Published in The Australian 15 August 2015
The debate rages around the proposed Carmichael coal mine development in central Queensland. Investors have reportedly spent over $1 billion on early development of the project but the expansion has been met with fierce opposition from conservationists. It is a polarising and emotive discussion which can be confusing for investors
This month the development was blocked by the courts after it was found the government had not taken the proper procedures relating to advice on protected species located at the site.
The persistent negative news has spooked some investors in Adani Abbott Point (AAPT) bonds, sending fixed rate bond prices lower and, as a result, yields higher. AAPT has two senior secured bonds maturing in 2018 (wholesale only) and in 2020, with yields to maturity of 5 per cent and 5.75 per cent a year respectively.
Those willing to look beyond the current debate will discover the bonds were issued to fund the existing terminal and not the new development, and AAPT is worth considering for its high returns.
To give you some insight into the relative returns, Qantas also has a fixed rate bond maturing just one month earlier than the AAPT 2020 bond and it has a yield to maturity of 4.64 per cent a year. Yet, according to credit rating agency Standard and Poor’s, Qantas is higher risk and has a lower credit rating.
A fixed rate bond issued by Lend Lease has the same credit rating as the AAPT bonds and matures in the same month as the 2020 bond but the yield to maturity is more than 1.5 per cent lower at 4.06 per cent a year.
Credit ratings should only be a guide, but support the fact that the AAPT bonds offer high relative returns.
While I can’t possibly cover all of the merits or risks of the bonds – our internal report runs to 20 pages - I think the key points are:
- AAPT bonds relate to the existing terminal which has been operating for over 30 years. The terminal was bought by Adani in 2011 from the Queensland State government
- The development of the Carmichael project is separate to the existing operational AAPT coal terminal, and the approval or rejection of it does not directly impact the existing bonds
- The existing AAPT bonds are ring-fenced from other Adani operations
- AAPT is underpinned by long term take-or-pay contracts, ensuring minimum cashflows for very long terms, from some of the world’s largest mining groups including GlencoreXstrata and Rio Tinto
- The vast majority of these contracts extend past the maturity of the 2020 bond and the weighted average life of existing contracts is around 10.5 years
- Companies that contract to use the terminal must give three years’ notice of their intentions to the terminal, prior to expiry of the current contract, giving the terminal time to contract tonnage to other coal miners
- There are protections embedded in the bonds:
- Minimum cashflow coverage to debt ratio of over 1.1 times, the most recent ratio was 2.54 times
- If the terminal is sold and the credit rating of the new entity is lower, investors have the right to sell the bonds back to the new owner at $101
- Interest paid on the bonds will increase if the credit ratings decline
- The ownership structure is complex and the operation is highly geared with total debt of $1.55 billion, but this is typical of infrastructure assets
- Refinancing risk of the debt and the rollover of contracts are key risks. AAPT is dependent on the demand, price and cost of producing Queensland coal in the long term and a prolonged decline in the profitability of coal mining operations in the area would clearly have implications for AAPT. However, current forecasts are for many of the operations in the area to have effective mine lives of 30 to 40 years and for demand for coal to remain high from Asia well into the 2020s and 2030s
Like any investment decision, you need to ask yourself if the returns compensate for the risk involved.
*Please note pricing accurate as at Thursday 13 August 2015 and subject to change.