Three trade ideas this week - Darryl Bruce suggests a USD switch, Nick Roffey a FIIG originated bond and Tom Guest offers a rare fixed rate bank subordinated bond
Switch NCIG and longer dated Frontier Communications bonds into the Frontier 2020s
by Darryl Bruce Perth office (08) 9421 8500
Investors with an appetite for higher yielding USD bonds might well want to consider Frontier 8.5% 2020. At current levels the bond is trading slightly above par offering a yield of c.8.25% to maturity in April 2020. The very high yield points to the fact that there are risks involved however there are also valid reasons to look at it more closely.
The independent research house that we use for USD bonds is wary of the longer term challenges facing Frontier however they like the shorter dated issues including the 8.5% 2020 bond. The fundamental drivers behind favouring the shorter dated issues relate to the group’s cashflow, access to liquidity and limited near term refinancing requirements.
Despite pressure on customer numbers, Frontier generated adjusted EBITDA of $906m during 2Q17 with management targeting $3.8bn for the full year. As far as liquidity is concerned at the end of 2Q the group had a cash balance of $387m plus a revolving credit facility of $850m which was only drawn to $125m.
This means that Frontier has access to circa $1bn of liquidity but it also has a very significant debt burden. The chart below shows Frontier’s debt maturity profile. While the group has a substantial debt pile, a relatively small proportion of it matures in the near term. Frontier has been actively buying back its shorter debt so easing its refinancing requirement. The group recently issued a $1.5bn term loan part of which was used to pay down the 2020 bond.
Looking at this chart it is not hard to see why analysts are more concerned about the challenges facing the group from 2021 onwards. Between now and the end of 2020 Frontier has c.$2.3bn of refinancing to negotiate but this increases from 2021 with c.$14bn due to mature in the four years to 2025. Frontier will have to be on a very firm footing operationally to successfully refinance that amount of debt.
Further short term comfort is added by the fact that the group has ‘levers’ it can pull to create further liquidity in the shape of its dividend and capex. In the 2017 financial year, Frontier paid a dividend of c.$700m. History tells us when companies come under pressure dividends are reduced, or eliminated altogether to free up cash resources. Frontier also expects to spend >$1bn on capital expenditure in the current financial year. Clearly this would not be cut to zero but it could be reduced if the group was struggling to meet its legal obligations to banks and bondholders.
As stated at the outset – this investment is not without risk and this is clearly reflected in the return on offer for such a short dated bond. Frontier is under operational pressure, however I think a good argument can be made for the risk: return on the 2020 issue for those investors comfortable with higher yielding bonds.
It is also important to remember that this is a US dollar bond. Currency movements are notoriously hard to call, however investors expecting Australian dollar weakness might well consider c.US$0.785 as an attractive entry point for a US dollar denominated investment.
I think that there are a number of interesting switch alternatives into the Frontier 8.5% 2020 bond including NCIG, which has had a very strong run, and the longer dated Frontier bonds amongst others. I would encourage you to contact your FIIG relationship manager to discuss your options in more detail.
Order Ansett Aviation Training (AAT)
by Nick Roffey Melbourne office (03) 8668 8878
AAT has been one of my top FIIG bonds for a long time now. The combination of a monopolistic business, experienced management and strong asset base has made it a standout in the AUD space. As you may be aware, many bonds have early redemption (call) dates prior to maturity. The only reason I have shied away from AAT recently is the risk of an early call by the issuer would result in a negative return.
AAT’s, first call date is 13 November 2017 at a capital price of $103.65.
As per the bond documentation, the issuer must give a minimum 30 days’ notice prior to the call date if they wish to redeem. We are now under the 30 day notice period.
This means AAT cannot redeem the bond until November 2018 and removes any risk of a negative return to prospective investors due to an early redemption.
At current indicative pricing, AAT now offers a compelling yield to maturity of 6.23% p.a., yield to worst of 5.91%p.a. and a high running yield (income return) of 7.25% p.a.
About the Issuer
- AAT has a 40 year operating history and remained one of the few profitable businesses within the Ansett Group and has experienced steady growth prior to being purchased in 2012 by private equity firm CHAMP Ventures and current Chairman, Margaret Jackson (former Qantas Chairman 2000 – 2007)
- AAT plays a critical compliance role in the aviation industry as part of the airline and pilot compliance obligations required under the Civil Aviation Safety Authority (CASA) and the International Civil Aviation Organisation. AAT’s revenues are largely driven by regulatory requirements stipulating a minimum level of recurrent training hours for pilots as well as the demand for upgrade training to specific aircraft type
- AAT has a strong track record in retaining its customer base in part due to a lack of competing SIMs within an economically feasible distance, and the high cost of investment for a new entrant or airlines shifting training in house, coupled with a strict regulatory environment
- AAT’s status as an independent operator has enabled it to build a strong customer base and revenue profile, with 50% of FY16 revenue being generated from contracts under either use or pay, or exclusivity type arrangements
- AAT currently operates its facility with 13 owned SIMs, 11 were recently independently valued in July 2015 at US$33.14m (A$46.7m). Since then, AAT has purchased 2 new SIMs for $15m.
The bond is available to retail and wholesale investors from $10,000. Yield to call in November 2018 is 5.76% and to November 2019 is 6.05%. Yield to maturity in November 2020 is 6.17% p.a.
While we currently do not have supply any bids can be placed in the queue.
Add WBC subordinated fixed rate bond - Look for fixed rate yield spikes as the US transitions from QE to QT
by Tom Guest Brisbane office (07) 3231 6621
Donald Trump hopes to reduce taxes while the US Fed is beginning to tighten by not reissuing bonds as they come due and hiking cash rates. This is causing some volatility in US fixed rate bond yields.
Despite all the political uncertainty, and the fact that the market was anticipating four to five interest rate hikes this year and there has only been two, the market somehow finds moments of optimism.
And Australia follows even though we have the added complication of 26 years without a recession, high property prices and high debt levels…
When yields spike, fixed rate investment grade and government bonds get cheaper. And if the change in expectation doesn’t eventuate and yields normalise, the price of these bonds increases.
In my view this presents an opportunity, so how can investors take advantage?
Westpac have a FIXED coupon AUD subordinated bond that is currently yielding 3.99%pa. This security is very rare in that it has a fixed rate of return, whereas the vast majority of bank subordinated bonds are floating rate. The bond is investment grade rated (BBB) with a call date in June 2023.
The bond is now very good value in my opinion. Note: WBC-4.80%-14Jun23c are only available to wholesale investors in $200,000 minimum parcels only.
- Household name
- Investment grade rated
- Medium term
- Fixed rate
- Yielding 3.99%pa
- Minimum $200,000
Issuer research and updates can been found here: http://thewire.fiig.com.au/issuers