Tuesday 11 November 2014 by Lincoln Tragardh Legacy

From the Trading Desk (11/11/14)

Yield direction and volatility

Markets weren’t short of news last week with the Republicans winning the US mid-term elections, the European Central Bank (ECB) announcing its fresh stimulus measures and domestic data for unemployment and buildings approval was released.

The Republicans won their first senate majority in eight years, with the party now controlling both the US Senate and House of Congress. The US dollar strengthened in response to the outcome, with the Aussie dollar falling from highs of US87.35c to close near US85.80c in US trade. 

ECB President Mario Draghi announced new plans to purchase asset-backed securities for at least two years in an effort to ease credit constraints.  The purchases are due to begin this month.

In Australia, the unemployment rate held steady at 6.2% in October, a near 12 year high. Full-time jobs for the month rose by 33,400 to 8.06 million. Meanwhile, building approvals fell 11% in September, further than the 1% fall markets were expecting. This is a 13-month low of just over 15,000 approvals for the month.

Yields were mixed over the week in response to the news, with the five year benchmark swap rate opening and closing the week unchanged at 3.17%. The 10 year benchmark swap rate was lower by 4 basis points (bps), finishing the week at 3.68%. While the five and 10 year Commonwealth government yields were both higher by 8 bps to close at 2.85% and 3.35% respectively.


Qantas continued to trade heavily last week with many buyers stepping forward following its return to profit in 1Q15 and guidance that it would achieve a profit in the first half. All three AUD bonds rallied strongly as can be seen in the following graph illustrating yields moving tighter as the prices appreciated. 

Despite offer yields dropping markedly across the Qantas curve last week, we still see value across all three AUD denominated lines. Each issue is currently available with indicative offer yields listed below:

  • Qantas 20: 6.25%
  • Qantas 21: 6.64%
  • Qantas 22: 6.68%


Coffey’s AGM was held last week, coinciding with the 1Q15 trading update. Coffey returned to profit in FY14 driven by cost cutting measures (mainly head count reduction), and a focus on debt reduction.  1Q15 appears broadly consistent with FY14 trends. 

Geoservices: Continues to struggle in Australia with weakening resources and related industries, but recorded growth overseas.  Positively, revenue has continued to increase and is at its highest for the last four quarters ($53.1m), and the outlook is good with forward contracted fees also slightly up on the quarter. Margins, which were under pressure FY14, have stabilised and are consistent with 2H14.

Project Management:  Very small/immaterial part of the business so light on detail but “continues to be profitable”.

International Development:  Good revenue at $74.1m, however, this is down from $86.1m in 4Q14. 1Q15 included some low margin projects for the UN and World Bank and this, with the exit from small revenue/small margin business Specialist Training Australia (STA), contributed to the decline.

Debt:  While debt levels increased against 4Q14, debt reduced 11% compared to the corresponding 1Q14.  The increase on 4Q14 is due to payment cycles of major clients, particularly in International Development (this is evident in all Sept quarters in the chart).  Also, each 1c devaluation of the AUD against the USD increases Coffey debt by some $0.3m.  However, AUD deflation has some benefits in that GeoServices becomes more competitive against international competitors, and profits repatriated from overseas become more valuable.

The company has also negotiated extensions in bank facilities to FY17, which combined with the FIIG issued bond takes the company’s average debt duration from 1.4 years to a much more manageable 3.7 years.

Overall, the results were close to expectations and, on a positive note, generally stabilising in poor performing areas.  Cost cutting and other management actions in response to the challenging business environment appear to be working.  Positively for bondholders, management reiterated their intention to remain focused on debt reduction and cash generation. Given Coffey’s position as the highest yielding floating rate DirectBond, it is consistently well bid and finds a home in wholesale portfolios seeking exposure outside of the fixed rate and inflation linked sectors. FIIG is currently well positioned to fill client purchase orders at an inactive trading margin of +380bps with a yield to maturity of approximately 6.94%.


The credit story at Adani Abbot Point is as much about what Glencore is doing in coal, as it is about what Adani is doing.   Glencore’s contracted tonnage underpins the performance at Adani Abbott Point (about 25% of total contracted throughput).  Glencore also owns the operator of AAPT, which gives it an extra vested interest in the continued operation of Abbot Point.

Glencore’s thermal coal exports from Australia for the nine months to September have increased by 15%, despite very low prices. The company’s approach is similar to what BHP / Rio are doing in the iron ore space – massive production increases in a low price environment to realise cost savings and maintain a dollar level of profit.

Glencore’s activity in Australian coal is a good leading indicator for the outlook of coal terminals in Australia generally. The increase in exports  provides comfort that the biggest player in the Australian market is not pulling back on coal production, rather it is expanding production to improve its production costs.

While there has been speculation of Adani looking to sell a partial stake in the terminal to free up capital, the fact that Glencore is boosting coal production is probably more important to the fundamental credit risk of Adani Abbot Point, and gives greater confidence that Glencore will look to roll over its take or pay contract at Adani in 2020.

News of Glencore’s ramped up production is a credit positive story for both AAPT and DBCT.  Adani is currently in excellent supply at an indicative offer yield of 6.00%, making it the highest yielding investment grade bond available in FIIG’s spectrum.


Following its previous earnings downgrade, Ausdrill has flagged a further impairment charge on the value of its assets at its AGM. This is because of the continued depressed conditions in the mining industry, resulting in a changed outlook for the mining services business. Note that a writedown of assets does not have any impact on Ausdrill’s actual cash flows or operations.

Like many mining services companies, Ausdrill is trying to reduce its costs, limit its capital expenditure and review its working capital requirements, but with mining investment still in a ‘bottoming out’ phase, the mining sector as a whole is yet to fully work through the effects of the downturn, and it is likely that we will see further profit downgrades in this sector.

With the continued uncertainty in the mining sector driven by falling commodity prices, it is likely that we will see continued volatility in the Ausdrill share price and bond price until conditions stabilise. Both the share price and the bond price have experienced falls in recent weeks. While there is a fair degree of risk in the mining services sector at present, it is times like these where volatility and negative sentiment can create a buying opportunity for an opportunistic investor. Ausdrill is a high yielding representative of our USD denominated bonds, however, it comes with a very high degree of volatility. We’re currently seeing an indicative market of 10.57% Bid / 10.00% Offer with FIIG able to execute both sides of the trade.

Rabobank Nederland Update

Standard & Poor's Ratings Services (S&P) lowered its long-term counterparty credit ratings on Rabobank to 'A+’ from 'AA-' with a negative outlook on 4 November 2014.  The downgrade reflects the view that the bank’s overall credit strengths are no longer in line with the highest rated commercial banks globally. In particular, the combination of Rabobank’s capitalisation and risk position is not as strong. Moreover, S&P believe Rabobank’s reputation has been lessened by the fallout from its October 2013 announcement of a large settlement related to the setting of interbank offered rates.

This is of particularly importance for Australian Depository Institutions (ADIs) as they will now have to mark the stock (with maturity of over one year) in their liquidity portfolios with a 50% risk weighted rather than the previous 20%.