds.
Just last year, persistent low inflation, below the RBA target of 2 to 3 per cent per annum, prompted many to sell-down their Sydney Airport bond holdings pushing bond prices lower. Then the market got interesting.
Prices of other similarly rated fixed and floating rate corporate bonds offered lower projected returns and the two Sydney Airport bonds looked like great relative value – they still are but I’ll circle back on that point.
Investors piled back in. The 2020 bond was thought too short to provide inflation protection and the 2030 bond attractive as it was trading at about $123, a discount to its underlying face value. Investors that reasoned the discount would be eroded over time saw an opportunity for a higher than expected return.
In circa seven months, the discount eroded, the price rose and investors made money. Currently, the 2030 bond is trading at $133, a premium to its underlying face value. So, less attractive to the bond investor with an eye to trading, perhaps time to sell and look for opportunities elsewhere.
Investors didn’t need to look far, just back to the good old Sydney Airport 2020 inflation linked bond, which is now in demand. Again it looks like great relative value.
The 2020 bond’s current yield is CPI + 2.54 per cent. The fixed quarterly coupon of 2.54 per cent is close to term deposit rates, but investors also get capital appreciation of CPI. Last December’s 1.9 per cent headline annual inflation figure, if steady over the next couple of years would result in investors earning circa 4.44 per cent per annum for a low risk investment grade asset.
To put the yield into context, consider two other bonds that are considered to be similar risk both maturing within a month of the Sydney Airport 2020 bond – a floating rate bond from ME Bank, with an expected yield of 3.16 per cent per annum and a fixed rate bond from Global Switch with a 3.32 per cent yield.
The 2020 Sydney Airport inflation linked bond looks a stand-out.
Some clients have been frequent buyers and sellers of Sydney Airport inflation linked bonds as the market between the two ebbs and flows.
Around 50 per cent of our clients trade their bond portfolios while the remainder are hold to maturity investors.
Those prepared to trade can earn higher returns.
Note: Sydney Airport inflation linked bonds are available in the over-the-counter market to retail investors from $10,000 per bond and $250,000 up front investment. Sydney Airport also issues bonds in US dollars, Canadian dollars and Euros.
Source: FIIG Securities