Tuesday 25 November 2014 by Lincoln Tragardh Legacy

From the Trading Desk (25/11/14)

Economic wrap
For the first time in two years, the Chinese central bank made the surprise decision to cut interest rates last week.  The People’s Bank of China cut the 12 month lending rate by 40 basis points (bps) to 5.60% and the 12 month deposit rate by 25bps to 2.75% to help boost growth.  The markets rallied on the back of the news with the Australian SPI 200 futures index up 1%, on the back of a surge in mining stocks which stand to benefit most from the Chinese rate cut. Fortescue’s share price is up almost 10% from last week. Meanwhile, the ECB president signalled further monetary stimulus may be required to help the Eurozone deal with a low inflation rate and weak growth. 

Yields were lower in response to the news, with the 5 and 10 year benchmark swap rates down 3 to 6bps over the week, closing at 3.14% and 3.68% respectively. The 5 year Commonwealth government yield was down 3bps, ending the week at 2.77% and the 10 year yield closed where it opened at 3.26%.

The minutes from the US Federal Reserve’s last meeting were released, showing policy makers are concerned there could be a downward shift in longer-term inflation expectations. The consumer price has remained below the target for 29 consecutive months.

Yesterday the country’s second largest initial public offering, Medibank Private Ltd, had its debut on the Australian Stock Exchange.  The government raised $5.68bn in the IPO, which surpasses the $4.3bn raised in the sale of rail operator Aurizon Holdings Ltd. in 2010. 

New Direct Bond – Virgin Australia Holdings Limited

FIIG is pleased to offer the Virgin Australia Holdings Limited (‘Virgin’) 8.5% fixed rate US dollar bond which was DirectBonded this week and is now available in US$10,000 parcels. The bond matures in November 2019 and, with a lower credit rating than Qantas, we expect to see the bond trade at a higher yield despite having a shorter duration than Qantas’ fixed rate bonds. We are seeing strong inquiry coming through with many dealers impressed by the support being shown for the Virgin name. FIIG has prepared a full research report to support the Virgin launch, which can be accessed here. We believe the Virgin bond is a valuable high yield addition to a diversified bond portfolio. Note: Foreign currency bonds are only available to wholesale investors.

Pricing and trading situation

With both domestic airlines expecting a return to profitability in 2H15, supported by stabilising capacity and reductions in fuel prices, we see a positive outlook for both Qantas and Virgin. The Virgin launch is a good opportunity to remind investors of the high yields which continue to be on offer with Qantas. All Qantas bonds traded well although not at the level of intensity as in recent weeks. The May 2022s were favoured among wholesale clients while a modest $1m of the April 2020s found its way into retail hands. All of Qantas’ AUD denominated issues are currently available with indicative offer yields shown below:

  • Qantas 2020: 6.27% (retail and wholesale investors)
  • Qantas 2021: 6.60% (wholesale investors only)
  • Qantas 2022: 6.67% (wholesale investors only)

Sydney Airport – highly active trading week

The Sydney Airport 2020 and 2030 capital indexed bonds (CIB) experienced an extremely active week with over $20m in turnover between them, recorded across 242 trades. This activity far outstripped that of any of our other AUD denominated securities, easily making the Sydney Airport’s our two most traded bonds for the week. Supply in the Sydney 2030s drove many holders to switch out of the shorter dated 2020 issue in favour of the pickup in yield. The popularity of the switch compressed the spread between the two issues from 70bps at the beginning of the week to 65bps by Friday. Given the intensity of last week’s trading, the 2030 are becoming scarce, however, the 2020’s are available in decent size. Indicative offer yields below:

  • Syd Air 2020: 5.57% (nominal) (retail and wholesale investors)
  • Syd Air 2030: 6.29% (nominal) (retail and wholesale investors)

US dollar bonds continue to be actively traded

Fortescue’s November 2019 fixed coupon bond was a standout last week after turnover in excess of $8m easily made it the most traded US dollar denominated security. A declining iron ore price made it a volatile week for Fortescue with offer prices declining earlier in the week before rebounding late on Friday. The majority of trades went through in the middle of the week as clients capitalised on the dip in price. Fortescue’s US$10k minimum investment level appealed to a range of investors, with an average purchase size of about $56k across 145 trades. Fortescue is now trading off its low at a current indicative market of $97/$99.25. China is Fortescue’s key export market for iron ore so we expect to see some positive sentiment flow through to Fortescue following China’s surprise decision to cut interest rates.

Adani Abbot Point – 1H15 results in line with forecast

Adani Abbot Point last week released its 1H15 results, which were in line with forecast results. With contracted capacity close to fully ramped up levels, we expect future operating performance to stabilise. In what is a depressed and volatile environment for the natural resources sector, the Adani Abbot Point performance is more reflective of the steady, predictable returns of an infrastructure asset, supported by contracted take or pay revenues over the full terminal capacity. Adani Abbot Point’s May 2020 fixed rate bond continues to offer value as FIIG’s highest yielding investment grade bond. FIIG’s access to supply has not wavered for a number of weeks and is very well positioned to execute client purchase orders. The Adani’s are currently offered at a yield of 5.98%.

Company updates
PMP confirms debt free strategy

PMP highlighted its capital management initiatives at its Annual General Meeting (AGM) last week:

  • Capital required for reinvestment in their current business is relatively small
  • PMP is ready to participate in consolidation of the industry, but no acquisition opportunities have presented
  • Therefore PMP plans to return cash to shareholders (to the bond covenant limit of 50% NPAT) & aims to pursue a debt free balance sheet by 2017

Given the strong cash generation, confirmation of debt free strategy, the dividend restrictions the FIIG bond imposes and the likelihood of being able to secure funding more cheaply than the FIIG bond, we expect PMP will give very strong consideration to calling the issue when each opportunity presents.

Emeco AGM and full research report available

We have prepared a full research report for Emeco which can be accessed here. Emeco has been one of our highest yielding bonds and we have seen yields increase even further recently as the company’s performance remains subdued and negative sentiment prevails over the mining sector more broadly. After its AGM last week, we remain of the view that Emeco is going through a bottoming out phase which will persist over FY15, but we have greater confidence following the AGM that it won’t get worse for the company over FY15. However, our view could change if Emeco announces an earnings downgrade or loss of contract(s) over the course of FY15, so we remain cautious on the credit outlook until the 1H15 and FY15 results materialise.

Note: Fortescue, Adani Abbott Point, PMP and Emeco bonds are only available to wholesale investors

Prices are accurate as at 24 November 2014 but subject to change.