Over the last week, two separate events have highlighted the attractiveness of Sydney Airports’ domestic bonds
First, the company issued a US dollar denominated bond in the US private placement market, raising USD900 million dollars or $1.2 billion Australian dollars equivalent. The funds will be used to provide additional liquidity, to cover future debt maturities and to help fund investment.
The new bond issue was oversubscribed, meaning they could have raised more funds if they had wanted. The bonds mature in ten years in 2026 and will pay a fixed rate of interest of 3.625 per cent per annum.
That’s cheap financing for the Group even after it pays to fully hedge currency movements. The all in cost of funding the deal, when swapped back into Australian dollars is 4.9 per cent per annum, well below Sydney Airport’s average cost of funding of 5.7 per cent per annum. It’s a fantastic result. The debt maturity profile is extended and the cost of funds lowered.
Second, quarterly inflation figures were released on Wednesday. Inflation for the March 2016 quarter was lower than expected at -0.2 per cent, taking the yearly headline figure from March 2015 to March 2016 to 1.3 per cent, down from 1.7 per cent the previous quarter.
The most significant price falls this quarter were automotive fuel (-10.0%) and fruit (-11.1%). International holiday travel and accommodation was also lower at (-2.0%). Offsetting these cheaper goods were higher costs for secondary education (+4.6%) and pharmaceutical products (+4.8%).
Even though inflation is very low by historical averages, it remains positive and that is important. Deposit investors earning around 3 per cent per annum, are having returns whittled away by inflation, meaning returns are sub 2 per cent per annum. If you are paying tax on deposit income, you are almost better putting it under the mattress!
Combined, the two events lead us to reassess the attractiveness of Sydney Airports two Australian dollar denominated bonds. Both of these bonds are inflation linked. The capital value of the bond rises with inflation and as long as it is positive, the value of your investment rises over time. At maturity, Sydney Airport in effect owes investors the $100 face value of the bond when it was first issued plus compounding inflation over the term of the bond. These are great investments for SMSFs wanting to preserve capital and spending power.
The bond that matures first in 2020 has a current indexed value of $135.48. That is the amount Sydney Airport would owe you if the bond matured today. The fixed rate of return, on top of inflation for this bond is 2.81 per cent per annum. This rate doesn’t change but it’s calculated on the growing indexed value, now $135.48, so your interest income keeps pace with inflation as well.
Very roughly if inflation is 1.3 per cent and the fixed interest is 2.81 per cent then the total return per annum on the 2020 bond is 4.11 per cent. The longer dated 2030 maturity domestic bond also uses the same principle, but being longer dated has a higher fixed interest rate to compensate. Its approximate return is inflation of 1.3 per cent plus fixed interest of 3.49 per cent to deliver 4.79 per cent.
Why invest in these bonds now?
The rate of return on offer from existing bonds is better relative value than the Group’s very recent USD issue. The 2020 bond matures six years before the new bond, so you would expect a lower overall return, not a higher one.
You would be buying the investment when inflation is low, so contrary to the cycle. Even if inflation turns negative, and your indexed value declines, you would still be protected from overall loss by the positive fixed rate of interest. While it is hard to envisage a sustained period of low inflation or even deflation, it can be devastating. Traded assets lose value across the board. These investments are very protective under multiple scenarios and should be considered by investors planning for the longer term.