Fortescue’s announcement that it is calling its remaining 2019 unsecured bonds is a win for both existing 2019 holders as well as investors in the longer dated 2022 lines. We believe the credit has materially derisked through the company’s continued free cash flow generation and debt reduction, despite a weaker commodity price environment
Fortescue has announced it has initiated a process to call its remaining 2019 unsecured bonds (link to announcement here). The USD577m redemption will be funded from available cash on hand and the bonds will be called at a redemption price of USD104.125.
The redemption is planned to take place on 1 June 2016, however pricing on the 2019 bonds has already appreciated to around the redemption price. Rather than going through the administration of the call process, existing 2019 bondholders can take advantage of the announcement by taking profit now and reinvesting the proceeds into either of the longer dated Fortescue lines or other alternatives. We outline the reinvestment considerations below.
Impressively, Fortescue has now repaid USD1.7bn of debt in the past 12 months in what has been a relatively weak environment for iron ore prices. A total of USD4.8bn in debt repayments has been made over the past two and a half years. The company has stated that it will continue to repay debt from accumulated cash balances and operating cashflows.
We also consider the call as positive for the remaining 2022 lines and expect Fortescue will look to make further debt reduction payments, targeting one or both of the 2022 lines. Lower outstanding debt would improve gearing and the credit quality and could lead to further price increases in the outstanding bonds.
Considerations for reinvestment options
- The 2022 secured bond is currently indicatively offered at yield to maturity of 7.80% (capital price USD109). We note that the high coupon (9.75%) delivers a good running yield and we expect greater stability in capital price in the secured bond versus the unsecured bond
- The 2022 unsecured bond is still trading at a discount to par, offering an indicative yield to maturity of 8.60% (capital price USD92.25)
- Given the company’s statements and the recent strong performance of the bonds there are clearly incentives for the company to pay down either of the secured or unsecured 2022 bonds ahead of maturity. In making an investment decision on Fortescue, investors should therefore consider not only the yield to maturity but also the respective payoffs if the company does initiate an earlier repayment of debt:
- The first call date on the 2022 secured line is 1 March 2018 at a call price of USD109.75. Yield to first call would be around 9.30% for a two year holding period which we believe would still represent good value. We note that further capital price appreciation in the 2022 secured bond may be limited by the call price level being relatively close to the current market price
The 2022 unsecured bond is trading at a discount to par. The first call on the bond is USD103.438 on 1 April 2017. Current pricing translates to a yield to first call of around 20% for less than a one year holding period. While we see a call being less likely if current pricing levels persist it could be a possibility if further price appreciation occurs in this bond, with the potential for a very high yield for a short holding period. However, the company could tender the remaining bonds (and offer a premium to bondholders as an incentive to participate in the tender)
The chart below shows the spread history of the Fortescue 2022 lines versus similarly dated Glencore and Newcrest US dollar bonds. On a spread to maturity basis, we still see the Fortescue lines as offering good relative value against similar resources bonds.
Alternatively, investors may see this as an opportunity to de-risk their resource bond exposure, and there are a variety of other bonds which are worth considering.
Please contact your FIIG representative for further details on the Fortescue USD bonds and other options. Fortescue bonds are available to wholesale investors only with a minimum face value of USD10,000.