Tuesday 02 December 2014 by Lincoln Tragardh Legacy

From the Trading Desk (02/12/14)

Economic wrap
As the market expected, the Reserve Bank of Australia (RBA) has left the cash rate unchanged at 2.50%. Looking ahead, the RBA expects economic growth to be ‘a little below trend for the next several quarters’. Perhaps more important than this rate decision is that we are seeing more market commentators predicting a rate cut in 2015, including Deutsche Bank today calling for a 50bps cut next year. The RBA and market analysts are citing the significant fall in commodity prices, increases in the unemployment rate and a moderation in housing growth as a trigger for a more expansionary monetary policy. This reinforces FIIG’s view that rates will be ‘lower for longer’.

Oil prices dropped sharply, hitting a four year low after the Organisation of the Petroleum Exporting Countries (OPEC) kept oil production unchanged when it met last week. OPEC maintained its 30 million barrel limit, taking no action to ease a global oil supply glut. Energy stocks fell in response to the news, with airline and transport logistics shares leading market gains. World oil prices slumped 6% and the ASX 200 index was down 1.63% following the news.

Bond yields were lower over the week with the fall in oil prices unsettling the market and sparking deflationary concerns. The 5 and 10 year benchmark swap rates were down 11-18 basis points (bps) over the week, closing at 3.00% and 3.46% respectively. The Commonwealth government yields were also lower in response to the news, with the 5 and 10 year rates 19-22 bps lower, finishing the week at 2.56% and 3.03%. The US markets were closed for Thanksgiving Day holiday on Thursday.  Shopping on the post-Thanksgiving ‘Black Friday’ weekend was down by 11% on last year’s figures, which is the second year in a row that sales have declined. 

Moving onto local news, domestic building approvals have shown a strong increase compared to survey estimates, with approvals up 11.4% on last month (survey estimate: 5%) and 2.5% year on year (survey estimate: 6.0% drop). Along with the RBA rates decision yesterday, the Australian GDP figures are due out on Wednesday with the market expecting 0.7% quarter-on-quarter growth and no change to the prior year growth rate of 3.1%.

New Direct Bond – Alumina Limited

FIIG is pleased to launch the Alumina Limited (‘Alumina’) 5.5% AUD fixed rate bond maturing in November 2019, available to wholesale investors only in minimum parcel sizes of $10,000. The bond has an investment grade credit rating and is currently offered to investors at an indicative yield to maturity of 4.85%. We believe the bond is showing good relative value versus the DBNGP 2019 bond, which has the same credit rating and is indicatively offered at a yield to maturity of 4.48%.

Our pick in the fixed rate medium term space remains the Adani Abbot Point 2020 bond. For the same credit rating as Alumina and DBNGP and a slightly higher duration, Adani Abbot Point is offering in excess of 100bps in yield pickup. The Adani Abbot Point 2020 bond is indicatively offered at a yield to maturity of 5.89%.

FIIG has prepared a 2-page factsheet covering the Alumina bond, which can be accessed here. With a minimum investment size of $10,000, the Alumina bond offers the opportunity for portfolio diversification and exposure to the aluminium sector.

Pricing and trading situation
Qantas rallies off the back of oil price plunge

In this week’s WIRE article, “How the falling oil price affects your bond portfolio“, we discuss what the recent fall in oil prices means for bondholders. One of the big winners from the fall in oil prices has been the airline sector, which will reap a benefit through lower jet fuel prices. Bond and equity investors who have bought into Qantas over the past six months have reaped the benefits of an improved earnings outlook. The chart below highlights the reduction in offer yields in the Qantas 2022 bonds over this most recent 6 month period:

Source: FIIG Securities

Offer yields on the Qantas 2022 bonds have come in by 84bps over the past six months. Since late October, offer yields have contracted by 64bps, largely driven by a 42bps tightening in the credit spread in response to the falling oil price. The Qantas 2022 bond is currently offered to investors at a yield to maturity of 6.41%. Additionally, the Virgin 2019 US dollar bond is currently offered to investors at a yield of 7,55%. If oil and fuel prices remain at current levels or continue to fall, then we can expect a flow through to continued strong equity and bond performance in these names.

Company updates
Cash Converters: capital raise and 1Q15 results

Last week, Cash Converters (CCV) announced an equity raising of $45m. $30.8m of this will be used to buy licences which have been in place for 10 years and allow the licensees to receive a commission for every loan the company writes. The transaction will end the ongoing obligations and will save approximately $5.7m per year based on the current book size (priced therefore a 5.4x EBIT multiple). The remaining $12m will be used to fund potential store acquisitions. The licence termination will have a negative impact of $18.8m after tax for FY15, however going forward this is a positive development and will improve profitability, especially if CCV’s loan portfolio continues to grow.

In addition, CCV’s 1Q15 results illustrate the company’s ability to grow and improve profitability even under the new Australian “payday lender” regulatory regime. Strong quarter on quarter revenue growth up 26.2% to $97.2m was driven by an increase in personal loan products and an increase in corporate store revenue. Normalised EBITDA is up 61% supported by segments; corporate store, personal loan and cash advance.

The personal loan book stood at $105m, up 23.4% compared to 1Q14. However, bad debt (total written off to total principal) has jumped to 7.2% from 6.6% over the quarter but is still within the historic range – an area to watch especially given strong loan growth. CCV expects the positive momentum to continue, and will be further supported by the Christmas period

Fortescue halves its FY15 capex guidance to US$650m and maintains FY15 production guidance

Fortescue has identified capital savings and deferral opportunities that will halve FY15 capital expenditure (capex) from US$1.3bn to US$650m. This will generate about US$4/tonne in capex savings for FY15 based on a 160m tonnes per annum annualised run rate. The company also highlighted that the reduction in FY15 capex has not impacted its FY15 production guidance of 155-160m tonnes. In light of the fall in the iron ore price, this is a positive move from Fortescue, especially given that production has not been impacted by the capex reduction. Further, it is reflective of the general trend in the mining sector to defer expenditure, reduce exploration activity and manage free cash flow in a low commodity price environment.