There are a number of factors to consider when assessing a new bond investment – not just the return
In 2004, Sydney Airport Finance, the financing vehicle for ASX-listed Sydney Airport, issued AUD535m of inflation-linked debt, scheduled to be repaid in November 2020. Since the issuance of the bond, Sydney Airport’s market capitalisation has quadrupled and was just shy of AUD20bn at the end of 2019.
Air travel has been the worst affected of all sectors since the start of the COVID-19 pandemic. Borders have been closed and even interstate travel has been severely restricted. Qantas and Virgin Australia, the two largest airlines in the country, have shut down international routes and reduced domestic capacity by approximately 90%. Since airports rely on air travel, Sydney Airport, like many other airports around the country, is expected to see a material impact on its earnings. Over the last month, Sydney Airport’s share price has dropped by about 20% and was down by as much as 40% mid-March.
The Sydney Airport bond, on the other hand, has experienced significantly lower price movements. This is because, fundamentally, bonds have the benefit of a number of structural features which we explore through the Sydney Airport bond as an example.
Our top 10 tips for assessing bonds:
1. Assess the “survivability” of the company
Do you think the company will be able to survive for the term of the bond and thus pay you interest and return the face value of the bond at maturity? Although highly correlated to passenger numbers, Sydney Airport also generates other forms of revenue that is independent (e.g. lease rentals from its property portfolio) and also benefits from minimum revenue guarantees from its retail operators. Combined with very low costs (as evidenced by its historical EBITDA margin of about 80%), Sydney Airport is in a much stronger position than airlines which have much higher fixed costs.
2. Understand where the bond sits in the capital structure
This bond is senior secured, which means it not only sits at the senior debt level but has the benefit of security over Sydney Airport’s assets (they key asset being the concession over Sydney Kingsford Smith airport). This level, in the event of a wind up, means that subordinated debt, hybrids (if there are any) and shares that rank below senior secured in the capital structure, must be wiped out completely before you would incur a loss. It also means that holders of Sydney Airport’s debt rank in priority to unsecured creditors and would have a significant say in the (highly unlikely) scenario of Sydney Airport appointing a voluntary administrator. Well before reaching such a (remote) case, we believe that Sydney Airport would raise fresh equity to support its liquidity.
Source: FIIG Securities
3. Check if the bond is fixed, floating or inflation linked
The Sydney Airport bond is inflation-linked. This means that the amount outstanding will gradually increase over time in line with inflation. To illustrate this, while Sydney Airport received only AUD535m of proceeds when the bond was issued, the company would have to repay AUD776m if the bond was to mature today. This increase reflects the inflation impact over the last 16 years. Inflation-linked bonds will see their periodic interest payments reflect and movement in inflation as well.
Other companies will also issue fixed rate or floating rate bonds. Fixed rate bonds will have a fixed scheduled of payment over their life and will not change. This provides complete certainty for investors. On the other hand, floating rate bonds will have their interest payment determined on each payment date (typically quarterly) by reference to a particular benchmark (BBSW in Australia). The key difference between fixed and floating rate (other than the fluctuation in interest payments) is that fixed rate bonds are a lot more sensitive to interest rate movement. When rates go down, the price of a fixed rate bond will go up. Floating rate notes have virtually no sensitivity to interest rates, since interest payments are reset on a periodic basis.
4. Check the term to maturity
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There is a large secondary market where bonds are traded, but if you hold a bond to maturity, you’ll need to make sure the maturity date suits your portfolio.
5. Determine if you can buy the bond
The vast majority of bonds are traded in the over the counter (OTC) market and you need to find a bond broker to trade on your behalf. Over the counter bonds are available to retail and wholesale investors, however wholesale investors have a greater range of bonds to choose from.
The Sydney Airport bond was issued in the wholesale OTC market and is available to both wholesale and retail investors through a bond broker.
6. Assess the return given the risks
Every bond and company has risks. Do you know what they are and do the returns on offer adequately compensate you for the risks involved?
7. Check the size of the issue
The larger the issue, the likely greater the liquidity, as there will be a larger number of investors that hold the bond and it will be included in bond indices. The Sydney Airport bond raised AUD535 million on issue and given the size, we would expect it to have good liquidity.
8. Confirm the bond has a credit rating
This will give you an indication of the risk involved. The higher the credit rating, the lower the risk. The highest investment grade credit rating is “AAA”. Others include “AA”, “A” and “BBB”. The last three categories can also have a “+” or a “-“ attached to them. The lower the risk, the lower the expected return. Non-investment grade is anything rated “BB+” or lower.
Sydney Airport has an investment grade credit rating, and it is considered low risk. It’s important to note that in Australia, only wholesale investors can be informed of the credit rating.
9. Assess the relative value to other company investments
What returns are available on other investments in Sydney Airport’s capital structure? Does the company issue senior secured or subordinated debt? Is the return on the senior bond what you would expect, given returns on these other investments?
10. Assess the relative value compared to other bonds from similar companies
What rates of return are available from companies in the same sector and/or similarly rated companies?
At the time the bond was issued, it was attractive to wholesale investors as it met the above criteria.
This list will help you determine if a bond is suitable for your portfolio and can be used to ask your broker questions.