We look at the recent volatility in commodity sector bonds and what this means for bond investors
Resource sector bonds are displaying a level of volatility which some would probably call equity like. The heightened volatility and uncertainty in commodity prices is translating to large movements in resource related bonds. The chart below is a perfect example of this. It highlights four resource sector names (Fortescue, Newcrest, Glencore and BHP) and how the market has reassessed the fortunes of these companies in a short space of time.
The turnaround in the trajectory of these bonds in the space of a few weeks is massive, particularly in the context of fixed income which is meant to be relatively stable asset class.
Along with a mini recovery in commodity prices (as shown in spot price history graph above), each of the companies has reported recent news which has either supported their credit profile or addressed key uncertainties surrounding the businesses. A brief summary for each name is outlined below:
- Fortescue: continues to improve its cost position and is narrowing the gap on major rivals BHP and Rio. Fortescue recently provided guidance in its 1H16 result of a FY16 exit breakeven price of USD28.80 per tonne (link to article here). With increasing confidence in the company’s ability to survive a prolonged downturn we believe the 2022 bonds are worth considering. Overnight bond prices rallied significantly following a 18.5% increase in the iron ore price and a new deal on product and investment opportunities struck with Vale (link to article here). We believe now would be a good time for investors sitting on meaningful capital gains to consider taking profit
- Newcrest: has shown the most stability out of the four names, but the recent increase in gold prices has sparked a moderate rally. The company reported a strong improvement in performance at its troubled Lihir mine, continues to deliver strong margins over cost. A link to the 1H16 results article is available here.
- Glencore: has increased its debt reduction target by a further USD1bn to USD17-18bn by the end of 2016. The company is targeting an upgrade to a ‘strong BBB/Baa’ credit rating. Link to 2015 results article here
- BHP Billiton: announced major cuts to its dividends and capital expenditure guidance (article available here) in order to protect the balance sheet and preserve cash flow. While the corporate credit rating has been downgraded by both rating agencies (from A+/A1 to A/A3) we believe the measures taken to protect cash flow are supportive to bondholders over the medium term. In addition, the company has reached agreement with Brazilian authorities on remediating the Samarco dam failure which mitigates a key uncertainty (article available here)
We believe each of the company’s credit profiles are sound and longer term we remain confident that these companies will survive the structural downturn in commodities. Meanwhile, uncertainty and volatility in commodity prices is directly translating to large swings in their bond prices, given their earnings are highly exposed to price fluctuations.
We don’t believe the volatility is over either. This means that investors should stay mindful of the current state of markets, and use opportunities to take meaningful profit and/or diversify their risk profile. We are currently seeing a mini rebound in commodity prices but this could turn around at any time. Investors who are sitting on capital gains and believe the commodity rally will be short lived should consider taking some profit in this environment. Investors who believe we are seeing a recovery in commodity markets should hold onto or increase their exposure.
A ‘set and forget’ strategy on resource bond holdings may not deliver the best returns for investors given this current volatile environment.
Current indicative pricing on each of the bonds available in these names is listed below:
| Company | Bond | Indicative capital price | Indicative yield to
first call/maturity |
|
Fortescue
|
USD 8.25% November 2019
|
USD98.00
|
8.90%
|
|
USD 9.75% March 2022 (secured)
|
USD104.25
|
8.82%
|
|
USD 6.875% April 2022
|
USD82.25
|
10.96%
|
|
Newcrest
|
USD 4.450% November 2021
|
USD96.97
|
5.07%
|
|
USD 4.20% October 2022
|
USD94.13
|
5.27%
|
|
USD 5.75% November 2041
|
USD84.14
|
7.10%
|
|
BHP Billiton
|
USD non call 5 year
|
USD102.50
|
5.62%*
|
|
USD non call 10 year
|
USD102.75
|
6.36%*
|
|
GBP non call 7 year
|
GBP101.55
|
6.20%*
|
|
EUR non call 9 year
|
EUR103.50
|
5.11%*
|
|
Glencore
|
AUD 4.50% September 2019
|
AUD91.00
|
7.45%
|
|
USD 4.95% November 2021
|
USD94.00
|
6.22%
|
|
GBP 6.50% February 2019
|
GBP103.00
|
5.38%
|
*Yields to first call date
Pricing is accurate as at 8 March 2016, but subject to change. Please contact your FIIG representative for further more information and current pricing levels on any of the bonds listed above. The bonds are only available to wholesale investors.
